May 20, 1991
TO: TAX MEMBERS NO. 15-91
ACCOUNTING/TREASURERS MEMBERS NO. 11-91
RE: SUPREME COURT DECISION IN COTTAGE SAVINGS ASSN. V.
COMMISSIONER
__________________________________________________________
The Supreme Court recently ruled in Cottage Savings Assn. v.
Commissioner, 59 U.S.L.W. 4314 (April 17, 1991) (attached) that
the swap of two portfolios of mortgage interests between savings
and loan associations was a transaction in which any deductible
losses would be realized, despite the fact that the mortgage swap
was a non-recognition event for savings and loan regulatory
purposes.
The regulations under Internal Revenue Code section 1001
provide that, for gain or loss to be taken into account, there
must be a realization event in which there is a "material
difference" between the properties exchanged. The Internal
Revenue Service took the position in the Cottage Savings case
that properties were not materially different if they were
"economic substitutes" for each other. The Supreme Court held
that the Service had no legal basis for its standard. Rather,
the Court stated that a difference in the kind or extent of legal
entitlements determined whether properties were materially
different. Because the mortgage loans which were swapped had
different obligors and were secured by different properties, the
Supreme Court concluded that the properties were materially
different, and that Cottage Savings must recognize the losses
incurred upon the exchange of the portfolios.
It has been suggested that this case may have implications
for mutual funds which engage in reverse repurchase agreements
secured by mortgage-backed securities such as Ginnie Maes, Fannie
Maes and Freddie Macs if, upon unwinding the reverse repurchase
agreement, the fund does not receive back the exact security
which it pledged. We will keep you informed of developments.
David J. Mangefrida, Jr.
Assistant Counsel - Tax
Attachment