"IRS Approves ‘Excess Servicing Spreads’ as a New Qualifying Asset for REIT Purposes"

by Skadden, Arps, Slate, Meagher & Flom LLP

[authors: Fred T. Goldberg, Jr., David F. Levy, David Polster, John D. Rayis]

Real estate investment trusts interested in broadening the range of assets in which they invest should take some encouragement from a recent private letter ruling. On August 24, 2012, the IRS released Private Letter Ruling 201234006, addressing the classification of certain “excess servicing spreads” (also known as “excess mortgage servicing rights” or “excess MSRs”) for purposes of the tax rules applicable to real estate investment trusts (REITs). Those rules require, among other things, that 75 percent of a REIT’s assets consist of “real estate assets” and that 75 percent of a REIT’s income consist of certain types of qualifying income, including interest on mortgages. Private Letter Ruling 201234006 concludes that excess servicing spreads are real estate assets that produce qualifying mortgage interest income for purposes of the REIT rules.

As described in the ruling, an excess servicing spread represents the right to receive a portion of the interest payments made on a pool of residential mortgages. Originators of residential mortgage loans will often bundle those loans into pools and sell the pools to a government agency or government-sponsored entity (GSE), such as Fannie Mae or Freddie Mac, or a private securitization vehicle. Often, the servicer of the pool (which may be the originator or another party) will retain, as compensation for its servicing duties, the right to receive a portion of the total interest payments made on the pool, as well as items of ancillary income such as late fees (collectively, mortgage servicing rights or MSRs). For example, the servicer may retain the right to receive 35 basis points of interest, plus the ancillary income. Typically, however, GSE policies and other factors require that the total amount of the MSR exceed the arm’s-length reasonable compensation that the servicer would demand for its services. The excess servicing spread represents this excess. For example, the arm’s-length reasonable compensation of a servicer may be 25 basis points of interest on the underlying pool of loans. If the servicer actually receives 35 basis points, then the servicer has an excess servicing spread of 10 basis points. The excess servicing spread therefore represents a passive investment in the interest component of a pool of mortgages, akin to an “interest-only strip.”

In anticipation of new financial industry regulations and in order to improve their liquidity and capital positions, many servicers have begun selling their excess servicing spreads to passive investors, and many REITs are beginning to explore opportunities to participate in the new market created by these developments. Before Private Letter Ruling 201234006, however, no IRS authority squarely addressed whether excess servicing spreads are qualifying “real estate assets” that produce qualifying mortgage interest income for purposes of the REIT requirements. In a welcomed development, Private Letter Ruling 201234006 builds on earlier IRS guidance on excess servicing spreads in non-REIT contexts and concludes that excess servicing spreads are qualifying REIT assets that produce qualifying REIT income.

Although Private Letter Ruling 201234006 is not binding precedent and therefore cannot be relied on by other taxpayers, it is indicative of the IRS’s comfort in treating excess servicing spreads as qualifying REIT assets that generate qualifying REIT income.

Download PDF

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.