Income from a Freddie Mac mortgage-backed security is taxed as ordinary interest at your federal marginal rate, and the Freddie Mac trust income tax rules you follow depend on whether your security is held through a grantor trust or a Real Estate Mortgage Investment Conduit (REMIC). Interest from the underlying mortgage pool passes through to you, but original issue discount, premium amortization, market discount, and (for REMIC residual holders) excess inclusion rules can change how much of that income is taxable in a given year. Higher earners also owe a 3.8% surtax on net investment income above $200,000 for single filers or $250,000 for joint filers. And unlike Treasury interest, this income is generally subject to state and local tax.
Grantor Trusts and REMICs
Freddie Mac buys residential mortgages, pools them, and sells securities backed by the pools. Two trust structures carry the cash flow out to you, and they are taxed differently.
A grantor trust gives you an undivided interest in the pool. Income keeps its character on the way through: interest stays interest, principal stays principal, and the trust itself pays no tax. Many single-class Freddie Mac participation certificates use this structure.
A REMIC splits the pool’s cash flows into tranches with different payment priorities. It has two kinds of interests: regular interests, which are treated as debt instruments, and a single class of residual interests, treated as equity-like claims on whatever is left after the regular interests are paid. The REMIC pays no entity-level tax but passes income, losses, and deductions through under the rules in Internal Revenue Code Sections 860A through 860G.1Office of the Law Revision Counsel. 26 U.S. Code 860D – REMIC Defined
Tax Forms You Should Expect
If you hold a grantor trust pass-through or a REMIC regular interest, you should receive Form 1099-INT for stated interest and Form 1099-OID for any original issue discount, generally by early February.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses Those forms feed directly into your Form 1040.
REMIC residual interest holders receive Schedule Q (Form 1066) instead. Schedule Q details your share of the REMIC’s taxable income or net loss, expenses, and excess inclusion income, which a standard 1099 generally can’t capture.3eCFR. 26 CFR 1.860F-4 – REMIC Reporting Requirements and Other Administrative Rules
Stated Interest and Prepayments
The largest piece of most Freddie Mac security income is the stated interest paid by homeowners in the pool. It passes through as ordinary income taxed at your marginal rate, and you report the amount shown on your 1099-INT for the year.
Prepayments complicate the cash flow. When borrowers refinance or pay off early, the pool’s principal shrinks faster than the amortization schedule predicted, and your interest payments decline because they’re calculated on a smaller balance. The character of the income doesn’t change, but your annual taxable interest can swing in ways fixed-income investors don’t always expect.
Original Issue Discount and Phantom Income
If a Freddie Mac security was issued below its stated redemption price at maturity, the gap is original issue discount (OID). OID is treated as interest, and you must include it in gross income each year you hold the instrument, even if no cash arrives that year.4Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount The allocation follows the constant yield method: OID is spread across accrual periods based on the yield to maturity and the adjusted issue price at the start of the period.5eCFR. 26 CFR 1.1272-1 – Current Inclusion of OID in Income
This is where phantom income shows up. You owe tax on OID that has economically accrued whether or not you’ve received cash, and the effect is largest in the early years when the adjusted issue price is growing fastest. For REMIC regular interests, you must use the accrual method for this income even if you otherwise report on a cash basis.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
Bond Premium Amortization
If you bought the security above its principal amount, you paid a premium. For taxable bonds like these, amortizing the premium is an election rather than an automatic adjustment.2Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses If you elect, you offset part of your stated interest each year with that period’s premium: $1,000 of interest minus $100 of amortized premium leaves $900 of taxable interest.
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 taxable bonds you hold and is irrevocable without IRS consent. Amortization follows the constant yield method.6eCFR. 26 CFR 1.171-2 – Amortization of Bond Premium Skip the election and the full premium stays in your basis, surfacing as a loss only when the security is sold, redeemed, or matures.
Buying on the Secondary Market
Market Discount
Buy a security below its adjusted issue price (original issue price plus previously accrued OID) and the difference is market discount. When you later sell or receive principal payments, gain is treated as ordinary income up to the accrued market discount, with anything beyond that taxed as capital gain if the security is a capital asset in your hands.7Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income
For mortgage-backed securities, each partial principal payment is a partial disposition, so you include the payment in ordinary income up to the accrued market discount attributable to it.7Office of the Law Revision Counsel. 26 USC 1276 – Disposition Gain Representing Accrued Market Discount Treated as Ordinary Income By default market discount accrues ratably over the remaining life, but you can elect the constant yield method, or elect to include the discount in income currently and avoid a larger ordinary income hit on disposition.
Accrued Interest Paid at Purchase
Buy between payment dates and your purchase price typically includes interest that accrued before you owned the security. That accrued interest belongs to the seller. When the next full payment arrives and your 1099-INT shows the gross amount, subtract the accrued interest you paid at purchase so you’re taxed only on interest earned while you held it.
REMIC Regular Interests
REMIC regular interests are treated as debt, so the OID, market discount, and premium rules all apply.8Office of the Law Revision Counsel. 26 U.S. Code 860B – Taxation of Holders of Regular Interests One structural difference matters: you must use an accrual method for this income even if you report everything else on a cash basis. Phantom income is therefore a more persistent issue for regular interest holders than for grantor trust pass-through holders. Your 1099-OID will report OID and interest that accrued during your holding period, and if you bought at a premium or acquisition premium you’ll adjust those figures under the constant yield method.
REMIC Residual Interests and Excess Inclusion
Residual interests are the hardest piece of this tax regime. A residual holder takes into account a daily portion of the REMIC’s taxable income or net loss as ordinary income or loss.9eCFR. 26 CFR 1.860C-1 – Taxation of Holders of Residual Interests Because the residual captures whatever is left after the regular interests are paid, cash distributions can diverge sharply from taxable income allocations. In the early years of a REMIC, the taxable income allocation to a residual holder often far exceeds the cash actually distributed.
Then there is excess inclusion income, which is the portion of your residual-interest taxable income that exceeds a calculated daily accrual amount. Your taxable income for the year cannot be reduced below your excess inclusion amount, so net operating losses and other deductions can’t offset it below that floor.10Office of the Law Revision Counsel. 26 U.S. Code 860E – Treatment of Income in Excess of Daily Accruals on Residual Interests A tax-exempt organization that holds a residual interest treats the excess inclusion as unrelated business taxable income. For non-U.S. investors, excess inclusion is generally subject to 30% withholding, and treaty benefits typically cannot reduce the rate.
Selling, Wash Sales, and Inherited Securities
When you sell, your adjusted basis is your purchase price plus OID already included in income, minus principal payments received and any premium you’ve amortized. Compare that to your sale proceeds to get your gain or loss. Gain is capital gain, long-term if you held more than a year, except that 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
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 loss is added to the basis of the replacement, so it’s deferred rather than lost. “Substantially identical” is a judgment call for MBS: two pass-throughs backed by different pools with different coupons and weighted average maturities are arguably not identical, but two tranches from the same REMIC series likely are. When it’s close, wait out the window.
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 Unrealized gain or loss in the decedent’s hands disappears, and future OID, premium, or market discount is calculated as though you had purchased at that date for fair market value. A later sale is long-term regardless of how long you personally held the security.
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 IRC Section 1411. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income 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 These thresholds are not indexed for inflation and have not changed since the tax took effect in 2013.
Trusts and estates that hold Freddie Mac securities and retain the income face the NIIT once undistributed net investment income exceeds the threshold where the highest trust bracket begins, which is far lower than the individual thresholds.14Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
State and Local Tax
Freddie Mac security income is generally subject to state and local income tax. Treasury interest is exempt from state tax because Treasuries are direct obligations of the United States; Freddie Mac is a government-sponsored enterprise, and its securities are not direct federal obligations.
The Supreme Court drew this line in Rockford Life Insurance Co. v. Illinois Department of Revenue, holding that government-guaranteed securities do not qualify for the state tax exemption where the government’s role is a secondary, contingent guarantee rather than a primary promise to pay specified sums on specified dates.15Justia. Rockford Life Ins. v. Dept. of Revenue Freddie Mac guarantees timely payment of principal and interest, but the United States is not the one making that promise, so the exemption doesn’t reach these securities. Factor that in when comparing after-tax yields against Treasuries.
Where to Get the Numbers
Calculating taxable income on a Freddie Mac security by hand is not realistic for most investors. Freddie Mac publishes quarterly and annual tax factor files through its Capital Markets website covering single-class certificates, multiclass certificates, REMIC tranches, and widely held fixed investment trust (WHFIT) interests.16Freddie Mac. Tax Information – Capital Markets These files carry the pool-level and tranche-level data needed to calculate OID accruals, principal paydowns, and premium amortization. Most brokerages use them to generate your 1099s, but if you hold directly or need to verify what a broker reported, the raw data is available for download.