In the homeowner’s war, the battlefield is taking shape, A prime area of engagement is whether the securitization process represents a series of independent transactions (lender’s position) or that all the transactions should be aggregated (BORROWER’S POSITION) and treated as a single transaction.

For reasons explained more fully below, it is our opinion that the transactions should be aggregated into a single transaction under the three tests used by the courts to determine whether a tax event should be considered to have occurred.

Given the fraudulent and deceptive practices used before and at closing, plus the TILA and other violations, the single transaction would create only one possibility for a holder in due course out of all the “holders” in the chain — the investor who actually put up the money that was used to fund the loan.

We predict that there will be instances where the investor actually did know what was going on at the loan origination and loan closing stage and participated because of the temporary boost to the manager’s performance rating in a pension fund, hedge fund or other entity. Certainly these were all, by definition, “qualified investors” who by definition are presumed to have knowledge sophistication and access to information that the borrower did not have and could not have and which the parties intentionally concealed. Thus it is possible that investors, even if they were found, might not be able to sustain their burden of showing their clean hands. If so, they might be doubly challenging for anyone to locate and tie to a particular transaction — the information for which is within the sole care, custody and control of the participants in the chain of securitization.

However, due to pre-selling and fulfilling the requirements of the tranches AFTER investment, it is entirely possible that one investor actually put up the money that was loaned and eventually given to the Seller in a specific purchase transaction or a specific borrower in a specific refi, while another investor received delivery of a certificate of asset backed securities that were unrelated to the trail of money downstream to a particular transaction.

All other parties may have been “holders” but not holders in due course under the UCC, Article 3, since the bad behavior including fraud in the inducement and fraud the execution etc. travels with the instrument unless the holder can prove they were innocent and had no knowledge. Since these parties were in many ways so interrelated, intertwined, and co-owned or operated through common service agents, it is difficult to conceive how they would meet this challenge.

Under the binding commitment test, we look at whether there was a binding commitment to enter into a later agreement. This is determined by looking at the agreements of the parties in “privity” and by the conduct of the parties and their obvious intent. Clearly the intent of the mortgage broker was to initiate the mortgage application with the intent that it would be accepted by an originating lender, knowing that the loan was either pre-sold, or would be sold on the application terms, or would be sold after the loan documents themselves.

The very existence of “selling forward” presumes securitization and the existence of one or more investors at the other end of the chain, who probably were not told that they were buying loans that did not yet exist. In fact, it appears at least in some cases, that these investors were mislead in much the same way as the borrowers were down line. Many report, and some lawsuits filed by State and County authorities assert that ABS certificates were sold under the guise of securities that were ultra-short term, could not fluctuate in value and could be liquidated at par at weekly auction. See New York State Attorney General Andrew Cuomo and related suits.

Even where the loans were completed, the description of them was at variance with reality but the intent to convey and pledge an interest in the mortgage and note is clear from the behavior of the parties.
Dropping the underwriting and appraisal standards in order to satisfy the insatiable appetite of Wall Street for paper, regardless of how worthless it was, is also a clear indication that there was a commitment intended to be fulfilled. The behavior of the “lender” in creating high risk loans and masquerading them otherwise surely indicates that the “lender” did not perceive itself at risk, thus implying a continuing transaction in the chain wherein a third party would receive the risk.

The payment of 2.5% premium over the total amount of the mortgage, instead of the usual practice of discounting loans, together with the accounting treatment where these transactions were kept “off balance sheet” is a clear indication that they were providing a service in chain that was leading upward to investment bankers and investors.

Under the end result test the case gets even easier. The investor put up the money and the borrower signed the documents. Under the investor deal, it was backed by the borrowers’ signatures and under the loan documents, it was based on money that came from the investor.

Under the interdependence test the argument is complete. There would be no reason for any of the actions of any of the parties in the chain but for the investor purchasing securities with money that would be used for the loan. Nor would there have been any loan without the money from the investor. Had the investor funds not been the source, the underwriting, appraisal and closing standards would have complied with industry regulations and expectations.


The step transaction doctrine is a rule of substance over form that treats a series of formally separate but related steps as a single transaction if the steps are in substance integrated, interdependent, and focused toward a particular result. Penrod v. Commissioner, 88 T.C. 1415, 1428 (1987). Because the Tax Court has applied the step transaction doctrine even where it did not find a sham transaction, this doctrine should be considered in addition to the economic substance argument discussed above. See Packard v. Commissioner, 85 T.C. 397 (1985).

In characterizing the appropriate tax treatment of the end result, the doctrine combines steps; however it does not create new steps, or recharacterize the actual transactions into hypothetical ones. Greene v. United States, 13 F.3d 577, 583 (2nd Cir. 1994); Esmark v. Commissioner, 90 T.C. 171, 195-200 (1988), aff’d per curiam, 886 F.2d 1318 (7th Cir. 1989).

Some lease stripping transactions may lend themselves to being collapsed. If so, the question is whether the transitory steps added anything of substance or were nothing more than intermediate devices used to enable the subsidiary corporation to acquire the lease property stripped of its future income, leaving the remaining rental expense and depreciation deductions to be used to offset other income. See Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179, 184-185 (1942).

Courts have developed three tests to determine when separate steps should be integrated. The most limited is the “binding commitment” test. If, when the first transaction was entered into, there was a binding commitment to undertake the later transaction, the transactions are aggregated. Commissioner v. Gordon, 391 U.S. 83 (1968); Penrod, 88 T.C. at 1429. If, however, there was a moment in the series of transactions during which the parties were not under a binding obligation, the steps cannot be integrated using the binding commitment test, regardless of the parties’ intent.

Under the “end result” test, if a series of formally separate steps are prearranged parts of a single transaction intended from the outset to achieve the final result, the transactions are combined. Penrod, 88 T.C. at 1429. This test relies on the parties’ intent at the time of the transactions, which can be derived from the actions surrounding the transactions. For example, a short time interval suggests the intervening transactions were transitory and tax-motivated. A short time interval, however, is not dispositive.

A third test is the “interdependence” test, which considers whether the steps are so interdependent that the legal relations created by one transaction would have been fruitless without completing the series of transactions. Greene, 13 F.3d at 584; Penrod, 88 T.C. at 1430. One way to show interdependence is to show that certain steps would not have been taken in the absence of the other steps. Steps generally have independent significance if they were undertaken for valid business reasons.

In this transaction, the nature of B and C’s involvement may support the conclusion that steps involving B and C should be eliminated from the transaction. In this event, D could be required to recognize the accelerated income arising from the purported sale of the rent stream to the bank. Therefore, through the consolidated return, E would recognize the income, and thereby match the income with the deductions.

The “step transaction doctrine,” under which “interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction,” forms a vital part of our tax law.

The scope of this extra-statutory “doctrine” in particular cases can be quite uncertain; nevertheless, the parameters of its application in some transactional forms have become well-accepted and, in those cases, some certainty has been attained by taxpayers and the Internal Revenue Service (“IRS”) regarding which individual steps of a “larger” transaction would and would not be granted independent significance for tax purposes. In Revenue Ruling 2001-46 (October 15, 2001), however, the IRS arguably changed its approach to analyzing one common form of corporate asset acquisition, described below, under the step transaction doctrine.

An acquiring corporation (“X”) wishing to effect an acquisition of the assets of a widely-held target corporation (“T”) may form a wholly owned subsidiary (“Y”). Pursuant to an overall “plan,” Y will merge into T, with the shareholders of T tendering their T stock in exchange for cash, stock, or securities of X (or some combination thereof), following which T will merge into X.

Under longstanding guidance from the IRS, the “transitory steps” of the formation of Y and its merger into T were ignored; these transactions in which X became, at least momentarily, the sole shareholder of T were treated as an acquisition of T stock by X directly from the shareholders of T. By contrast, in analyzing the consequences of that “direct acquisition” of stock, the subsequent “upstream” merger of T into X was treated as a separate transaction, rather than as part of an overall “plan.”

The effect of this analysis was to permit, in those cases in which the portion of the consideration received by the shareholders of T which did not consist of stock in X was sufficiently preponderant, treatment of the acquisition as a “qualified stock purchase” and the making by X of an election under section 338 of the Internal Revenue Code (“Code”) to “step-up” the basis of T’s assets to X’s acquisition cost.

In Rev. Rul. 2001-46, however, the IRS held that all the steps described above, including the merger of T into X, would be treated as a single transaction, which could then be treated a statutory merger of T into X, if, under the circumstances, an actual merger of T into X would have qualified as a nontaxable reorganization under Code section 368(a)(1)(A).