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.
- 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.
- 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.
- 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.
- 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.