Income from Freddie Mac trust securities is taxed as ordinary income at your federal marginal rate, with the specifics depending on whether you hold an interest in a grantor trust pass-through or a Real Estate Mortgage Investment Conduit (REMIC). The interest portion of the mortgage payments passes through to you largely unchanged, but original issue discount, premium, market discount, and (for residual holders) excess inclusion rules can shift how much you actually owe. Higher earners also pay a 3.8% net investment income surtax once modified adjusted gross income crosses $200,000 single or $250,000 joint. State and local income taxes usually apply too, because Freddie Mac securities do not carry the state-tax exemption that Treasuries do.
Two Trust Structures Behind the Tax Rules
Freddie Mac buys residential mortgages, pools them, and sells securities backed by those pools. How your income is taxed depends on which of two structures wraps the pool.
A grantor trust gives you an undivided interest in the mortgage pool itself. The income keeps its character on the way through: interest stays interest, principal stays principal, and the trust pays no entity-level tax. Many single-class Freddie Mac participation certificates use this structure.
A REMIC is a multi-class structure that carves the pool’s cash flows into tranches. It issues two kinds of interests: regular interests, which are treated as debt instruments, and a single class of residual interests, which are treated as equity-like claims on whatever cash flow is left after the regular interests are paid. The REMIC itself generally owes no entity-level tax, and income, deductions, and losses flow through to holders under Sections 860A through 860G.1Office of the Law Revision Counsel. 26 U.S. Code 860D – REMIC Defined
What Tax Forms You Should Receive
If you hold a grantor trust pass-through or a REMIC regular interest, expect Form 1099-INT for stated interest and Form 1099-OID for original issue discount, delivered by early February.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses Those figures feed straight into your Form 1040.
Residual interest holders get something different: Schedule Q (Form 1066), which reports your share of the REMIC’s taxable income or loss, expenses, and excess inclusion income. Schedule Q captures characterizations a 1099 cannot.3eCFR. 26 CFR 1.860F-4 – REMIC Reporting Requirements and Other Administrative Rules
Ordinary Interest Income
The bulk of most Freddie Mac security income is stated interest paid by borrowers in the underlying pool. It passes through as ordinary income at your marginal rate and shows up on your 1099-INT for the year it accrues or is paid.
Prepayments complicate the cash flow. When borrowers refinance or pay off early, the pool’s principal balance shrinks faster than the original amortization schedule, and the interest payments calculated on that shrinking balance drop. The character of the income does not change, but your annual taxable income from the security can move around more than fixed-income investors sometimes expect.
Original Issue Discount and Phantom Income
If the security was issued at a price below its stated redemption price at maturity, the shortfall is original issue discount, and it counts as interest. You have to include OID in gross income each year you hold the instrument, whether or not you received cash for it that year.4Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount The allocation uses the constant yield method: OID is spread across accrual periods based on the security’s yield to maturity and its adjusted issue price at the start of each period.5eCFR. 26 CFR 1.1272-1 – Current Inclusion of OID in Income
Investors call the result phantom income. You owe tax on OID that has economically accrued even before any matching cash arrives, and the effect is largest in the early years, when the adjusted issue price is climbing fastest. Form 1099-OID reports the amount to include. For REMIC regular interests, you must use an accrual method for this income even if your other reporting is on a cash basis.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Bond Premium Amortization
Buy a Freddie Mac security above its principal amount and you have paid a premium. For taxable bonds, amortizing that premium against your interest income is an election, not automatic.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses If you elect, each year you offset stated interest by the premium allocated to that period. Take in $1,000 of stated interest and amortize $100 of premium, and you report $900.
You make the election by offsetting interest with premium on a timely filed return for the first year you want it to apply. Once made, it covers all your taxable bonds and is irrevocable without IRS consent. Amortization runs on the constant yield method, which puts slightly more of the premium into the early periods.6eCFR. 26 CFR 1.171-2 – Amortization of Bond Premium Skip the election and the full premium stays in your basis, producing a loss only on sale, redemption, or maturity.
Buying on the Secondary Market
Market Discount
Pay less than the adjusted issue price (original issue price plus previously accrued OID) and the shortfall is market discount. On sale or when principal is returned, gain up to the accrued market discount is recharacterized as ordinary income rather than capital gain.7Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income Because mortgage-backed securities return principal in many installments, each partial principal payment is a partial disposition and pulls its share of accrued market discount into ordinary income.
By default, market discount accrues ratably over the remaining life of the security. You can elect the constant yield method instead, and you can also elect to include market discount in income currently rather than waiting for disposition, which spreads the ordinary income hit rather than concentrating it.
Accrued Interest at Purchase
Buy between payment dates and the price usually includes interest that accrued while the prior holder owned the bond. That interest is the seller’s, not yours. When the next coupon lands and your 1099-INT reports the full amount, subtract the accrued interest you paid at purchase so you are only taxed on what you actually earned during your holding period.
REMIC Regular Interests
REMIC regular interests are treated as debt instruments, so all the OID, market discount, and premium rules above apply.8Office of the Law Revision Counsel. 26 U.S. Code 860B – Taxation of Holders of Regular Interests The distinctive point is that you must use an accrual method for this income even if you otherwise report on cash. Phantom income is therefore a more persistent issue here than with grantor trust pass-throughs.
REMIC Residual Interests and Excess Inclusion Income
Residual interests are the hardest piece of this to hold cleanly. As a residual holder you pick up a daily portion of the REMIC’s taxable income or loss as ordinary income or ordinary loss.9eCFR. 26 CFR 1.860C-1 – Taxation of Holders of Residual Interests The residual is whatever is left after the regular interests are paid, so cash distributions and taxable allocations can diverge sharply. In a REMIC’s early years, high mortgage interest flows first to regular interest holders, and the residual holder’s taxable income can far exceed the cash actually received.
The harshest rule is excess inclusion income. This is the portion of your taxable income from the residual that exceeds a calculated daily accrual, and your taxable income for the year cannot fall below it. Net operating losses and other deductions cannot bring you under that floor.10Office of the Law Revision Counsel. 26 U.S. Code 860E – Treatment of Income in Excess of Daily Accruals on Residual Interests
Two categories of holders face particularly rough treatment. For a tax-exempt organization that holds a residual, the excess inclusion is treated as unrelated business taxable income, overriding the exemption for that income. For non-U.S. investors, excess inclusion income is generally subject to 30% withholding, and tax treaties usually cannot reduce that rate.
Selling a Freddie Mac Security
Calculating Gain or Loss
Start with your original cost. Add OID you have already included in income. Subtract principal payments received and any premium you have amortized against interest. The resulting adjusted basis, set against your sale proceeds, gives you gain or loss. Gain is capital, taxed at long-term rates if you held for more than a year, with one recharacterization: any portion attributable to accrued market discount is ordinary income.7Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
Wash Sales
Sell at a loss and buy a substantially identical security within 30 days before or after the sale, and the wash sale rule disallows the loss.11Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss From Wash Sales of Stock or Securities The disallowed amount rolls into the basis of the replacement, so you defer rather than lose it. For mortgage-backed securities, “substantially identical” is a judgment call. Two pass-throughs backed by different pools with different coupons and weighted average maturities are arguably not identical; two tranches from the same REMIC series likely are. When the call is close, waiting out the 30 days is the safer move.
Inherited Securities
Inherit a Freddie Mac security and your basis generally resets to the fair market value on the date of the decedent’s death.12Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Any unrealized gain or loss in the prior owner’s hands disappears. Going forward, OID, premium, and market discount are calculated as if you had purchased at that fair market value, and any later sale is treated as long-term regardless of your actual holding period.
The 3.8% Net Investment Income Tax
Interest, OID, and capital gains from Freddie Mac securities all count as net investment income for the 3.8% surtax under Section 1411. The tax applies to the lesser of your net investment income or the amount by which modified AGI exceeds the statutory threshold: $200,000 single, $250,000 married filing jointly, $125,000 married filing separately.13Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax Those thresholds have no inflation adjustment and haven’t moved since 2013.
Trusts and estates that hold Freddie Mac securities and retain the income hit the NIIT once undistributed net investment income exceeds the dollar figure where the highest trust bracket starts, which is much lower than the individual thresholds.14Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
State and Local Taxes
Interest on U.S. Treasury securities is exempt from state and local income tax because Treasuries are direct obligations of the United States. Freddie Mac is a government-sponsored enterprise, not the federal government, and its securities are not direct federal obligations. The Supreme Court, in Rockford Life Insurance Co. v. Illinois Department of Revenue, held that government-guaranteed instruments do not qualify for the state-tax exemption when the government acts as a secondary, contingent guarantor rather than the primary obligor.15Justia. Rockford Life Ins. v. Dept. of Revenue Freddie Mac guarantees timely payment on its securities, but the direct promise to pay is not the federal government’s. Income from these securities is therefore generally subject to state and local income tax. Factor that in when comparing after-tax yields against Treasuries.
Where the Tax Factor Data Comes From
Calculating OID, premium amortization, and principal paydowns by hand is not realistic for most holders. Freddie Mac publishes quarterly and annual tax factor files through its Capital Markets website, with separate files for single-class certificates, multiclass certificates, REMICs, and widely held fixed investment trusts (WHFITs).16Freddie Mac. Tax Information – Capital Markets Brokerages generally use these files to produce your 1099s, but the raw data is public if you hold securities directly or want to check your broker’s numbers.