SECTION 5. EXAMPLES — Internal Revenue Bulletin 2014-37

.01 Example 1 . In 2007, X , a REIT, made a $100 mortgage loan to A . X ’s loan to A was se- cured by both real property and personal prop- erty. When X ’s commitment to make the loan became binding on X , the real property had a fair market value of $115. At the end of the calendar quarter in which X made the loan, the value of the loan as determined under § 1.856–3(a) was $100. At all times through the end of 2010, under § 1.856–5(c)(3), the amount of the loan continued to be $100.

By the start of 2009, the fair market value of the real property securing the loan had fallen to $55 and the fair market value of the personal property was $5. The values remained at these levels throughout 2009 and 2010. Throughout 2009 and 2010, the value of the loan, as deter- mined under § 1.856–3(a), was $60.

During 2009, X and A modified the terms of the mortgage loan. The modification of the loan is described in section 3.01 of this revenue proce- dure and is a significant modification under § 1.1001–3.

(1) Income Test . When X made the mortgage loan in 2007, the loan value of the real property for purposes of § 1.856–5(c) was its fair market value ($115) determined as of the date on which the commitment to make the loan became binding on X . This amount exceeded the amount of the loan for that year ($100). Accordingly, in the year that the loan was made, all of the interest from the loan was apportioned to the real property. See § 1.856–5(c)(1).

Between the time that the loan was made and the time of the modification, the loan value of the real property continued to be $115, notwithstand- ing changes in the fair market value of that real property. See § 1.856–5(c)(2). Similarly, the amount of the loan continued to be $100. Accord- ingly, the loan value of the real property ($115) continued to exceed the amount of the loan ($100), and all of the interest on the loan contin- ued to be apportioned to the real property.

The fair market value of the real property that secured the mortgage loan had fallen to $55 by the time that X and A modified the loan in 2009. That modification, however, is described in section 3.01 of this revenue procedure, and X chose to treat the modification as not being a new commitment to make or purchase a loan. There- fore, the loan value of the real property ($115) does not change. Because the loan value of the real property ($115) continued through the end of 2010 to exceed the amount of the loan ($100), all of the interest from the loan during that year is apportioned to real property.

(2) Asset Test . In 2007, at the end of the cal- endar quarter in which X made the mortgage loan, the current value of the real property secur- ing the loan was $100, the value of the loan (as determined under § 1.856–3(a)) was $100, and the loan value of the real property securing the loan (as determined under § 1.856–5(c)(2)) was $115. For this calendar quarter, in determining

the amount of the loan that is a real estate asset for purposes of the 75% Asset Test, X may use the safe harbor in section 4.02 of this revenue proce- dure. If X does so, the amount of the loan that is a real estate asset for purposes of the 75% Asset Test is the lesser of—

The value of the loan as determined under § 1.856–3(a) (see section 2.04 of this revenue procedure) ($100); or
The greater of— X The current value of the real property securing the loan ($100); or X The loan value of the real property se- curing the loan as determined under § 1.856–5(c) and, if applicable, section 4.01 of this revenue procedure (in this case, section 4.01 is not applicable) ($115). Accordingly, X may treat $100 of the loan as a qualifying asset.

At the end of the calendar quarter immedi- ately preceding the quarter in 2009 in which X modified the mortgage loan, the current value of the real property securing the loan was $55, the value of the loan (as determined under § 1.856– 3(a)) was $60, and the loan value of the real property securing the loan (as determined under § 1.856–5(c)(2)) was $115. As described earlier in this section 5.01, beginning with the calendar quarter in which the loan was modified, X may use the safe harbor in section 4.01 of this revenue procedure to treat the modification as not being a new commitment to make or purchase the loan. In addition, in determining the amount of the loan that is a real estate asset for purposes of the 75% Asset Test, X may use the safe harbor in section 4.02 of this revenue procedure. If X does so, the amount of the loan that is a real estate asset for purposes of the 75% Asset Test is the lesser of—

The value of the loan as determined under § 1.856–3(a) (see section 2.04 of this revenue procedure) ($60); or
The greater of— X The current value of the real property securing the loan ($55); or X The loan value of the real property se- curing the loan as determined under § 1.856–5(c) and, if applicable, section 4.01 of this revenue procedure (in this case, section 4.01 is applicable) ($115). Accordingly, X may treat $60 of the loan as a qualifying asset.

.02 Example 2 . The facts include all of the facts in Example 1. Additionally, during the first quarter of 2010, Y , a REIT, committed to pur- chase, and purchased, the mortgage loan from X for $60.

(1) Income Test . Under § 1.856–5(c)(2), the loan value of the real property securing the loan is the fair market value of the real property de- termined as of the date on which Y ’s commitment to purchase the loan became binding on Y ($55). This value is compared to the amount of the loan for the year ($100). Because the amount of the loan exceeds the loan value of the real property, the interest income apportioned to the real property is

Bulletin No. 2014–37 545 September 8, 2014

an amount equal to the interest income multiplied by a fraction the numerator of which is the loan value of the real property ($55) and the denomina- tor of which is the amount of the loan ($100). There- fore, 55 percent of the interest income from Y ’s loan is apportioned to the real property securing the loan. Interest income apportioned to the other prop- erty is the excess of the total interest income over the interest income apportioned to the real property. See § 1.856–5(c)(2).

(2) Asset Test . At the end of every calendar quarter during 2010, the current value of the real property securing the loan was $55, the value of the loan (as determined under § 1.856–3(a)) was $60, and the loan value of the real property se- curing the loan (as determined under § 1.856– 5(c)(2)) was $55. For every calendar quarter dur- ing 2010, in determining the amount of the loan that is a real estate asset for purposes of the 75% Asset Test, Y may use the safe harbor in section 4.02 of this revenue procedure. If Y does so, the amount of the loan that is a real estate asset for purposes of 75% Asset Test is the lesser of—

The value of the loan as determined under § 1.856–3(a) (see section 2.04 of this revenue procedure) ($60); or
The greater of— X The current value of the real property securing the loan ($55); or X The loan value of the real property se- curing the loan as determined under § 1.856–5(c) and, if applicable, section 4.01 of this revenue procedure (in this case, section 4.01 is not applicable) ($55). Accordingly, X may treat $55 of the loan as a qualifying asset.

.03 Example 3. On January 1, 2011, Z, a REIT, purchased for $60 a distressed mortgage loan with a principal amount due of $100. During the taxable year 2011, the amount of the loan under § 1.856–5(c)(2) was $100. The value of the real property securing the loan on the date Z commit- ted to purchase the loan was $55 and the value of the personal property securing the loan was $5. At the end of the first calendar quarter in 2011, the current value of the real property securing the loan was $55, and the value of the loan (as determined under § 1.856–3(a)) was $60.

Asset Test. Under section 4.02 of this revenue procedure, Z may treat $55 of the loan as a “real estate asset” for purposes of the 75% Asset Test. This amount is the lesser of—

The value of the loan as determined under § 1.856–3(a) (see section 2.04 of this revenue procedure) ($60); or
The greater of— X The current value of the real property securing the loan ($55); or X The loan value of the real property se- curing the loan as determined under § 1.856–5(c) and, if applicable, section 4.01 of this revenue procedure (in this case, section 4.01 is not applicable) ($55). At the end of the second calendar quarter of 2011, the current value of the real property se- curing the loan had increased to $65, and the value of the loan (as determined under § 1.856– 3(a)) had increased to $70. Accordingly, at the end of the second quarter of 2011, under section 4.02 of this revenue procedure, Z may treat $65 of the loan as a “real estate asset” for purposes of the 75% Asset Test. This amount is the lesser of—
The value of the loan as determined under § 1.856–3(a) (see section 2.04 of this revenue procedure) ($70); or
The greater of— X The current value of the real property securing the loan ($65); or X The loan value of the real property se- curing the loan as determined under § 1.856–5(c) and, if applicable, section 4.01 of this revenue procedure (in this case, section 4.01 is not applicable) ($55).