REMIC Impairments May Qualify As Worthless Bad Debts

In the September 2008 issue of TAXING TIMES we discussed the general tax rules that apply to write-downs of impaired investment assets. In the prior article, we explained the different tax treatment for instruments treated as securities versus other debt instruments. In summary, “securities” are not eligible for a worthlessness deduction until the security is wholly worthless, and the worthlessness deduction is capital in character. A “security” is defined as a stock, subscription right or bond, debenture, note or certificate or other evidence of indebtedness with interest coupons or in registered form issued by a corporation, government or a political subdivision thereof. Classification of an investment asset as a security is a double disadvantage, in that it delays the timing of the deduction and, in some instances, may limit the ability to realize any benefit because capital losses can be used only against capital gains and the carry-over of capital losses is limited to five years. In the current economic environment, there is no certainty that capital gains will be available to offset capital losses. For these reasons, nonsecurity treatment is preferable because the instruments potentially are eligible for partial bad debt deductions as the instruments become worthless and the deductions are ordinary in character, meaning they can be used to offset ordinary operating income and can be carried forward for a
longer period of time.