Loan Servicing Rights & Material Tax Savings

Energy cannot be created or destroyed, it can only be changed from one form to another.” – Albert Einstein

 

Sophisticated tax structuring of loan servicing rights may save investors millions. How?

Hypothetical and Simplified Assumptions:

  • An investment fund is planning to acquire mortgage servicing rights (MSRs) on a pool of loans with an unpaid principal balance of $10 billion.
  • The fund’s allocations and distributions to investors are straight-up.
  • 50% of the fund’s capital is committed by non-US investors.
  • 25% of the fund’s capital is committed by US tax-exempt investors.
  • 25% of the fund’s capital is committed by US taxable investors.
  • The MSRs entitle the fund to 35 basis points of servicing compensation.
  • The fund hires a servicer to service the loans for 25 basis points.
  • The fund’s US tax-exempt investors are subject to US federal income tax at a rate of 35% on unrelated trade or business income.
  • The fund’s non-US investors do not benefit from an income tax treaty and are subject to US federal income tax (including branch profits tax) at an effective rate of 54.5%.

Option 1: The fund may acquire the MSRs into a wholly-owned entity that is disregarded for US federal income tax purposes. If the fund earns approximately $10 million net servicing revenue ($10 billion * 10 basis points) in the first year, then the total unnecessary US federal income tax drag from this structure in the first year may be $3.6 million [($10 million * 50% * 54.5%) + ($10 million * 25% * 35%)]. This Option 1 may also trigger US federal income tax return filing obligations for the fund’s US tax-exempt investors and non-US investors.

Option 2: The fund may acquire the MSRs into a “blocker” corporation. This structure will obviate the need for the fund’s US tax exempt investors and non-US investors to file US federal income tax returns; however, the total unnecessary US federal income tax drag from this structure in the first year may be $4.475 million [the $3.6 million drag calculated in Option 1 plus ($10 million * 25% * 35%)].

Option 3: The fund may structure the MSR acquisition as an acquisition of two assets: MSRs and a series of 10 basis point “interest-only strips” off the underlying loans. The fund may acquire the MSRs into a “blocker” corporation that operates at or near break-even; and the fund may acquire the series of 10 basis point “interest-only strips” into a subsidiary grantor trust. The total unnecessary US federal income tax drag from this structure is $0. In addition, this structure will obviate the need for the fund’s US tax exempt investors and non-US investors to file US federal income tax returns.

 Summary: A sophisticated tax structurer is worth her weight in gold. There are a number of “traps for the unwary” when implementing these structures that I would be happy to discuss anytime 24/7. Should you have any questions, please pick up the phone and call me.

Thanks!

–Todd–

Todd S. Anderson
Direct Dial: 646-942-0311
Website: http://andersontaxandfinance.com/
Bio: http://andersontaxandfinance.com/attorney-profile/

andersonsm
61 Massachusetts Avenue, PO Box 205, Hyannis Port, MA 02647

0 replies

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *