The Taxation Of CRE-CLOs

Author:Mr Jason Schwartz, Gary T. Silverstein and Daniel Ng
Profession:Cadwalader, Wickersham & Taft LLP
 
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INTRODUCTION

Commercial real estate collateralized loan obligations (CRE-CLOs) are growing in popularity as a way to securitize mortgage loans. Market participants have predicated as much as $14 billion of new CRE-CLO issuances in 2018,1 compared to $7.7 billion in 2017.2

In many ways, CRE-CLOs are a more flexible financing option than real estate mortgage investment conduits (REMICs), the traditional vehicles for commercial mortgage-backed securitizations. Unlike RE- MICs, CRE-CLOs may hold mezzanine loans, ''delayed drawdown'' loans, and ''revolving'' loans (and, in some cases, preferred equity), may borrow against a managed pool of assets, and may have more liberty to modify and foreclose on their assets. But structuring a CRE-CLO is not without challenges, and failing to properly structure a CRE-CLO could create adverse tax consequences for investors and could even subject the CRE-CLO to U.S. corporate tax.

This article discusses the tax considerations applicable to CRE-CLOs: what a CRE-CLO is; the overarching tax considerations relevant to CRE-CLOs; the two most common CRE-CLO tax structures — the qualified REIT subsidiary (QRS) and the foreign corporation that is not a QRS; and the material benefits of using a CRE-CLO instead of a REMIC to securitize mortgage loans.

WHAT IS A CRE-CLO?

CRE-CLOs are special purpose vehicles that issue notes primarily to institutional investors, invest the proceeds mainly in mortgage loans, and apply the interest and principal they receive on the mortgage loans to pay interest and principal on the notes that they issue. CRE-CLOs allow banks, real estate investment trusts (REITs), and other mortgage loan originators to sell their mortgage loan portfolios, freeing up capital that they can then use to make or acquire additional mortgage loans. By issuing multiple classes of notes with different seniorities and payment characteristics backed by a pool of mortgage loans, CRE- CLOs appeal to investors that may not be willing or able to invest directly in mortgage loans.

OVERARCHING TAX CONSIDERATIONS

Taxable Mortgage Pool Rules

Under the taxable mortgage pool (TMP) rules of the Internal Revenue Code, a vehicle (other than a REMIC) that securitizes real estate mortgages is treated as a TMP and taxed as a separate corporation for U.S. tax purposes if it issues two or more classes of ''debt'' with different maturities and the payment characteristics of each debt class bear a relationship to payments on the...

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