Lenders must use caution to protect mortgages from mark-to-market provision in tax bills.

Lenders will have to exercise caution to avoid the application to whole mortgages of a mark-to-market provision in tax bills before Congress.

Both the House and Senate versions of the Revenue Act of 1992 (H.R. 11) contain provisions that require market valuation and taxation of unrecognized gains on securities held in inventory.

But the definitions of securities dealers and securities are so broad that there is no question they apply to all financial institutions including thrifts, and to whole mortgages. "They have defined securities to include everything in the Western Hemisphere and everything not in it," said Charles W. Wheeler, partner and national director of bank tax services in the Washington office of Ernst & Young.

The problem comes in the definitions of security. The bills specify that securities include "any note, bond, debenture or other evidence of indebtedness," a definition, Wheeler said, that clearly includes whole mortgages that are not held for investment.

He said mortgage bankers, banks and thrifts must be careful when they hold on to whole mortgages that they keep them until maturity or payoff. If they decide to sell a mortgage that they had not carried at market value before maturity or payoff, they would be subject to a penalty in the bill that would prevent their gaining advantage of any capital losses.

Mortgages that are later sold in pools to a secondary market agency probably wouldn't be affected by the provision, Wheeler said.

The provision was originally proposed as a revenue raiser by the Bush administration earlier this year. It died when President Bush vetoed a Democratic tax stimulus bill in March.

Lobbyists for financial trade associations thought they had succeeded in exempting whole mortgages from the provision, but they have not prevailed.

Though the section is titled "Mark-to-Market Accounting Method for Dealers in Securities," it is not limited to brokers. It clearly applies to thrifts and other financial institutions.

A dealer is defined as any taxpayer that either "regularly purchases securities from or sells securities to customers in the ordinary course of business" or that "regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of a trade or business."

The mark-to-market provision in both the House and Senate bills lays down two genera1 rules:

* Any security that is in inventory would be required to be carried at fair market value.

* Any security that is not inventory that is held at the close of any taxable year would be treated as sold by the dealer for its fair market value on the last business day of the taxable year. and gains or losses would be taken into account in determining gross income.

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