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What Are REMIC Rules and Why Should Investors Care?

Apr 23, 2021 by Kristi Waterworth
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Real estate investments often go far beyond a simple flip property or rental unit. For some investors, collateralized assets are more in line with what they see as an ideal place to put their money for the best end results. That’s where Real Estate Mortgage Investment Conduits (REMICs) come into play. Unlike real property assets, REMICs act as pass-through investments in mortgage-backed securities, essentially allowing people to invest in strong real estate markets without all the extra steps and associated risk of investing in real property.

REMIC requirements

There are two sets of rules for REMICs: One is primarily definitional, outlining what a REMIC is and isn’t, and the other centers on the taxation of REMICs. Although neither is overly complicated, it makes sense to discuss these rules separately for clarity’s sake.

Defining a REMIC

REMICs have some pretty strict rules about what can be included in them, making them a fairly tightly controlled investment. A REMIC can be made up of a few types of assets.

  1. Qualified mortgages. By and large, qualified mortgages are the bread and butter of a REMIC. Qualified mortgages are, in basic terms, mortgages that meet very specific rules outlined in the Dodd-Frank Wall Street Reform and Consumer Protection Act (passed in 2010). These tend to be less risky loans made to underwriting standards that qualify for purchase by Freddie Mac and Fannie Mae.
  2. Loans modified under the CARES Act. As of April 13, 2020, formerly qualified mortgages that are held in securities like REMICs are allowed to be modified to include a forbearance as outlined for federally backed mortgage loans under the CARES Act, provided it was requested prior to December 31, 2020.
  3. Permitted investments. Certain other investments can be enmeshed within a REMIC, although they must be related to the real estate market. These include cash flow investments, qualified reserve assets, and some limited foreclosure property.
  4. De minimis nonqualifying assets. No more than 1% of the assets of a REMIC can be considered "nonqualifying." The types listed above are considered "qualifying," so it can be assumed that anything not listed would fall under non-qualifying assets.

Taxation rules of REMICs

There are several rules that apply specifically to REMICs within the U.S. Tax Code. As you might expect, they define what is and what is not taxable within a REMIC and how to report income that results from these holdings. These are a few examples.

  1. Gains are treated as ordinary income. When you sell your investment in a REMIC or otherwise dispose of the investment, it’s generally treated as ordinary income. The accrual method of interest or other income reporting is required.
  2. Net quarterly losses are limited. Net quarterly losses can’t exceed the adjusted basis of an investor’s interest on the day the REMIC was issued. However, additional losses can be carried forward to the succeeding calendar quarter.
  3. Prohibited transactions will incur high taxation. Taxation rates equal to 100% of the net income derived from them are possible for transactions that are prohibited. This includes assets that are neither qualified mortgages nor permitted investments.
  4. Investing too late can be a costly mistake. A tax of up to 100% of a contribution made after the startup day can be assessed in the taxable year of the contribution.

Why REMIC rules should matter to investors

No matter what you’re investing in, you should have a solid understanding of the structure of your investment as well as the tax burdens that may accompany any gains. Without having a strong footing in the basics of the investment in question, you could make very serious mistakes by assuming one investment is similar to another, when they are, in fact, very different.

For example, not being aware of the high taxation levels on certain types of transactions within a REMIC could cost an investor dearly, especially if they came into the investment late to the party. This might lead a savvy investor to instead research up-and-coming REMICs in order to choose those that they believe will be highly successful before their issue dates.

Not understanding the rules of any type of financial asset is a great way to lose your investment and get upside down very quickly. REMICs aren’t any different. Because they’re backed by mortgage instruments, there are additional layers of complexity that any and all investors should be aware of before putting their money to work.

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