Primary Roles in Asset Securitization

A lenders cost basis is the capitalized cost of originating a mortgage. A registrant’s basis in assets is the capitalized cost of originating a pooled mortgage investment. So the cumulative cost for the plaintiffs loan and subject mortgage is a percentage of the entire pooled assets capital cost. The Treasury Regulations under 1.266-1(b)(1) highlight several types of expenses that would be carrying charges, such as (1) taxes on various types of property, (2) loan interest used to finance property, or (3) the costs to improve property (or to cure it of defects ). The IRS contrasted this with an investment management fee, which is generally for the management of property, not for its acquisition, financing, or holding/storage.

Under the IRS opinion it states “consulting and advisory fees are not carrying charges and cannot be capitalized. For they are not incurred independent of a taxpayer’s acquiring property and because they are not a necessary expense of holding property. Stated differently, consulting and advisory fees are not closely analogous to common carrying costs, such as insurance, storage, and transportation.” 

As for the tax payer corporation and assessing the standing to bring foreclosure, the court is asked to consider the reporting requirements and rules, for how a custodian would know that cost basis needed to be updated for clients who choose to capitalize their investment management fees, instead of deducting them as a current expense.

The strategy to capitalize investment management fees, instead of deducting them, has been increasingly popular over the past decade, as the AMT has expanded its reach, resulting in no effective deduction for such fees for a large number of financial services clientele. Unfortunately, though, the IRS responded to the strategy in 2007 with Chief Counsel Memorandum 200721015, which explicitly tackled the issue – and said that investment management fees are not eligible to be capitalized.

The ruling was relatively straightforward. The taxpayer paid a flat quarterly fee for investment management, which covered the cost of transactions, and compensation to the financial consultant and investment manager. The taxpayer wanted to know if such fees could be treated as “carrying charges” that may be added to cost basis, instead of deducted as current expenses.

The Treasury Regulations under 1.266-1(b)(1) highlight several types of expenses that would be carrying charges, such as taxes on various types of property, loan interest used to finance property, or the costs to construct or improve property (or to store it in the case of personal property). The IRS contrasted this with an investment management fee, which is generally for the management of property, not for its acquisition, financing, or holding/storage. As the IRS put it: “Consulting and advisory fees are not carrying charges because they are not incurred independent of a taxpayer’s acquiring property and because they are not a necessary expense of holding property. Stated differently, consulting and advisory fees are not closely analogous to common carrying costs, such as insurance, storage, and transportation.” 

Accordingly, investment management fees should not be capitalized into the cost basis of investments. They can be deducted, or not, as investment expenses and the taxpayer will receive whatever benefits are possible in light of the 2%-of-AGI floor for miscellaneous itemized deductions, and the AMT ramifications. But if the advisor wants a better outcome for the tax treatment of a client’s AUM fee, it’s up to Congress to change the rules.

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