A real estate mortgage investment conduit (REMIC) holds a fixed pool of mortgages for investors and could be used as a tax shelter for capital gains. It’s similar in composition to an exchange-traded fund (ETF) or mutual fund, but it’s complex for purposes of taxation. Even so, REMICs can be good investment vehicles for risk-averse retail investors if you choose them wisely and pay attention to their taxation, preferably with the help of a professional. A financial advisor can help you decide on types of real estate investments for your portfolio.
What Is a REMIC, and How Does It Work?
A REMIC is a debt instrument that holds a fixed pool of mortgages used to issue mortgage-backed securities. It is not dissimilar to a mutual fund or exchange-traded fund due to its composition as a pool of securities. These pools of mortgages are generally divided up, repackaged according to risk and maturity and sold to investors as individual securities. They are like collateralized mortgage obligations, a type of collateralized debt obligation, that are then turned into bonds or other fixed-income securities and sold on the secondary mortgage market.
The holders of a REMIC have a claim on the principal and interest payments on the underlying security. A REMIC may be a bond or another type of debt security that pays interest in the form of a coupon rate to its investors. The interest rate on a REMIC is similar to the interest rates the homeowners who made the mortgages paid on their mortgage loans.
The federal agencies that issue REMICs are primarily Fannie Mae and Freddie Mac. They do not issue home loans, but they do guarantee those issued by other lenders.
Types of REMICS
REMICs are tightly controlled investments, and they are typically split up based on the assets they hold. Here’s an overview of the the various types of REMICs you might come across:
- Qualified mortgages: Most REMICs are made up largely, of qualified mortgages. Qualified mortgages meet the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Simply stated, these are relatively safe mortgage loans that have been subject to underwriting standards and are eligible to be bought by Fannie Mae and Freddie Mac.
- Loans modified under the CARES Act: Because of the pandemic, many homeowners and commercial property owners have suffered hardships in making mortgage loan payments. The CARES Act (2020), signed by then-President Donald J. Trump and reaffirmed by the Biden administration has offered forbearance to many of these individuals. This will inevitability progress to the restructuring of these loans.
- Permitted investments: Other investments are permitted to be contained within a REMIC, but they must be related to the real estate market. They are cash flow investments, some qualified foreclosure property and qualified reserve assets.
- Non-qualifying assets: No more than 1% of a REMIC’s assets can be non-qualifying assets.
History of REMICs
REMICs were first authorized by the Tax Reform Act of 1986. REMICs act as pass-through investments to mortgage-backed securities and are appropriate for risk-averse investors. They are not directly taxed. They allow investors to invest in the real estate market without the risks of investing in actual real property.
Owners of commercial properties that make up a REMIC are not allowed to make material changes to their properties since the mortgages in a REMIC are collateralized and any material changes would cause a different relationship with the collateral. This made for hardship for the commercial property mortgage holders. As a result, there is a movement to change this portion of the law associated with REMICs that began with 2009 legislation.
A change was proposed to REMICs in 2009 when Congress introduced the Real Estate Mortgage Investment Conduit Act of 2009. This act is supposed to ease some of the restrictions on commercial REMICs. It includes a provision that allows owners of the commercial properties to make improvements and enhancements to their mortgaged properties to make them more attractive to the market.
At time of this article’s writing, this law has not been passed and is still in the Senate’s Committee on Banking, Housing and Urban Affairs. However, the Coronavirus Aid, Relief and Economic Security Act (2020) (CARES), signed by then-President Donald J. Trump, provided some relief to mortgage holders due to the financial hardships caused by the pandemic.
How Is Income From a REMIC Taxed?
The rules regarding taxation of income from REMICs are complex and should be addressed by a certified public accountant (CPA) with expertise in real estate taxation. Because REMICs are considered pass-through securities with an underlying asset, there are several layers of complexity there that can be confusing to investors, particularly new investors.
For example, if there are non-qualified investments within a REMIC that you own, you could be subject to a 100% taxation rate on any income derived from them. If you make a contribution after the startup date of a REMIC, taxes are assessed on that contribution during the first year and the rate may be as high as 100%.
REMICs have tax advantages as well. The income or loss from a REMIC is not considered the result of a passive activity. This allows owners of REMIC residual interest can offset losses against other sources of income, like capital gains, which is a significant tax advantage.
Bottom Line
Even though REMICs, which are special purpose vehicles, are collateralized mortgage obligations and can be complex investment vehicles, they are debt securities and suitable for the more risk-averse investors. It is important to choose the REMICs in which you invest carefully so you don’t have any nasty surprises when tax time rolls around. Chosen properly, REMICs can allow you to shelter other income from taxes.
Tips on Real Estate Investing
- It’s important to have professional advice when dealing with a complex financial instrument like a REMIC. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Your mortgage debt can play a significant role in the way you plan retirement. That’s why one of your most useful tools is a free mortgage calculator.
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