Fannie Mae, Freddie Mac Come Out on Top in IRS Battle
Fannie Mae, Freddie Mac and other companies bleeding red ink as mortgage delinquencies continue to rise have won a substantial victory in a two-year battle with the Internal Revenue Service, and will now be allowed to use those losses to reduce their tax burden.
The IRS withdrew proposed regulations that had asserted that mortgage loans are capital assets and any losses from them could be used only to offset capital gains. The agency also said it would not challenge companies that count such losses against ordinary income.
The potential impact on the companies is tremendous, considering that Fannie Mae and Freddie Mac together own or guarantee more than $5 trillion in U.S. mortgages, which represents approximately 45 percent of the mortgage market. As the nation's two biggest mortgage investors, Fannie and Freddie posted record mortgage losses of $3.55 billion and $2.45 billion respectively during the fourth quarter.
The IRS’ action also clears the way for Fannie Mae, Freddie Mac and other holders of defaulted loans to benefit from tax legislation passed in the Senate that would allow companies to apply those losses against previous tax years to get immediate refunds. Since early 2007, about 70 of the world's largest banks, securities firms and mortgage companies have taken more than $290 billion in asset writedowns and credit losses.
Noted Christopher Whalen, managing director of California-based Institutional Risk Analytics, “This is a serious windfall. Essentially, the Street gets a $290 billion tax shelter they did not have available” under the earlier IRS position.
Tax law generally allows companies to “carry back” losses realized this year to previous years and get a refund for earlier taxes paid or apply them to later years, known as a “carry forward” to reduce future liability. Carry backs currently are limited to two years; the Senate legislation would temporarily expand that to four. A House panel passed a separate relief measure that does not contain the provision.
Winning the right to treat mortgage-loan losses as a loss against regular income is “a great victory for Fannie Mae,” concurred Robert Willens, president of a New York tax-consulting firm and an expert on tax and accounting rules.
“It means that the losses they sustain on these instruments will be eligible for the four-year carry back, assuming that provision gets enacted,” he said.
The Senate passed the provision earlier this month as part of legislation intended to alleviate the housing crisis earlier this month.
Published on April 23, 2008
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