Roundtable Weekly
Final IRS Regulations Reduce Tax Risks When Replacing LIBOR With Alternative Benchmarks
January 8, 2022
LIBOR graphic

The IRS on Dec. 30 issued final regulations clarifying how parties can replace the London Interbank Offered Rate (LIBOR) as a reference rate in mortgages and other financial contracts without triggering negative tax consequences. The Real Estate Roundtable offered extensive input and comments during the Treasury Department’s LIBOR regulatory review. 

LIBOR Transition, Roundtable Comments & Tax Guidance 

  • LIBOR is currently used in outstanding financial contracts worth an estimated $223 trillion, including commercial real estate debt, mortgages, student loans and derivatives. (Roundtable Weekly, July 30)

  • Financial regulators are phasing out LIBOR in its current form following serious cases of manipulation.

  • The anticipated replacement of LIBOR in existing financial contracts poses a potential tax problem – avoiding a deemed taxable “exchange” of the contract if the replacement index is viewed as “significantly modifying” the interest rate or yield of the existing contract.

  • In June 2019, Roundtable President and CEO Jeffrey DeBoer wrote to Treasury officials and emphasized, “… addressing the tax issues associated with the transition away from LIBOR is critical to the stability of financial markets, the real estate industry, and the overall economy.” (Roundtable LIBOR letter, June 6, 2019)
  • The Roundtable letter offered a suggested framework for tax guidance that would clarify when a replacement rate is not considered a significant modification. The IRS issued favorable proposed rules shortly thereafter, in October 2019.

  • The final IRS regulations provide bright-line rules for determining when replacement of LIBOR with an alternative rate in a contract qualifies as a “covered modification,” which is not treated as a taxable exchange of property under the tax code. (Federal Register, Guidance on the Transition From Interbank Offered Rates to Other Reference Rates; ABA Banking Journal, Jan. 3)

  • The final tax rules generally are effective for contract modifications made on or after March 7, 2022.
  • The Roundtable’s initial recommendations were developed with the assistance of an industry task force that included Tax Policy Advisory Committee (TPAC) Chairman Frank Creamer Jr., TPAC member Don Susswein, and chair of the Real Estate Capital Policy Advisory Committee (RECPAC) Working Group on LIBOR, Joseph Philip Forte.  

Tough Legacy Contracts 

Libor transition to SOFR image

  • Another significant LIBOR issue is a safe harbor for market participants seeking to transition to a replacement benchmark for debt instruments, such as the Secured Overnight Financing Rate (SOFR). Some difficult LIBOR-based contracts – referred to as “tough legacy” – have insufficient fallback language or include provisions that cannot be amended. (Roundtable Weekly, Dec. 10, 2021)

  • Legislation passed by the House of Representatives on Dec. 8, 2021 would protect trillions in “tough legacy” contracts that use LIBOR as a reference rate for financial transactions. The bill (H.R. 4616) provides a safe harbor for market participants and includes a federal preemption.

  • The House bill also provides that when LIBOR reaches its final replacement date on June 30, 2023, all contracts with no adequate fallback provisions for an alternative benchmark substitute will be replaced with SOFR.
  • The Roundtable and 17 national trade groups previously submitted letters this year on April 14 and July 27 to House Financial Services Committee policymakers in support of legislation to address “tough legacy” contracts during the transition away from LIBOR.
  • The Roundtable and a broad coalition of industry groups have long-supported measures to ensure that the transition away from the LIBOR reference rate does not cause market disruptions or diminish credit capacity. (Industry Coalition letter, Dec. 7, 2021 and BloombergDec. 8, 2021) 

LIBOR transition issues will be discussed during The Roundtable’s Jan. 25-26 virtual State of the Industry Business Meeting and at scheduled TPAC and RECPAC meetings. 

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