Sept. 15 (Bloomberg) -- The U.S. Treasury Department adopted rules letting lenders revise commercial real estate loans without triggering tax penalties in an effort to stem a rise in defaults.

The guidance would ease requirements for collateral and other guarantees in many cases. Borrowers in investor pools known as Real Estate Mortgage Investment Conduits would be allowed to refinance some loans without paying tax penalties. The rules were urged by the Real Estate Roundtable trade association while the Commercial Mortgage Securities Association favored narrower revisions.

“Changes to the regulations are necessary to better accommodate evolving practices in the commercial-mortgage industry,” the regulations say. “These changes will affect lenders, borrowers, servicers and sponsors of securitizations of mortgages” in Real Estate Mortgage Investment Conduits. Those are tax-advantaged organizations used for pooling investments in mortgage-backed securities.

The rules, effective Sept. 16, were issued as Wall Street braces for a refinancing crisis in commercial real estate. The default rate on commercial mortgages held by U.S. banks more than doubled in the second quarter to 2.88 percent, according to New York-based Real Estate Econometrics. It may reach 4.1 percent by year’s end, the highest since 1993.

More Than $1 Trillion

Deutsche Bank said in an April report that more than $1 trillion in commercial loans that are scheduled to mature over the next decade will involve refinancing difficulties.

Sam Chandan, chief economist at Real Estate Econometrics LLC, said the IRS guidance is important even though it is limited to investment pools and not loans held by banks.

Banks, which don’t have the same tax-advantaged treatment, held $1.09 trillion of commercial mortgages in the second quarter of this year and $213.5 billion in mortgages for multi- family housing, according to the Federal Reserve. Commercial mortgage asset-backed securities totaled about $682 billion in the quarter.

“This change removes a significant disincentive for the revision of commercial mortgages otherwise at risk of default,” Chandan wrote in a note to clients today. “By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular.”

Tax Flexibility

The Treasury today also asked for comments about extending tax flexibility to loan revisions for properties held by other types of investment trusts.

The Treasury issued a so-called revenue procedure that explains how loan modifications can be structured to avoid converting the investor pools into a taxable entity, which investors, lenders and the government all say they want to avoid.

The revenue procedure says loan modifications can avoid tax penalties in certain cases where lenders foresee a “significant risk of default” within a year. Earlier proposals had allowed such relief for risks stretching as long as five years in the future, while groups such as the Commercial Mortgage Securities Association advocated shorter time frames.

“This is not a free ticket to get a loan modification when you’re two or three or four years out” from a loan maturing, said Patrick Sargent, president of the commercial mortgage group and a partner at the Dallas law firm Andrews & Kurth LLP. “I think the Treasury took to heart some of the concerns that we raised.”

Roundtable Plea

The Real Estate Roundtable had sought more flexibility than the new rules offer. Jeffrey DeBoer, president of the Real Estate Roundtable, didn’t immediately return a call seeking comment.

Steven Wechsler, president and chief executive of the National Association of Real Estate Investment Trusts, said his organization “strongly endorses” the new rules.

“This new guidance provides servicers with a useful tool to assist the workout process, and we look to them to utilize it in a reasonable manner to support the nation’s efforts to recover from the financial crisis and the Great Recession,” Wechsler said in a statement.

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net.

Last Updated: September 15, 2009 16:31 EDT