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[LETTERHEAD OF WENDEL ROSEN BLACK & DEAN]
August 7, 2000
DM Mortgage Investors, LLC
2901 El Camino Avenue, Suite 206
Las Vegas, NV 89102
Re: Federal Income Tax Consequences of an Investment in DM Mortgage
Investors, LLC
Ladies and Gentlemen:
We have acted as tax counsel for DM Mortgage Investors, LLC, a Nevada
limited liability company (the "Company") in connection with the preparation of
the prospectus (the "Prospectus") for the Company to be filed with the
Securities and Exchange Commission on or about August 7, 2000, pursuant to the
Securities Act of 1933, as amended, (the "Act") as part of its Registration
Statement on Form S-11, file number 333-32800, as amended from time to time (the
"Registration Statement"). This opinion as to certain material federal income
tax aspects of an investment in the Company is being delivered at your request
in connection with the disclosure requirements under the Act and will be filed
as an exhibit to the Prospectus. Capitalized terms used herein and not otherwise
defined herein shall have the meanings ascribed to them in the Registration
Statement.
In connection with our opinion, we have examined: (i) the Registration
Statement and the Prospectus; (ii) the Operating Agreement for the Company that
is attached as an exhibit to the Prospectus (the "Operating Agreement"); (iii)
the certificate of the Manager (the "Certificate"), dated as of March 15, 2000;
and (iv) such other documents and records pertaining to the organization and
operation of the Company as we have considered necessary or appropriate as a
basis for the opinions set forth below. In our examination we have assumed the
genuineness of all signatures, the legal capacity of natural persons, the
authenticity of all documents submitted to us as originals, the conformity to
original documents of all documents submitted to us as certified or photostatic
copies, and the authenticity of the originals of such copies.
As to any facts material to this opinion, we have relied solely upon:
(i) the matters set forth in the Prospectus, (ii) the assumptions contained
herein, and (iii) the representations and statements of the Manager, and its
officers and representatives, including the facts set forth in the
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DM Mortgage Investors, LLC
August 7, 2000
Page 2
Certificate. We have not undertaken any independent investigation or
verification as to any such factual matters.
In rendering our opinion, we have considered the applicable provisions
of the Internal Revenue Code of 1986, as amended to the date hereof (the
"Code"), Treasury Regulations promulgated thereunder (the "Regulations"),
pertinent judicial and administrative authorities and interpretative rulings of
the Internal Revenue Service (the "IRS"). As indicated in the substantive
discussion which follows relative to the federal income tax consequences of an
investment in the Company, as to certain issues, we are unable to express an
opinion because of uncertainty in the law or for other reasons.
Whenever a statement herein is qualified by the expressions "to our
knowledge," "we are not aware" or a similar phrase or expression with respect to
our knowledge of matters of fact, it is intended to mean our knowledge is based
upon the documents, instruments and certificates described above and the current
actual knowledge of the attorneys in this firm who are presently involved in
substantive legal representation of the Company (but not including any
constructive or imputed notice of any information) and that we have not
otherwise undertaken any independent investigation for the purpose of rendering
this opinion.
Our opinion is subject to the limitations, qualifications, exceptions
and assumptions set forth herein. Our opinion is limited to the matters
discussed below. We give no opinion with respect to other tax matters, whether
federal, state or local, that may relate to an investment in the Company.
No ruling will be requested from the IRS regarding any of the material
federal income tax issues discussed below. Our opinion is not binding on the IRS
and does not constitute a guarantee that the IRS will not successfully challenge
a Member's tax treatment of any aspect of any investment in the Company. We
caution that our opinion is based on the federal income tax laws as they exist
on the date hereof. It is possible that subsequent changes in the tax law could
be enacted and applied retroactively to an investment in the Company and that
such changes could result in a materially different result that the result
described in this opinion.
The opinions set forth below represent our conclusions based upon the
documents reviewed by us, the facts and assumptions presented to us and stated
herein. Any material amendments to such documents or changes in any significant
fact or assumption stated herein or in the Certificate could affect the opinions
expressed herein.
We are of the opinion that:
1. The Company will be classified as a partnership rather than as an
association taxable as a corporation for federal income tax purposes.
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DM Mortgage Investors, LLC
August 7, 2000
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2. The Company will not be classified as a "publicly traded
partnership" for federal income tax purposes.
3. The discussion set forth below under the heading "Other Federal
Income Tax Consequences" and in the Prospectus under the heading "Federal Income
Tax Consequences" is an accurate summary of all material matters discussed
therein.
1. The Company Will Be Classified As A Partnership
As discussed in greater detail below, a limited liability company
generally is not subject to federal income tax if it is classified as a
partnership for federal income tax purposes, but rather each member is required
to report on such member's federal income tax return the member's distributive
share of the taxable income or loss of the Company for each year. Historically
(i.e., prior to 1997), one of the more significant issues which had to be
addressed in connection with a discussion of the material federal income tax
consequences relative to a limited liability company formed to take advantage of
the favorable tax treatment afforded to partnerships was whether such entity may
be classified as an association taxable as a corporation for income tax purposes
under the entity classification system that existed at that time. However, under
Regulations promulgated in December 1996 (the so-called "Check-the-Box"
Regulations), a domestic limited liability company with more than one member
will be classified as a partnership for federal income tax purposes unless it
makes an election to be classified as an association taxable as a corporation.
See Regulation Section 301.7701-3(b)(3)(ii).
The Company is a domestic limited liability company and if the minimum
offering of Units described in the Prospectus is completed will have more than
one member. The Manager has represented that it will not cause the Company to
make an election to be classified as an association taxable as a corporation.
Based on the foregoing and subject to the discussion which follows regarding the
tax treatment of publicly traded partnerships, it is our opinion that that the
Company will be classified as a partnership for federal income tax purposes.
In light of the foregoing opinion, as the context requires in the
discussion which follows: (i) the use of the term "partnership" will be
construed to refer also to a limited liability company classified as a
partnership for federal income tax purposes (e.g., the Company); (ii) the use of
the term "partner" will be construed to refer also to a member of a limited
liability company (e.g., a Member of the Company); and (iii) "partnership
interest" or "interest in the partnership" or similar terms will be construed to
refer also to the interest of a member in a limited liability company (e.g., the
interest of a Member in the Company).
2. The Company Will Not Be Classified As A Publicly Traded Partnership
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DM Mortgage Investors, LLC
August 7, 2000
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Section 7704 of the Code treats "publicly traded partnerships" as
corporations for federal income tax purposes. Section 7704(b) of the Code
defines the term "publicly traded partnerships" as any partnership (including a
limited liability company classified as a partnership for federal income tax
purposes) if the interests in such partnership are: (i) readily traded on an
established securities market; or (ii) readily tradable on a secondary market or
the substantial equivalent thereof.
In June 1988, the IRS issued Notice 88-75 which sets forth
comprehensive guidance concerning the application of Section 7704 prior to the
adoption of final Regulations under Section 7704. Notice 88-75 primarily
addresses the issue of when partnership interests will be considered to be
readily tradable on a secondary market or the substantial equivalent thereof
under Section 7704(b). In November, 1995, the IRS issued final Regulations under
Section 7704 (the "Final PTP Regulations"). See Regulation Section 1.7704-1. The
Final PTP Regulations generally retain the conceptual framework of Notice 88-75,
but contain a number of modifications. The Final PTP Regulations are generally
effective for taxable years beginning after December 31, 1995.
The Final PTP Regulations provide that an established securities market
includes: (i) a national securities exchange registered under the Securities
Exchange Act of 1934; (ii) a national securities exchange exempt from
registration because of the limited volume of transactions; (iii) a foreign
securities exchange; (iv) a regional or local exchange; and (v) an interdealer
quotation system that regularly disseminates firm buy or sell quotations by
identified brokers or dealers by electronic means or otherwise (i.e., an
over-the-counter market). See Final PTP Regulations Section 1.7704-1(b).
As indicated above, the primary focus of the Final PTP Regulations (and
Notice 88-75) is on determining when partnership interests will be treated as
"readily tradable on a secondary market or the substantial equivalent thereof."
The Final PTP Regulations provide a number of safe harbors relative to this
determination. Included as a safe harbor in the Final PTP Regulations is a safe
harbor described under the heading "Lack of Actual Trading" (the "Lack of Actual
Trading Safe Harbor"). The Lack of Actual Trade Safe Harbor provides that
interests in a partnership will not be considered readily tradable on a
secondary market or the substantial equivalent thereof within the meaning of
Section 7704(b) of the Code if the sum of the percentage interests in
partnership capital or profits that are sold or otherwise disposed of during the
taxable year does not exceed 2% of the total interests in partnership capital or
profits (the "Two Percent Safe Harbor").
As noted, certain transfers are disregarded for purposes of determining
whether the Two Percent Safe Harbor is met under the Final PTP Regulations. For
purposes of this safe harbor, the transfers which are disregarded include, but
are not limited to: (i) transfers between family members, transfers at death,
(ii) transfers in which the basis is determined under Section 732 of the Code,
(iii) interests issued by the partnership for cash, property or services, and
(iv) interests
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DM Mortgage Investors, LLC
August 7, 2000
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in the partnership which are redeemed pursuant to the "Redemption and Repurchase
Safe Harbor" discussed below.
The Final PTP Regulations contain a safe harbor for redemption and
repurchase agreements (the "Redemption and Repurchase Safe Harbor"). This safe
harbor provides that the transfer of an interest in a partnership pursuant to a
"redemption or repurchase agreement" is disregarded for purposes of determining
whether interests in the partnership are readily tradable on a secondary market
or the substantial equivalent thereof certain requirements are met. The Final
PTP Regulations provide that a redemption or repurchase agreement means a plan
of redemption or repurchase maintained by a partnership whereby the partners may
tender their interests in the partnership for purchase by the partnership,
another partner or certain persons related to another partner. See Section
1.7704-1(e)(3) of the Final Regulations.
The requirements which must be met in order to disregard transfers made
pursuant to a redemption or repurchase agreement are: (i) the redemption
agreement requires that the redemption cannot occur until at least 60 calendar
days after the partner notifies the partnership in writing of the partner's
intention to exercise the redemption right; (ii) the redemption agreement
requires that the redemption price not be established until at least 60 days
after receipt of such notification by the partnership (or the price is
established not more than 4 times during the partnership's taxable year); and
(iii) the sum of the percentage interests in partnership capital and profits
represented by partnership interests that are transferred (other than in
transfers otherwise disregarded, as described above) during the taxable year of
the partnership, does not exceed 10% of the total interests in partnership
capital or profits. See Section 1.7704-1(f) of the Final PTP Regulations.
The Operating Agreement provides that, subject to certain limitations,
a Member may withdraw or partially withdraw from the Company and obtain the
return of his outstanding capital account. These provisions of the Operating
Agreement constitute a redemption or repurchase agreement within the meaning of
the Final PTP Regulations.
The limitations on a Member's right to withdraw his capital account set
forth in the Operating Agreement include, without limitation: (i) a requirement
that the withdrawal will not be made until at least 61 days after written notice
of withdrawal is delivered to the Manager; (ii) the amount distributed to the
withdrawing Member will be a sum equal to such Member's capital account as of
the date of such distribution; and (iii) in no event will the Manager permit the
withdrawal during any calendar year of more than 10% of the outstanding Member
Units. In our opinion, these limitations satisfy the requirements of the Final
PTP Regulations set forth above.
The Operating Agreement provides that no transfer or assignment of a
Member's interest in the Company may be made, if the Manager determines that
such transfer or assignment would result in the Company being classified as a
publicly traded partnership within the meaning of Section 7704(b) of the Code.
To prevent such classification, the Operating Agreement provides
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DM Mortgage Investors, LLC
August 7, 2000
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that (i) the Company will not register Units or permit any other persons to
register Units for trading on an established securities market within the
meaning of Section 7704(b); (ii) the Manager will prohibit any transfer of Units
which would cause the sum of percentage interests in Company capital or profits
represented by Company interests that are transferred during any taxable year of
the Company to exceed the limitation under the Two Percent Safe Harbor under the
Final PTP Regulations (excluding for this purpose transfers which may be
disregarded pursuant to the safe harbor); and (iii) the Manager will not permit
during any fiscal year of the Company any withdrawal of Units except in
compliance with the provisions of the Operating Agreement.
Based upon the provisions of the Operating Agreement and the
representations of the Manager set forth in the Certificate, we are of the
opinion that:
(i) interests in the Company will not be traded on an
established securities market within the meaning of Section 7704 of the Code;
(ii) the operation of the Company with regard to the
withdrawal by Members will qualify for the Redemption and Repurchase Safe
Harbor;
(iii) the operation of the Company with regard to the transfer
of Units by Members will qualify for the Two Percent Safe Harbor;
(iv) based on the opinions rendered in clauses (ii) and (iii)
of this paragraph, interests in the Company will not be considered as readily
tradable on a secondary market or the substantial equivalent thereof; and
(v) based on the opinions rendered in clauses (i) through (iv)
of this paragraph, the Company will not be classified as a publicly traded
partnership for purposes of Section 7704 of the Code.
It should be noted that a partnership which is classified as a publicly
traded partnership under Section 7704 of the Code will not be treated as a
corporation for federal income tax purposes if 90% or more of its gross income
is "qualifying income." Section 7704(c) of the Code defines the term "qualifying
income" for this purpose to include, among other "passive-type" items, interest,
dividends, real property rents, and gains from the sale of real property, but
excludes interest derived in the conduct of a financial business. If a publicly
traded partnership is not taxed as a corporation because it meets the qualifying
income test, the passive loss rules discussed below are applied separately to
the partnership, and a tax-exempt partner's share of the partnership's gross
income may be treated as income from an unrelated trade or business under the
unrelated trade or business taxable income rules discussed below.
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DM Mortgage Investors, LLC
August 7, 2000
Page 7
It is not clear whether the Company would satisfy the "qualifying
income" test of Section 7704(c). (As noted, this inquiry would be relevant only
if it were determined that the Company should be classified as a publicly traded
partnership.) It is anticipated that more than 90% of the Company's income will
be of the passive-type included in the definition of "qualifying income"
contained in Section 7704(c). However, it is not clear whether the Company would
be considered to be engaged in the conduct of a financial business. If the
Company were classified as a publicly traded partnership and considered to be
engaged in a financial business, the Company would be treated as a corporation
for federal income tax purposes.
3. Other Federal Income Tax Consequences
General Principles of Partnership Taxation
A partnership generally is not subject to any federal income taxes. The
Company will file, for federal income tax purposes, partnership information
returns reporting its operations on the accrual basis for each taxable year. The
taxable year of the Company will be the calendar year. The Company will provide
Members with income tax information relevant to the Company and their own income
tax returns, including each Member's share of the Company's taxable income or
loss, if any, capital gain or loss (net short-term and net long-term) and other
tax items for the Company's taxable year.
Each Member that is not exempt from federal income tax will be required
to report on his own income tax return the Member's share of the Company's items
of income, gain, loss, deduction and credit. Accordingly, a Member will be
subject to tax on his distributive share of the Company's taxable income whether
or not any cash distribution is made to the Member. Because the Company will
originate mortgage investments that may be subject to the "original issue
discount" rules (see "Original Issue Discount Rules" below), it is possible that
a Member's taxable income from the Company will exceed any cash distributed to
the Member by the Company with respect to a particular year. It is anticipated
that substantially all of the income generated by the Company will be taxed as
ordinary income for federal income tax purposes.
Determination of Basis in Units
In general, a Member will not be taxed on Company distributions unless
such distributions exceed the Member's adjusted basis in his Units. A Member's
adjusted basis in his Units is the amount originally paid for such interest
increased by (i) his proportionate share of Company indebtedness with respect to
which no partner is personally liable, (ii) his proportionate share of the
Company's taxable income, and (iii) any additional contributions to the
Company's capital by such Member, and decreased by (x) his proportionate share
of losses of the Company, (y) the amount of cash, and fair value of noncash,
distributions to such Member, and (z) any decreases in his share of any
nonrecourse liabilities of the Company. Any increase in nonrecourse liabilities
of the Company is treated as a cash contribution and a decrease in
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DM Mortgage Investors, LLC
August 7, 2000
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nonrecourse liabilities is treated as a cash distribution, even though the
Member contributes or receives no cash, respectively. Distributions in excess of
such basis generally will be treated as gain from the sale or exchange of a
Member's interest in the Company.
Allocations of Profits and Losses
The Members will receive allocations of the Company's profits and
losses and cash distributions in the manner described in Article 7 of the
Operating Agreement. Allocations of profits and losses under a partnership
agreement will be recognized as long as they have "substantial economic effect"
under the Regulations promulgated under Section 704(b) of the Code. In general,
the Regulations provide that an allocation contained in a partnership agreement
will be respected if it satisfies the requirements of one of three tests: (i) it
has "substantial economic effect" (the "substantial economic effect test"); (ii)
it is in accordance with the partners' interest in the partnership (determined
by taking into account all facts and circumstances) (the "partners' interest in
the partnership test"); or (iii) it is "deemed" to be in accordance with the
partners' interest in the partnership.
The substantial economic effect test is a substantially objective test
which effectively creates a safe harbor for compliance with the requirements of
Section 704(b). However, in order to comply strictly with the requirements of
that test, it would be necessary to include in the Operating Agreement a
lengthy, intricate and complex set of provisions which may have little practical
significance based on the Company's anticipated operations. As a result, and
based also on the fact that a principal thrust of the Regulations under Section
704(b) is to prevent losses from being allocated for tax purposes to partners
who do not bear the economic risk of loss associated with such allocations and
that it is not anticipated that the operation of the Company and the allocation
provisions of the Operating Agreement will ever produce a situation in which a
Member will be allocated losses in excess of the economic losses actually borne
by such Member, the Manager has decided not to include these complex provisions
in the Operating Agreement and to rely instead on the partners' interest in the
partnership test as the basis for justifying the allocations under the Operating
Agreement.
The allocations contained in the Operating Agreement are generally
intended to match, insofar as practicable, the allocation of profits for tax
purposes with the economic benefit of cash distributions among the Members and
the allocation of losses with the related economic burden borne by the
respective Members. In general, a Member's interest in profits, losses and cash
distributions are proportionate to his capital account. Since the allocation of
profits, losses and cash distributions under the Operating Agreement will be
substantially proportionate to the capital accounts of the Members, in our
opinion in most instances such allocations should be substantially in accordance
with the "partners' interests in the partnership" within the meaning of this
alternative test, and such allocations should be substantially respected for tax
purposes.
Limitations on the Deduction of Losses
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DM Mortgage Investors, LLC
August 7, 2000
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It is not anticipated that the Company will incur net losses for income
tax purposes in any taxable year. However, if the Company were to incur losses
in any year, the ability of a Member to deduct such losses would be subject to
the potential application of the limitations discussed below.
(i) The Basis Limitation
Section 704(d) of the Code provides that a partner's share of
partnership losses is allowed as a deduction only to the extent of his adjusted
basis in his partnership interest at the end of the year in which the losses
occur. Losses disallowed under Section 704(d) may be carried forward
indefinitely until adequate basis is available to permit their deduction. Due to
this limitation, a Member in the Company will be precluded from deducting losses
in excess of his adjusted basis in his Units.
(ii) The At Risk Limitation
Under Section 465 of the Code, a taxpayer (other than a widely-held
corporation) may not deduct losses incurred in certain business activities,
including the lending activities contemplated by the partnership, in an amount
exceeding the aggregate amount the taxpayer is "at risk" in that activity at the
close of his taxable year. The effect of these rules generally is to limit the
availability of partnership tax losses as offsets against other taxable income
of a partner to an amount equal to such partner's adjusted basis in his
partnership interest excluding any portion of adjusted basis attributable to
partnership nonrecourse indebtedness. In addition, the at risk amount does not
include contributions by a partner to the extent the partner used the proceeds
of a nonrecourse borrowing to make such contributions.
(iii) The Passive Loss Rules
Section 469 of the Code limits the deductibility of losses from
"passive activities" for individuals, estates, trusts and certain closely-held
corporations. A passive activity includes an activity which involves the conduct
of a trade or business in which the taxpayer does not materially participate.
Generally, losses from passive activities are only allowed to offset income from
passive activities and will not be allowed to offset "portfolio" income, trade
or business income or other nonpassive income such as wages or salaries.
Suspended losses and credits attributable to passive activities are carried
forward and treated as deductions and credits from passive activities in the
next year. Suspended losses (but not credits) from a passive activity are
allowed in full when the taxpayer disposes of his entire interest in the passive
activity in a taxable transaction.
The Regulations under Section 469 provide that in certain situations,
net income, but not net loss from a passive activity (or a portion thereof) is
treated as nonpassive. See Regulation
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DM Mortgage Investors, LLC
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Section 1.469-2T(f). One of the items covered by this Regulation is net income
from an "equity-financed lending activity." An equity-financed lending activity
is defined as an activity that involves a trade or business of lending money, if
the average outstanding balance of liabilities incurred in the activity for the
taxable year does not exceed 80% of the average outstanding balance of the
interest-bearing assets held in the activity for such year.
Based on the manner in which it is anticipated that the Company will
conduct its operations, at no time will the average outstanding balance of
Company liabilities exceed 80% of the average outstanding balance of the
Company's interest earning assets. Consequently, if the Company is deemed to be
engaged in the trade or business of lending money, such business will constitute
an equity-financed lending activity, and income of the Company which arises from
that trade or business and would otherwise be considered income from a passive
activity will generally be recharacterized as nonpassive income, even though the
net losses of the Company or loss on the sale of a Unit will be treated as
passive activity losses. If the Company is not considered engaged in a trade or
business of lending money, then income and loss will be considered portfolio
income and loss. In either event, a Member will not be permitted to offset
passive losses from other activities against his share of the income of the
Company.
There are no cases or revenue rulings dealing with the question of
establishing the criteria for determining whether an entity (other than a bank)
is engaged in the ordinary conduct of a trade or business of lending money for
purposes of Section 469. Presumably, this determination would be dependent, at
least in part, on the facts and circumstances surrounding the Company's
operations, including the number of loans made during any particular year. Due
to this uncertainty, we cannot give an opinion as to whether the Company will be
considered to be engaged in an equity-based lending activity for this purpose.
Under Section 67(a) of the Code, most miscellaneous itemized deductions
are deductible by an individual taxpayer only to the extent that, in the
aggregate, they exceed 2% of the taxpayer's adjusted gross income; and are
subject to additional limitations for certain high-income taxpayers. Deductions
from a trade or business are not subject to these limitations. A Member's
allocable share of the expenses of the Company will be considered miscellaneous
itemized deductions subject to this 2% limitation only if the Company is not
considered to be in the trade or business of lending money.
Computation of Gain or Loss on Sale or Redemption of Units
Gain or loss on the sale by a Member of his Units (including a
redemption by the Company) will be measured by the difference between the amount
realized (i.e., the amount of cash and the fair market value of property
received), including his share of Company nonrecourse liabilities and his
adjusted basis in such Units.
Character of Gain or Loss
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Generally, gain recognized by a Member on the sale of Units which have
been held over 12 months will be taxable as long-term capital gain, except for
that portion of the gain allocable to "substantially appreciated inventory
items" and "unrealized receivables," as those terms are defined in Section 751
of the Code, which would be treated as ordinary income. The definition of these
terms will not be considered here beyond noting that the Company may have
"unrealized receivables" arising from the ordinary income component of "market
discount bonds." In addition, if the Company holds property as a result of
foreclosure which is unsold at the time a Member sells his Units, or holds an
investment in a mortgage loan that is classified as an equity interest, the
amount of ordinary income that would result if the Company were to sell such
property is generally an "unrealized receivable."
For noncorporate taxpayers, long-term capital gain for capital assets
held longer than 12 months is subject to a maximum rate of 20% (10% for
individuals in the 15% tax bracket). The amount of ordinary income against which
a noncorporate taxpayer may deduct a capital loss is the lower of $3,000 (or in
the case of a married taxpayer filing a separate return $1,500) or the excess of
such losses of the taxpayer over the taxpayer's capital gain.
Tax Rates on a Member's Share of Ordinary Income from the Company
A taxpayer's tax liability with respect to an investment in the Company
will depend upon his individual tax bracket. Currently, there are five tax
brackets for individuals. For calendar year 2000, the first bracket is at 15%
(on taxable income not over $43,850 in the case of married taxpayers filing
joint returns), the second at 28% (on taxable income from $43,850-$105,950), the
third at 31% (on taxable income from $105,950-$161,450), the fourth at 36% (on
taxable income from $161,450-$288,350), and the fifth at 39.6% (on taxable
income over $288,350). (As noted above, the long-term capital gain for capital
assets held longer than 12 months is subject to a 20% tax rate (10% for
individuals in the 15% bracket).)
Distributions and Deemed Distributions
Distributions to Members may take the form of either actual cash
distributions or so-called "deemed distributions." A deemed distribution is
treated as a cash distribution and can result from a Member's decision to
participate in the Company's distribution reinvestment plan. Under the terms of
the Operating Agreement, a Member who elects to participate in the distribution
reinvestment plan will be deemed to have received a distribution of the amount
being reinvested and to have recontributed an equivalent amount to the Company.
The Operating Agreement also provides that a deemed distribution and
equivalent recontribution will result if the Manager determines to reinvest any
of the Company's net proceeds from capital transactions in new mortgage loans.
Capital transactions for this purpose are defined in the Operating Agreement to
include payments of principal, foreclosures and
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DM Mortgage Investors, LLC
August 7, 2000
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prepayments of mortgage loans, and any other disposition of a mortgage loan or
property. For this purpose, a disposition of a mortgage loan is deemed to occur
if any "significant modifications" to the debt instrument are made within the
meaning of Section 1001 of the Code and the Regulations thereunder.
Distributions to a Member, including the deemed distributions described
above, generally do not generate taxable income unless and to the extent the
amount of any such distribution exceeds the Member's basis in his Units. Since
each of the deemed distributions described above will be matched by a deemed
recontribution of an equivalent amount, these transactions will have no net
impact on a Member's basis in his Units and should not cause subsequent deemed
distributions to be taxable.
Depreciation
From time to time the Company anticipates that it may acquire equity or
leasehold interests in real property by direct investment, foreclosure or
otherwise. Generally, the cost of the improvements on any such owned real
property may be recovered through depreciation deductions over a period of 39
years. See Section 168(c) of the Code.
Investment Interest
Section 163(d) of the Code, applicable to noncorporate taxpayers and S
corporation shareholders, places a limitation upon the deductibility of interest
incurred on loans made to acquire or carry property held for investment.
Property held for investment includes all investments held for the production of
taxable income or gain, but does not include trade or business property or
interest incurred to construct such property. In general, investment interest is
deductible by noncorporate taxpayers and S corporation shareholders only to the
extent it does not exceed net investment income for the taxable year.
Net investment income is the excess of investment income over the sum
of investment expenses. Interest expense of the Company and interest expense
incurred by Members to acquire Units will not be treated as investment interest
to the extent attributable to a passive activity of the Company. However, that
portion of interest expense allocable to portfolio investments is subject to the
investment interest limitations.
Interest attributable to debt incurred by a Member in order to purchase
or carry Units may constitute "investment interest" subject to the deductibility
limitations of Code Section 163(d). Therefore, Members should consider the
effect of investment interest limitations on using debt financing for their
purchase of Units.
Tax Treatment of Tax-Exempt Entities
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August 7, 2000
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Sections 511 through 514 of the Code impose a tax on the "unrelated
business taxable income" of organizations otherwise exempt from tax under
Section 501(a) of the Code. Entities subject to the unrelated business income
tax include qualified employee benefit plans, such as pension and profit-sharing
plans, Keogh or HR-10 plans, and individual retirement accounts. Other
charitable and tax-exempt organizations are also generally subject to the
unrelated business income tax. Such organization, plan or account is referred to
as a "Tax-Exempt Entity." Interest income is not subject to this tax unless it
constitutes "debt-financed income."
Unrelated business taxable income includes gross income, reduced by
certain deductions and modifications, derived from any trade or business
regularly carried on by a partnership of which the Tax-Exempt Entity is a
partner where the partnership is a publicly traded partnership (see the
discussion set forth above concerning the classification of the Company as a
partnership for federal income tax purposes) or which is an unrelated trade or
business with respect to the Tax-Exempt Entity. Among the items generally
excluded from unrelated business taxable income are (i) interest and dividend
income; (ii) rents from real property (other than debt-financed property or
property from which participating rentals are derived); and (iii) gains on the
sale, exchange or other disposition of assets held for investment.
In general, the receipt of unrelated business taxable income by a
Tax-Exempt Entity has no effect on such entity's tax-exempt status or on the
exemption from tax of its other income. However, in certain circumstances, the
continual receipt of unrelated business taxable income may cause certain
Tax-Exempt Entities to lose their exemption. Moreover, for certain types of
Tax-Exempt Entities, the receipt of any unrelated business income taxable may
cause all income of the entity to be subject to tax. For example, for charitable
remainder trusts, the receipt of any taxable income from an unrelated trade or
business during a taxable year will result in the taxation of all of the trust's
income from all sources for such year.
The Manager intends to invest Company assets in such a manner that
tax-exempt Members will not derive unrelated business taxable income or
unrelated debt-financed income with respect to their interests in the Company.
However, unrelated debt-financed income might be derived in the event that the
Manager deems it advisable to incur indebtedness in connection with foreclosures
on property where mortgagees have defaulted on their loans. Subject to certain
exceptions, if a Tax-Exempt Entity, or a partnership of which it is a partner,
acquires property subject to acquisition indebtedness, the income attributable
to the portion of the property which is debt financed (based on the ratio of the
average acquisition indebtedness to the average amount of the adjusted basis of
such property) may be treated as unrelated business taxable income. Sales of
foreclosure property might also produce unrelated business taxable income if the
Company is characterized as a "dealer" with respect to such property. Moreover,
mortgage loans invested in or funded by the Company which permit the Company to
participate in the appreciation value of the properties may be recharacterized
by the IRS as an equity interest and such recharacterization could result in
unrelated debt-financed income. However, there can be no
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DM Mortgage Investors, LLC
August 7, 2000
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assurance that the IRS will agree that the Company's other income is not subject
to tax under the unrelated business income and unrelated debt-financed income
tax provisions.
If a Qualified Plan's (defined below) income from the Company
constitutes unrelated business taxable income, such income is subject to tax
only to the extent that its unrelated business taxable income from all sources
exceeds $1,000 for the taxable year.
In considering an investment in the Company of a portion of the assets
of a qualified employee benefit plan and an individual retirement account
("Qualified Plan"), a fiduciary should consider (i) whether the investment is in
accordance with the documents and instruments governing the plan; (ii) whether
the investment satisfies the diversification requirements of Section
404(a)(1)(C) of the Employee Retirement Income Security Act of 1974 ("ERISA");
(iii) whether the investment is prudent considering, among other matters, that
there will not be a market created in which the investment can be sold or
otherwise disposed of; and (iv) whether the investment would cause the IRS to
impose an excise tax under Section 4975 of the Code. An investment in the
Company of the assets of an individual retirement account generally will not be
subject to the aforementioned diversification and prudence requirements of ERISA
unless the individual retirement account also is treated under Section 3(2) of
ERISA as part of an employee pension benefit plan which is established or
maintained by an employer, employee organization, or both.
Company Tax Returns and Audits
The Company's income tax returns will be prepared by the Manager.
Generally, all Members are required to report Company items on their individual
returns consistent with the treatment of such items on the Company's information
return. However, a Member may report an item inconsistently if he files a
statement with the IRS identifying the inconsistency. Otherwise, additional tax
necessary to make the partner's treatment of the item consistent with the
Company's treatment of the item may be summarily assessed without a notice of
deficiency or an opportunity to protest the additional tax in the Tax Court
being afforded to the partner. Penalties for intentional disregard of the
consistency requirements may also be assessed.
The Company's returns may be audited by the IRS. Tax audits and
adjustments are made at the Company level in one unified proceeding, the results
of which are binding on all Members. A Member may, however, protest the
additional tax by paying the full amount thereof and suing for a refund in
either the U.S. Claims Court or a U.S. District Court.
A Company must designate a "tax matters partner" to represent the
Company in dealing with the IRS. The Manager will serve as the "tax matters
partner" to act on behalf of the Company and the Members with respect to
"Company items," to deal with the IRS and to initiate any appropriate
administrative or judicial actions to contest any proposed adjustments at the
Company level. Members with less than a 1% interest in the Company will not
receive notice
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DM Mortgage Investors, LLC
August 7, 2000
Page 15
from the IRS of these Company administrative proceedings unless they form a
group with other Members which group has an aggregate interest of 5% or more in
the Company, and request such notice. However, all Members have the right to
participate in the administrative proceedings at the Company level. Members will
be notified of adjustments to their distributive shares agreed to at the Company
level by the "tax matters partner."
If the Company's return is audited and adjustments are proposed by the
IRS, the "tax matters partner" may cause the Company to contest any adverse
determination as to Company status or other matters, and the result of any such
contest cannot be predicted. Moreover, Members should be aware that any such
contest would result in additional expenses to the Company, and that the costs
incurred in connection with such an audit and any ensuing administrative
proceedings will be the responsibility of the Company and may adversely affect
the profitability, if any, of Company operations. To the extent that funds of
the Company are insufficient to meet such expenses, funds may have to be
furnished by Members, although they will be under no obligation to do so.
Adjustments, if any, resulting from any audit may require each Member to file an
amended tax return, and possibly may result in an audit of the Member's own
return. Any audit of a Member's return could result in adjustments of
non-Company items as well as Company income and losses.
The Company will endeavor to provide all required tax information to
the Members within 60 days after the close of each calendar year.
Original Issue Discount Rules
The original issue discount rules of Section 1271 through 1275 of the
Code will apply to obligations to the Company by third parties, i.e., mortgage
loans and obligations issued by the Company, if any. The original issue discount
rules will result in the Company realizing as interest income from a mortgage
loan the amount that economically accrues under the loan during the course of
the year (using compound interest concepts) even where a lesser amount is
actually paid or accrued under the terms of the mortgage loan. Identical
concepts will be used for determining the Company's interest deduction on its
obligations, if any.
Market Discount
The Company may purchase mortgage investments for an amount
substantially less than the remaining principal balance of such mortgage
investments. In such circumstances, each monthly payment which the Company
receives from a mortgagor will consist of interest at the stated rate for the
investment in a mortgage loan and a principal payment. If the Company purchases
an investment in a mortgage loan at a discount, for federal income tax purposes
the principal portion of each monthly payment will constitute (1) the return of
a portion of the Company's investment in the investment in a mortgage loan and
(2) the payment of a portion of the market discount for the investment in a
mortgage loan. The amount of each monthly
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DM Mortgage Investors, LLC
August 7, 2000
Page 16
payment attributable to market discount will be recognized by the Company as
ordinary income and the amount of each monthly payment representing the return
of the Company's investment will not constitute taxable income to the Company.
Accrued market discount will also be treated as ordinary income on the sale of
an investment in a mortgage loan.
No Section 754 Election - Impact on Subsequent Purchasers
Section 754 of the Code permits a partnership to elect to adjust the
basis of its property in the case of a transfer of an interest in the
partnership. The effect of such an election would be that, with respect to the
transferee partner only, the basis of partnership property would either be
increased or decreased by the difference between the transferee's basis for his
partnership interest and his proportionate share of the partnership's basis for
all partnership property.
The Manager has advised us that due to the accounting difficulties
which would be involved, it will not cause the Company to make an election
pursuant to Section 754 of the Code (a "754 Election"), although it is empowered
to do so by the Operating Agreement. Accordingly, the share of depreciation
deductions, if any, and gain or loss upon the sale of any Company assets
allocable to a subsequent purchaser of a Share will be determined by the
Company's tax basis in such assets which will not have been adjusted to reflect
such purchaser's purchase price for his Share (as would have been possible had
the Company made a 754 Election.) This treatment might not be attractive to
prospective purchasers of Units, and consequently, a Member might have
difficulty in selling these Units or might be forced to sell at a price lower
than the price that might have been obtained had such an election been made.
Taxation of Mortgage Loan Interest
Mortgage loans invested in or purchased by the Company may, in certain
situations, be structured to permit the Company to participate in the
appreciation in the value of the properties to which such mortgage loans relate
or in the cash flow generated by the operation of such properties by the
borrowers. The Manager anticipates that the Company will report for tax purposes
all earnings attributable to mortgage loans as interest income. In each case the
determination of whether the Company will be treated for tax purposes as a
creditor or as a partner or other equity participant will depend on an analysis
of the facts and circumstances of the specific mortgage loan. Consequently, we
cannot render an opinion as to the tax consequences of any of these prospective
transactions, and there is no assurance that the IRS will not successfully
recharacterize a mortgage loan as an equity interest. If a mortgage loan is
recharacterized as an equity interest, the Company would be required to
recognize an allocable share of the income, gain, loss, deductions, credits and
tax preference items attributable to the property to which the mortgage loan
relates. Recharacterization of a loan as an equity interest also could result in
the receipt of unrelated business taxable income for certain tax-exempt Members.
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DM Mortgage Investors, LLC
August 7, 2000
Page 17
Treatment of Compensation to Manager and its Affiliates
The Company will pay the Manager and its affiliates certain fees and
expenses for services relating to the offering and the operation of the
Company's business, including a lead dealer fee to be paid at the initial
closing and on a monthly basis thereafter and real estate brokerage fees of up
to 3% of proceeds from the resale of foreclosed property. The lead dealer fee
will be an amount equal to 1% of gross offering proceeds plus up to 0.5% of
gross proceeds as expense reimbursement. In addition, the Manager may receive an
"up-front" promotional interest in the Profits and Losses of the Company of 1%
or more and a "back-end" promotional interest equal to the sum of 10% of cash
available for distributions from operations and 15% of cash available from the
net proceeds of certain capital transactions after the Members have received
payments from these net proceeds equal to their capital contributions plus a 6%
cumulative annual return on those contributions.
In computing taxable income of the Company for each year, the Manager
intends: (i) to deduct the amount of all such lead dealer fees paid such year,
(ii) to reduce the Company's gain from the resale of any foreclosed property
sold during such year by the amount of all such real estate brokerage fees paid,
(iii) to allocate income and losses to the Manager consistent with its up-front
promotional interest in Profits and Losses, and (iv) to deduct as fees the
amount of all payments made to the Manager pursuant to its back-end promotional
interest during such year.
The ability of the Company to obtain the foregoing treatment relative
to these fees and promotional interests depends in large measure on the value of
the services rendered in exchange therefor, which is a question of fact that may
depend on events to occur in the future. Due to this uncertainty, we cannot give
an opinion as to the proper tax treatment of such fees and promotional
interests, and the IRS may attempt to recharacterize one or more aspects of the
Company's treatment of such items by, for example, disallowing the deduction
claimed and/or the reduction in gain claimed by the Company therefor. If
successful, such characterization could cause the tax benefits generated by the
payment of such fees to be deferred or lost.
The Manager will also be entitled to certain fees payable by borrowers
in connection with the Company's investing in or purchasing a mortgage loan.
These fees include, loan brokerage fees for loan selection and origination, loan
evaluation and processing fees and loan extension fees. The exact amount of the
foregoing fees will be negotiated with prospective borrowers on a case-by-case
basis. In addition, the Manager will act as a servicing agent with respect to
the Company's mortgage investments, for which it will be paid by the relevant
borrower an annual fee of up to one-quarter of one percent (0.25%) of the unpaid
balance of the respective mortgage loan serviced.
Since any of the commissions or fees described in the preceding
paragraph will be payable by the borrowers, such payment should not have any
effect on the calculation of the Company's taxable income. However, the IRS
could take the position that these commissions or
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DM Mortgage Investors, LLC
August 7, 2000
Page 18
fees, or any of them, are constructively paid by the Company, in which case
interest income of the Company would be increased by the amount of the
commissions, and the commissions would be deductible by the Company only to the
extent the commissions or fees are reasonable compensation for the services
rendered and otherwise considered deductible expenditures. Since this is
ultimately an issue of fact which may depend on future events, we are not able
to render an opinion regarding the issue.
The Manager or its Affiliates will be entitled to reimbursement from
the Company for certain expenses advanced by the Manager or its Affiliates for
the benefit of the Company and for salaries and related expenses for
nonmanagement and nonsupervisory services performed for the benefit of the
Company. The reimbursement of such expenses by the Company will generally be
treated in the same manner as if the Company incurred such costs directly.
Possible Legislative Tax Changes
In recent years there have been a number of proposals made in Congress
by legislators, government agencies and by the executive branch of the federal
government for changes in the federal income tax laws. In addition, the IRS has
proposed changes in regulations and procedures, and numerous private interest
groups have lobbied for regulatory and legislative changes in federal income
taxation. It is impossible to predict the likelihood of adoption of any such
proposal, the likely effect of any such proposals upon the income tax treatment
presently associated with investment in mortgage loans or the Company, or the
effective date, which could be retroactive, of any legislation which may derive
from any such past or future proposal.
State and Local Taxes
The Company may invest in or purchase loans in states and localities
which impose a tax on the Company's assets or income, or on each Member based on
his share of any income (generally in excess of specified amounts) derived from
the Company's activities in such jurisdiction. Members who are exempt from
federal income taxation will generally also be exempt from state and local
taxation. Members should consult with their own tax advisors concerning the
applicability and impact of state and local laws.
ERISA Considerations
ERISA generally requires that the assets of employee benefit plans be
held in trust and that the trustee, or a duly authorized investment manager
(within the meaning of Section 3(38) of ERISA), have exclusive authority and
sole discretion to manage and control the assets of the plan. ERISA also imposes
certain duties on persons who are fiduciaries of employee benefit plans subject
to ERISA and prohibits certain transactions between an employee benefit plan and
the parties in interest with respect to such plan (including fiduciaries). Under
the Code, similar prohibitions apply to all Qualified Plans, including IRA's,
Roth IRA's and Keogh Plans covering
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DM Mortgage Investors, LLC
August 7, 2000
Page 19
only self-employed individuals who are not subject to ERISA. Under ERISA and the
Code, any person who exercises any authority or control respecting the
management or disposition of the assets of a Qualified Plan is considered to be
a fiduciary of such Qualified Plan (subject to certain exceptions not here
relevant).
Furthermore, ERISA and the Code prohibit parties in interest (including
fiduciaries) of a Qualified Plan from engaging in various acts of self-dealing.
To prevent a possible violation of these self-dealing rules, the Manager and its
affiliates may not permit the purchase of Units with assets of any Qualified
Plan (including a Keogh Plan or IRA) if they (i) have investment discretion with
respect to the assets of the Qualified Plan invested in the Company or (ii)
regularly give individualized investment advice which serves as the primary
basis for the investment decisions made with respect to such assets.
Annual Valuation
Fiduciaries of Qualified Plans subject to ERISA are required to
determine annually the fair market value of the assets of such Qualified Plans
as of the close of any such plan's fiscal year. Although the Manager will
provide annually upon the written request of a Member an estimate of the value
of the Units based upon, among other things, outstanding mortgage investments,
it may not be possible to value the Units adequately from year to year, because
there will be no market for them.
Plan Assets Generally
If the assets of the Company are deemed to be "plan assets" under
ERISA, (i) the prudence standards and other provisions of Part 4 of Title 1 of
ERISA applicable to investments by Qualified Plans and their fiduciaries would
extend (as to all plan fiduciaries) to investments made by the Company, (ii)
certain transactions that the Company might seek to enter into might constitute
"prohibited transactions" under ERISA and the Code because the Manager would be
deemed to be a fiduciary of the Qualified Plan Members and (iii) audited
financial information concerning the Company would have to be reported annually
to the Department of Labor.
In 1986, the Department of Labor promulgated final regulations defining
the term "plan assets" (the "Final DOL Regulations"). Under the Final DOL
Regulations, generally, when a plan makes an equity investment in another
entity, the underlying assets of that entity will be considered plan assets
unless (1) equity participation by benefit plan investors is not significant,
(2) the entity is a real estate operating company or (3) the equity interest is
a "publicly-offered security."
(i) Exemption for Insignificant Participation by Qualified Plans. The
Final DOL Regulations provide that the assets of a corporation or Company in
which an employee benefit plan invests would not be deemed to be assets of such
plan if less than 25% of each class of
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DM Mortgage Investors, LLC
August 7, 2000
Page 20
equity interests in the corporation or Company is held in the aggregate by
"benefit plan investors" (including, for this purpose, benefit plans such as
Keogh Plans for owner-employees and IRA's). For purposes of this "25%" rule, the
interests of any person (other than an employee benefit plan investor) who has
discretionary authority or control with respect to the assets of the entity, or
who provides investment advice for a fee (direct or indirect) with respect to
such assets, or any affiliate of such a person, shall be disregarded. Thus,
while the Manager and its affiliates are not prohibited from purchasing Units,
any such purchases will be disregarded in determining whether this exemption is
satisfied. The Company cannot assure "benefit plan investors" that it will
always qualify for this exemption.
(ii) Exemption For a Real Estate Operating Company. The Final DOL
Regulations also provide an exemption for securities issued by a "real estate
operating company." An entity is a "real estate operating company" if at least
50% of its assets valued at cost (other than short-term investments pending
long-term commitment) are invested in real estate which is managed or developed
and with respect to which the entity has the right substantially to participate
directly in the management or development of real estate. The preamble to the
Final DOL Regulations states the Department of Labor's view that an entity would
not be engaged in the management or development of real estate if it merely
services mortgages on real estate. Thus, it is unlikely that the Company would
qualify for an exemption from "plan assets" treatment as a real estate operating
company.
(iii) Exemption for Publicly Offered Securities. Under the Final DOL
Regulations, a "publicly offered security" is a security that is (i) freely
transferable, (ii) part of a class of securities that is owned by 100 or more
investors independent of the issuer and of one another, and (iii) either is (a)
part of a class of securities registered under Section 12(b) or 12(g) of the
Securities Exchange Act of 1934, or (b) sold to the plan as part of an offering
of securities to the public pursuant to an effective registration statement
under the Securities Act of 1933 and the class of securities of which the
security is a part is registered under the Securities Exchange Act of 1934
within 120 days (or such later time as may be allowed by the Securities and
Exchange Commission) after the end of the fiscal year of the issuer during which
the offering of such securities to the public occurred. For purposes of this
definition, whether a security is "freely transferable" is a factual question to
be determined on the basis of all relevant facts and circumstances. If a
security is part of an offering in which the minimum is $10,000 or less,
however, certain customary restrictions on the transfer of partnership interests
necessary to permit partnerships to comply with applicable federal and state
laws, to prevent a termination or reclassification of the entity for federal or
state tax purposes and to meet administrative needs (which are enumerated in the
Final DOL Regulations) will not, alone or in combination, affect a finding that
such securities are freely transferable.
The Units will be sold as part of an offering of securities to the
public pursuant to registration under the Securities Act of 1933, and the
Manager has represented that it will cause the Company to register the Units
under the Securities Exchange Act of 1934 within 120 days (or
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DM Mortgage Investors, LLC
August 7, 2000
Page 21
such later time as may be allowed by the Securities and Exchange Commission)
after the end of the fiscal year of the Company during which the offering of
Units to the public occurred. In addition, the Units will not be subject to any
restrictions on transfer other than those enumerated in the Company's Operating
Agreement, the Final DOL Regulations and referenced in the preceding paragraph.
Based on the foregoing, the Units should be "publicly offered
securities" within the meaning of the Final DOL Regulations. As a result, the
underlying assets of the Company should not be considered to be plan assets
under the Final DOL Regulations.
This opinion is being rendered to the Company in connection with the
disclosure requirements under the Act and will be filed as an exhibit to the
Prospectus. We consent to the reference to our firm in the Prospectus under
"Legal Counsel." In rendering this opinion, we have not been asked to give nor
do we express any opinion as to questions or issues arising out of the
investment by Members in the Company other than those questions specifically
discussed.
In reviewing this opinion, prospective investors should be aware that
this firm represents the Company and the Manager and its affiliates in
connection with the preparation of certain portions of the Registration
Statement and expects to continue to represent the Manager and its affiliates in
other matters.
Very truly yours,
/s/ WENDEL, ROSEN, BLACK & DEAN, LLP
WRB&D:rag
