SECTION 2. BACKGROUND

.01 Section 301.7701–1(a)(1) states that the Internal Revenue Code (Code) prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

.02 Section 301.7701–1(b) provides that the classification of organizations that are recognized as separate entities is determined under §§ 301.7701–2, 301.7701–3, and 301.7701–4 unless a provision of the Code provides for special treatment of that organization.

.03 Section 301.7701–2(a) defines the term “business entity” as any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701–3 (“a disregarded entity”)) that is not properly classified as a trust under § 301.7701–4 or otherwise subject to special treatment under the Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classi

(iii) After Date 1 , B exercised its right to demand a release of the lien on property X B 10 (the outparcel). did not make any payment on the loan in connection with the lien release.

(2) Analysis. (i) Under § 1.860G–2(a)(8), R ’s release of the lien on property X 10 causes the loan to cease to be a qualified mortgage unless the release takes place in a transaction that satisfies either paragraph (a)(8)(i) or paragraph (a)(8)(ii) of § 1.860G–2. The lien release on property X 10 does not satisfy § 1.860G–2(a)(8)(ii) because it is not pursuant to a defeasance. The lien release on property X 10 satisfies § 1.860G–2(a)(8)(i) only if the transaction in which it occurs meets the requirements of both § 1.860G–2(a)(8)(i)(A) and § 1.860G–2(a)(8)(i)(B).

(ii) The transaction in which the lien was released resulted from the exercise of an option that is unilateral within the meaning of § 1.1001–3(c)(3). Thus, the transaction is not a significant modification as defined in § 1.860G–2(b)(2) and therefore is described in § 1.860G–2(a)(8)(i)(A). In addition, however, to satisfy § 1.860G–2(a)(8)(i)(B), the loan must continue to be principally secured by an interest in real property as determined by § 1.860G–2(b)(7).

(iii) The release of the lien on X 10 does not satisfy the 80-percent test in § 1.860G–2(b)(7)(ii) or the alternative test in § 1.860G–2(b)(7)(iii).

(iv) The unilateral right to release the lien on property X without paying down the loan is not a 10 grandfathered transaction described in section 5.02 of this revenue procedure because B issued the loan after December 6, 2010.

(v) The release of the lien on property X is 10 within the scope of section 5.03 of this revenue procedure only if it is pursuant to a “qualified paydown transaction.” Under the loan documents, the allocated loan amount of property X may be zero, 10 but that amount does not satisfy section 5.04(2) of this revenue procedure. Although property X was 10 assigned no value for underwriting purposes, the servicer knew or had reason to know that, at origination, it had a value greater than $0. Therefore, the amount required by section 5.04(2) of this revenue procedure is greater than zero.

(vi) Because the transaction does not meet the requirements either of section 5 of this revenue procedure or of § 1.860G–2(b)(7)(ii)-(iii), § 1.860G–2(a)(8)(i)(B) is not satisfied, and § 1.860G-(a)(8) causes the loan to cease being a qualified mortgage on the date that the lien is released.