[Federal Register Volume 61, Number 107 (Monday, June 3, 1996)]
[Proposed Rules]
[Pages 27834-27850]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-13719]
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DEPARTMENT OF THE TREASURY
26 CFR Part 1
[IA-292-84]
RIN 1545-AU11
Section 467 Rental Agreements
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
treatment of rent and interest under certain agreements for the lease
of tangible property. The proposed regulations apply to certain rental
agreements that provide increasing or decreasing rents, or deferred or
prepaid rent. This document also provides notice of a public hearing on
these regulations.
DATES: Written comments, requests to appear and outlines of topics to
be discussed at the public hearing scheduled for September 25, 1996,
must be received by September 3, 1996.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (IA-292-84), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (IA-292-84), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. The public hearing will be held in the Commissioner's
Conference Room, 3rd Floor, 1111 Constitution Avenue NW., Washington,
DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Forest Boone of the Office of Assistant Chief Counsel (Income Tax and
Accounting) at (202) 622-4960; concerning submissions and the public
hearing, Mike Slaughter at (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) relating to section 467 of the Internal
Revenue Code (Code). This section was added by the Tax Reform Act of
1984. In general, section 467 requires parties to certain rental
agreements to accrue rent and interest in accordance with the rules
specified in section 467. These proposed regulations provide guidance
regarding the applicability of section 467, and the amount of rent and
interest required to be accrued under section 467. No inference should
be drawn from any provision in the proposed regulations concerning
whether an arrangement constitutes a lease for Federal income tax
purposes.
Explanation of Provisions
1. Section 467 Rental Agreements
Section 467(a) provides that, if a rental agreement is a section
467 rental agreement, the lessor and lessee must take into account for
a taxable year the section 467 rent and the section 467 interest for
that year. A section 467 rental agreement is a rental agreement that
has increasing or decreasing rents, or prepaid or deferred rents. A
rental agreement has increasing or decreasing rents if the annualized
fixed rent allocated to any rental period exceeds the annualized fixed
rent allocated to any other rental period in the lease term. The
proposed regulations provide that a rent holiday at the beginning of
the lease term is disregarded in determining whether the rental
agreement has increasing or decreasing rent if the rent holiday period
is three months or less.
In addition, the proposed regulations provide that a rental
agreement has increasing or decreasing rent if it requires (or may
require) the payment of contingent rent, other than contingent rent
that is contingent due to (a) a provision computing rent based on a
percentage of the lessee's gross or net receipts (but only if the
percentage does not vary throughout the term of the lease); (b)
adjustments based on a reasonable price index; or (c) a provision
requiring the lessee to pay real estate taxes, insurance premiums,
maintenance costs, or any other cost (other than a debt service cost)
that relates to the leased property and is not within the control of
the lessor or lessee or a person related to the lessor or lessee.
Section 467(d)(1)(A) provides that a rental agreement has deferred
rent if rent allocated to a calendar year is payable after the close of
the succeeding calendar year. The proposed regulations provide that
there is prepaid rent if rent allocated to a calendar year is payable
prior to the beginning of the prior calendar year.
Section 467(d)(2) provides that section 467 does not apply to a
rental agreement if the aggregate rental payments and other
consideration to be received for the use of the property do not exceed
$250,000.
2. Section 467 Rent
Under the proposed regulations, the section 467 rent for a taxable
year is the sum of the fixed rent for any rental periods that begin and
end in the taxable year, a ratable portion of the fixed rent for other
rental periods beginning or ending in the taxable year, and any
contingent rent that accrues in the taxable year. In general, the
proposed regulations provide that rental periods may be of any length
as long as (a) the rental periods are one year or less, cover the
entire lease term, and do not overlap, and (b) each scheduled
[[Page 27835]]
payment under the rental agreement occurs within 30 days of the
beginning or end of a rental period. The amount of fixed rent for a
rental period depends on the terms of the rental agreement.
A. Disqualified Leaseback or Long-Term Agreement
Section 467 provides that if the section 467 rental agreement is a
leaseback or long-term agreement and has increasing or decreasing rents
a principal purpose of which is tax avoidance (a disqualified leaseback
or long-term agreement), the fixed rent for each rental period is the
constant rental amount. The proposed regulations provide that (a) the
Commissioner, rather than the parties to the rental agreement, will
determine whether a rental agreement is a disqualified leaseback or
long-term agreement and (b) a rental agreement will not be disqualified
unless it requires more than $2,000,000 in rental payments and other
consideration. The proposed regulations also provide that, if either
the lessor or the lessee is not subject to Federal income tax on its
income or is a tax- exempt entity (within the meaning of section
168(h)(2)), the rental agreement will be closely scrutinized, and clear
and convincing evidence will be required to establish that tax
avoidance is not a principal purpose for providing increasing or
decreasing rent.
Section 467(b)(5) provides that regulations should set forth
circumstances under which section 467 rental agreements will not be
treated as disqualified leasebacks or long-term agreements, including
circumstances relating to the use of price indices, percentage rents,
reasonable rent holidays, or changes in amounts paid to third parties.
In addition to these safe harbors, which have been included in the
proposed regulations, the Conference Committee Report stated that the
Committee anticipated that regulations under section 467 would adopt
standards under which leases providing for fluctuations in rents by no
more than a reasonable percentage above or below the average rent over
the term of the lease will be deemed not motivated by tax avoidance.
The report cited the standards for advance rulings on leveraged lease
transactions set forth in Rev. Proc. 75-21 (1975-1 C.B. 715), and
stated that such standards may not be appropriate for real estate
leases. H.R. Rep. No. 861, 98th Cong., 2d Sess. 893 (1984).
The proposed regulations contain a safe harbor providing that tax
avoidance will not be considered to be a principal purpose for
providing increasing or decreasing rents if the rents allocable to each
calendar year of the lease do not vary from the average annual rents
over the entire lease term by more than 10 percent. This safe harbor is
based on, but is not identical to, the safe harbor contained in Rev.
Proc. 75-21. The proposed regulations do not provide a safe harbor
specifically applicable to real estate leases. The IRS and the Treasury
Department invite comments regarding the nature and extent of a safe
harbor for such leases, as well as comments on whether additional safe
harbors are appropriate either generally or for particular industries.
Section 467(e)(1) provides that the constant rental amount is the
amount that, if paid at the end of each rental period, would result in
a present value equal to the present value of all amounts payable under
the disqualified leaseback or long-term agreement. If constant rental
accrual is required, all rental periods must be equal in length except
for an initial or final short rental period.
B. Agreements Without Adequate Interest
If the section 467 rental agreement is not a disqualified leaseback
or long-term agreement and does not provide adequate interest for
prepaid or deferred rent, the proposed regulations provide that the
fixed rent for each rental period is the proportional rental amount.
The proportional rental amount is the fixed rent allocated to the
rental period under the rental agreement multiplied by a fraction, the
numerator of which is the present value of the amounts payable as fixed
rent and interest on fixed rent under the rental agreement and the
denominator of which is the present value of the fixed rent allocated
to each rental period under the rental agreement. Under the proposed
regulations, a rental agreement provides adequate interest if (a) no
deferred or prepaid rent is required under the agreement, (b) there is
deferred or prepaid rent but the agreement requires the payment of
interest at an adequate single fixed rate, or (c) there is deferred or
prepaid rent but the present values of rent payments and rent accruals
meet certain tests set forth in the proposed regulations.
C. Rental Agreement Accrual
The proposed regulations provide that if neither the constant
rental amount nor the proportional rental amount is required to be
accrued, the fixed rent for a rental period is the fixed rent allocated
to that rental period in accordance with the section 467 rental
agreement. The amount of fixed rent allocated to a rental period by the
rental agreement depends on whether the agreement provides a specific
allocation of fixed rent. The proposed regulations provide that if a
rental agreement provides a specific allocation of fixed rent, the
amount of fixed rent allocated to each rental period during the lease
term is the amount of rent allocated to that period by the agreement.
For this purpose, a rental agreement that allocates rent to a period is
treated as allocating rent ratably within that period. Thus, if a
rental agreement provides that $120,000 is allocated to each calendar
year in the lease term, $10,000 of rent is allocated to each calendar
month. In general, under the proposed regulations, a rental agreement
specifically allocates fixed rent if the agreement unambiguously
specifies, for periods of no longer than a year, a fixed amount of rent
for which the lessee becomes liable on account of the use of the
property during that period.
If a section 467 rental agreement does not provide a specific
allocation of fixed rent, the amount of fixed rent allocated to a
rental period is the amount of fixed rent payable during that rental
period.
3. Section 467 Interest
The section 467 interest for a taxable year is the sum of the
interest on fixed rent for any rental period that begins and ends in
the taxable year, a ratable portion of the interest on fixed rent for
any other rental period beginning or ending in the taxable year, and
any interest that accrues on contingent rent during the taxable year.
If a section 467 rental agreement provides an adequate stated rate of
interest, the interest on fixed rent for a rental period is the
interest provided in the agreement for that period. If no adequate
stated rate of interest is provided, the interest on fixed rent for a
rental period is determined under the section 467 loan rules.
Under the proposed regulations, there is a deemed loan (a section
467 loan) in a rental period if, at the beginning of that period, there
is a difference between the amount of fixed rent payable under the
section 467 rental agreement and the amount of fixed rent required to
be accrued under the proposed regulations. For rental periods in which
there is a section 467 loan, the interest for the rental period is
equal to the product of the principal balance of the section 467 loan
at the beginning of the rental period and the yield of the section 467
loan.
In general, the principal balance of a section 467 loan as of the
beginning of any rental period is the difference between the cumulative
amount of accrued fixed rent and interest and the
[[Page 27836]]
cumulative amount of fixed rent and interest payable under the section
467 rental agreement. The yield of a section 467 loan is the discount
rate at which the sum of the present values of all amounts payable by
the lessee as fixed rent and interest on fixed rent, plus the sum of
the negative present values of all amounts payable by the lessor as
interest on prepaid fixed rent, equals the sum of the present values of
the fixed rent allocated to the rental periods.
The amount constituting a section 467 loan may be either positive
or negative. For purposes of applying any aspect of the proposed
regulations relating to a section 467 loan, the principal balance of
the loan should be clearly identified as either positive or negative.
For example, if the principal balance of a loan at the beginning of a
rental period is a negative number, the interest on the loan for that
period will also be a negative number.
4. Rental Agreements With Variable Rates of Interest
The proposed regulations provide rules for section 467 rental
agreements that provide for certain types of variable rates of
interest. The rules in the proposed regulations are similar to the
rules provided in Sec. 1.1275-5 for the computation of original issue
discount (OID) for variable rate debt instruments providing for
interest at qualified floating rates. Under the proposed regulations, a
rental agreement provides variable interest if the rental agreement
provides for stated interest that is paid or compounded at least
annually at a rate or rates that meet the requirements of Sec. 1.1275-
5(a)(3)(i) (A) or (B) and Sec. 1.1275-5(a)(4). If a rental agreement
provides for fluctuations in interest other than pursuant to one or
more qualified floating rates the interest will be subject to the rules
for contingent payments.
Under the proposed regulations, if a section 467 rental agreement
provides variable interest, the fixed rate substitutes (determined in
the same manner as under Sec. 1.1275-5(e) treating the agreement date
as the issue date) for the variable rates of interest called for by the
agreement must be used in computing the proportional rental amount, the
constant rental amount, the principal balance of a section 467 loan,
and the yield of a section 467 loan. Further, in determining the
interest on fixed rent for any rental period, the variable interest
adjustment amount must be taken into account. The variable interest
adjustment amount for a rental period is the difference between (a) the
amount of interest that would have accrued during the rental period
under the terms of the rental agreement, and (b) the amount of interest
that would have accrued during the rental period under the terms of the
agreement using the fixed rate substitutes.
5. Rental Agreements With Contingent Payments
The proposed regulations reserve on the issue of the section 467
treatment of contingent rent. The IRS and the Treasury Department
anticipate that regulations addressing this issue will provide rules
for contingent rent similar to those provided for computing OID for
contingent payment debt instruments in Sec. 1.1275-4. The IRS and the
Treasury Department invite comments regarding the application of the
Sec. 1.1275-4 rules to section 467 rental agreements.
6. Recapture
Section 467(c) provides that if a section 467 rental agreement is a
leaseback or long-term agreement providing for increasing rent but is
not subject to constant rental accrual, and the property subject to the
agreement is disposed of, a portion of the gain realized on the
disposition is required to be recaptured by the lessor as ordinary
income. Accordingly, a leaseback or long-term agreement could be
subject to section 467(c) even though it does not require more than
$2,000,000 in rental payments and other consideration and is thus not
subject to constant rental accrual.
The recapture amount is equal to the lesser of the prior
understated inclusions or the section 467 gain. The prior understated
inclusions are the excess of (a) the aggregate amount of section 467
rent and section 467 interest for the period during which the lessor
held the property, determined as if the section 467 rental agreement
were a disqualified leaseback or long-term agreement, over (b) the
aggregate amount of section 467 rent and section 467 interest accrued
by the lessor during that period. The section 467 gain is the excess of
(a) the amount realized from the disposition, over (b) the sum of the
adjusted basis of the property and the amount of any gain from the
disposition that is treated as ordinary income under any provision of
subtitle A of the Code other than section 467(c) (e.g., section 1245 or
1250).
In the case of a disposition that is not a sale, exchange, or
involuntary conversion, the section 467 gain is the excess of (a) the
fair market value of the property on the date of disposition, over (b)
the sum of the adjusted basis of the property and the amount of any
gain from the disposition that is treated as ordinary income under Code
provisions other than section 467(c). The regulations provide
exceptions to this recapture rule for dispositions by gift, transfers
at death, and certain tax-free transactions.
7. Other Disposition Rules
Under the proposed regulations, if property subject to a section
467 rental agreement is sold, exchanged, or otherwise disposed of, the
section 467 rent for a period is taken into account by the owner of the
property during the period. The lessee, however, must continue to take
section 467 rent and section 467 interest into account without regard
to the change of ownership.
Further, if there is a sale, exchange or other disposition of
property subject to a section 467 rental agreement, the beginning
balance of the transferor's section 467 loan after the transfer equals
the net present value at the time of the transfer of all amounts
subsequently payable as fixed rent and interest on fixed rent to the
transferor and all amounts subsequently payable as interest on prepaid
fixed rent by the transferor. The transferor must continue to take into
account interest on the transferor's section 467 loan balance after the
transfer. The beginning balance of the transferee's section 467 loan is
equal to the principal balance of the section 467 loan immediately
before the transfer reduced by the beginning balance of the
transferor's section 467 loan after the transfer. Amounts payable to
the transferor after the transfer are not taken into account in
adjusting the transferee's section 467 loan balance.
Finally, under the proposed regulations, if there is a disposition
of property subject to a section 467 rental agreement, the transferor
and transferee must treat the beginning balance of the transferee's
section 467 loan as a liability that is either assumed in connection
with the transfer of the property or secured by the property acquired
subject to the liability (if negative) and as a reduction in the
consideration for the transfer of the property (if positive). In the
case of a positive section 467 loan balance, a reduction in the
consideration for the transfer of the property is appropriate because
the transferee will also be deemed to have acquired an asset other than
the property itself, i.e., the loan, and a portion of the total
consideration should be allocated to the loan balance. Similar rules
apply to transfers of leasehold interests under section 467 rental
agreements.
In order to account for any timing differences that may exist
between a schedule of payments under a section
[[Page 27837]]
467 rental agreement and a separate schedule providing an allocation of
rent, it will be necessary, in appropriate cases, to determine the
amount of a section 467 loan balance even if the rental agreement does
not have either deferred or prepaid rent or if the rental agreement has
deferred or prepaid rent but provides adequate stated interest. The
proposed regulations provide that the section 467 loan rules apply to
rental agreements described in the preceding sentence, but only for
purposes of the rules relating to dispositions of property subject to a
section 467 rental agreement and the rules relating to transfers of
leasehold interests under a section 467 rental agreement.
Although the proposed regulations contain rules applicable to all
dispositions of property subject to a section 467 rental agreement and
all transfers of leasehold interests under a section 467 rental
agreement, the regulations reserve guidance on the question of whether
special rules should be provided for transfers of property and
leasehold interests in transactions in which gain or loss is not
recognized in whole or in part. Examples of these transactions would
include transfers between a partnership and one or more of its
partners, transfers to a controlled corporation under section 351,
transfers pursuant to a reorganization described in section 368(a),
like-kind exchanges subject to section 1031, and transfers by gift or
upon the death of the owner of the property or the holder of the
leasehold interest. The IRS and Treasury Department invite comments on
whether special rules should be provided for any of these transactions.
8. Proposed Effective Date
The regulations are proposed to be effective for (1) rental
agreements entered into after the date that final regulations under
section 467 are published and (2) disqualified leasebacks and long-term
agreements entered into after June 3, 1996. No inference should be
drawn from the proposed effective date concerning the treatment of
rental agreements entered into before the regulations are applicable.
Moreover, the IRS will, in appropriate circumstances, apply the
provisions of section 467 requiring constant rental accrual to rental
agreements entered into on or before June 3, 1996.
9. Issues Not Addressed
The proposed regulations do not address the application of section
467 to payments for services. The IRS and the Treasury Department
invite comments on the appropriate scope of rules under section 467 for
transactions involving deferred payments for services in light of the
scope of section 404. In addition, the IRS and the Treasury Department
invite comments on whether rules should be provided for transactions
involving prepayments for services.
The proposed regulations do not address the application of section
467 to transactions sometimes referred to as ``lease strips'' or
``stripping transactions'', as described in Notice 95-53 (1995-44
I.R.B. 21). Notice 95-53 provides that regulations will be issued
pursuant to section 7701(l) (and, as appropriate, other sections of the
Code) recharacterizing stripping transactions. The IRS and the Treasury
Department invite comments on whether rules should be provided that
would apply section 467 to such transactions.
The proposed regulations do not provide for an adjustment to
section 467 rent and interest where a section 467 rental agreement is
modified. The IRS and the Treasury Department invite comments on the
appropriate treatment of the lessor and lessee in these cases.
The proposed regulations do not provide rules addressing the
treatment of payments by the lessor to induce a lessee to enter into a
rental agreement.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these proposed regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small businesses.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for September 25, 1996 at 10
a.m. in the Commissioner's Conference Room, 1111 Constitution Avenue
NW., Washington, DC. Because of access restrictions, visitors will not
be admitted beyond the Internal Revenue Building lobby more than 15
minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons
that wish to present oral comments at the hearing must submit written
comments and submit an outline of the topics to be discussed and the
time to be devoted to each topic by September 3, 1996. A period of 10
minutes will be allotted to each person for making comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these proposed regulations is Forest Boone
of the Office of Assistant Chief Counsel (Income Tax and Accounting).
However, other personnel from the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.467-1 is also issued under 26 U.S.C. 467.
Section 1.467-2 is also issued under 26 U.S.C. 467.
Section 1.467-3 is also issued under 26 U.S.C. 467.
Section 1.467-4 is also issued under 26 U.S.C. 467.
Section 1.467-5 is also issued under 26 U.S.C. 467.
Section 1.467-6 is also issued under 26 U.S.C. 467.
Section 1.467-7 is also issued under 26 U.S.C. 467.
Section 1.467-8 is also issued under 26 U.S.C. 467.
* * * * *
Par. 2. In Sec. 1.61-8, the first sentence of paragraph (b) is
revised to read as follows:
Sec. 1.61-8 Rents and royalties.
* * * * *
(b) * * * Except as provided in section 467 and the regulations
thereunder, gross income includes advance rentals, which must be
included in income for the year of receipt regardless of the period
covered
[[Page 27838]]
or the method of accounting employed by the taxpayer. * * *
* * * * *
Par. 3. In Sec. 1.451-1, paragraph (g) is added to read as follows:
Sec. 1.451-1 General rule for taxable year of inclusion.
* * * * *
(g) Timing of income from section 467 rental agreements. For the
timing of income with respect to section 467 rental agreements, see
section 467 and the regulations thereunder.
Par. 4. Section 1.461-1 is amended by:
1. Adding a sentence at the end of paragraph (a)(1).
2. Adding paragraph (a)(2)(iii)(E).
The additions read as follows:
Sec. 1.461-1 General rule for taxable year of deduction.
(a) * * * (1) * * * See section 467 and the regulations thereunder
for rules under which a liability arising out of the use of property
pursuant to a section 467 rental agreement is taken into account.
(2) * * *
(iii) * * *
(E) Except as otherwise provided by regulations or other published
guidance issued by the Commissioner, in the case of a liability arising
out of the use of property pursuant to a section 467 rental agreement,
the all events test (including economic performance) is considered met
in the taxable year in which the liability is to be taken into account
under section 467 and the regulations thereunder.
* * * * *
Par. 5. Section 1.461-4 is amended by:
1. Revising the heading of paragraph (d)(3)(ii).
2. Redesignating the text of paragraph (d)(3)(ii) following the
heading as paragraph (d)(3)(ii)(A) and adding a heading for newly
designated paragraph (d)(3)(ii)(A).
2. Adding paragraph (d)(3)(ii)(B).
3. Adding sentence at the end of the introductory text of paragraph
(d)(7).
The revisions and additions read as follows:
Sec. 1.461-4 Economic performance.
* * * * *
(d) * * *
(3) * * *
(ii) Exceptions--(A) Volume, frequency of use, or income. * * *
(B) Section 467 rental agreements. In the case of a liability
arising out of the use of property pursuant to a section 467 rental
agreement, economic performance occurs as provided in Sec. 1.461-
1(a)(2)(iii)(E).
* * * * *
(7) * * * Assume further that the examples do not involve section
467 rental agreements and, therefore, section 467 is not applicable.
* * * * *
Par. 6. Sections 1.467-0 through 1.467-8 are added to read as
follows:
Sec. 1.467-0 Table of contents.
This section lists the major captions that appear in Secs. 1.467-1
through 1.467-8.
Sec. 1.467-1 Treatment of lessors and lessees generally.
(a) Overview.
(1) In general.
(2) Cases in which rules are inapplicable.
(3) Limited effect for rental agreements with total rents
between $250,000 and $2,000,000.
(4) Summary of rules.
(i) Basic rules.
(ii) Special rules.
(b) Method of accounting for section 467 rental agreements.
(c) Section 467 rental agreements.
(1) In general.
(2) Increasing or decreasing rent.
(i) Fixed rent.
(A) In general.
(B) Certain rent holidays disregarded.
(ii) Fixed rent allocated to a rental period.
(A) Specific allocation.
(1) In general.
(2) Rental agreements specifically allocating fixed rent.
(B) No specific allocation.
(iii) Contingent rent.
(A) In general.
(B) Certain contingent rent disregarded.
(3) Deferred or prepaid rent.
(i) Deferred rent.
(ii) Prepaid rent.
(iii) Rent allocated to a calendar year.
(iv) Examples.
(4) Rental agreements involving total payments of $250,000 or
less.
(i) In general.
(ii) Special rules in computing amount described in paragraph
(c)(4)(i).
(d) Section 467 rent.
(1) In general.
(2) Fixed rent for a rental period.
(i) Constant rental accrual.
(ii) Proportional rental accrual.
(iii) Section 467 rental agreement accrual.
(e) Section 467 interest.
(1) In general.
(2) Interest on fixed rent for a rental period.
(i) In general.
(ii) Section 467 rental agreements with adequate interest.
(3) Treatment of interest.
(f) Modification of a rental agreement.
(g) Treatment of amounts payable by lessor to lessee.
(1) Interest.
(2) Other amounts. [Reserved]
(h) Meaning of terms.
(i) [Reserved]
(j) Computational rules.
(1) Counting conventions.
(2) Conventions regarding timing of rent and payments.
(i) In general.
(ii) Time amount is payable.
(3) Annualized fixed rent.
(4) Allocation of fixed rent within a period.
(5) Rental period length.
Sec. 1.467-2 Rent accrual for section 467 rental agreements
without adequate interest.
(a) Section 467 rental agreement for which proportional rental
accrual is required.
(b) Adequate interest on fixed rent.
(1) In general.
(2) Section 467 rental agreements that provide for a variable
rate of interest.
(c) Computation of proportional rental amount.
(1) In general.
(2) Section 467 rental agreements that provide for a variable
rate of interest.
(d) Present value.
(e) Applicable Federal rate.
(1) In general.
(2) Source of applicable Federal rates.
(3) 110 percent of applicable Federal rate.
(4) Term of the section 467 rental agreement.
(i) In general.
(ii) Section 467 rental agreements with variable interest.
(f) Examples.
Sec. 1.467-3 Disqualified leasebacks and long-term agreements.
(a) General rule.
(b) Disqualified leaseback or long-term agreement.
(1) In general.
(2) Leaseback.
(3) Long-term agreement.
(i) In general.
(ii) Statutory recovery period.
(A) In general.
(B) Special rule for leases of properties having different
statutory recovery periods.
(c) Tax avoidance as principal purpose for increasing or
decreasing rent.
(1) In general.
(2) Safe harbors.
(d) Calculating constant rental amount.
(1) In general.
(2) Initial or final short periods.
(3) Method to determine constant rental amount; no short
periods.
(i) Step 1.
(ii) Step 2.
(iii) Step 3.
(e) Example.
Sec. 1.467-4 Section 467 loan.
(a) In general.
(1) Overview.
(2) No section 467 loan in the case of certain section 467
rental agreements.
(3) Rental agreements subject to constant rental accrual.
(4) Special rule in applying the provisions of Sec. 1.467-7(e)
or Sec. 1.467-7(f).
(b) Principal balance.
(1) In general.
(2) Section 467 rental agreements that provide for prepaid fixed
rent and adequate stated interest.
(3) Timing of payments.
[[Page 27839]]
(c) Yield.
(1) In general.
(i) Method of determining yield.
(ii) Method of stating yield.
(iii) Rounding adjustments.
(2) Yield of section 467 rental agreements for which constant
rental amount or proportional rental amount is computed.
(3) Determination of present values.
(d) Contingent payments.
(e) Section 467 rental agreements that call for payments before
or after the lease term.
(f) Examples.
Sec. 1.467-5 Section 467 rental agreements with variable interest.
(a) Variable interest on deferred or prepaid rent.
(1) In general.
(2) Exceptions.
(b) Variable rate treated as fixed.
(1) In general.
(2) Variable interest adjustment amount.
(i) In general.
(ii) Sign of adjustment.
(3) Section 467 loan balance.
(c) Examples.
Sec. 1.467-6 Section 467 rental agreements with contingent
payments.
[Reserved]
Sec. 1.467-7 Section 467 recapture and other rules relating to
dispositions.
(a) Section 467 recapture.
(b) Recapture amount.
(1) In general.
(2) Prior understated inclusions.
(i) In general.
(ii) Partial rental periods.
(3) Section 467 gain.
(i) In general.
(ii) Certain dispositions.
(c) Special rules.
(1) Gifts.
(2) Dispositions at death.
(3) Certain tax-free exchanges.
(i) In general.
(ii) Dispositions covered.
(4) Dispositions by transferee.
(5) Like-kind exchanges and involuntary conversions.
(6) Installment sales.
(7) Dispositions covered by sections 170(e), 341(e)(12), or
751(c).
(d) Examples.
(e) Other rules relating to dispositions.
(1) In general.
(2) Treatment of section 467 loan.
(3) Special rules for transfers in certain nonrecognition
transactions. [Reserved]
(f) Treatment of assignments by lessee and lessee-financed
renewals.
(1) Substitute lessee use.
(2) Lessor use.
(3) Special rules for transfers in certain nonrecognition
transactions. [Reserved]
Sec. 1.467-8 Effective date.
Sec. 1.467-1 Treatment of lessors and lessees generally.
(a) Overview--(1) In general. When applicable, section 467 requires
a lessor and lessee of tangible property to treat rents consistently
and to use the accrual method of accounting regardless of their overall
method of accounting. In addition, in certain cases involving tax
avoidance, the lessor and lessee must take rent and stated or imputed
interest into account under a constant rental method, pursuant to which
time value of money principles are applied to treat the rent as having
accrued ratably over the entire lease term.
(2) Cases in which rules are inapplicable. Section 467 applies only
to leases (or other similar arrangements) that constitute section 467
rental agreements as defined in paragraph (c) of this section. For
example, a rental agreement is not a section 467 rental agreement, and,
therefore, is not subject to the provisions of this section and
Secs. 1.467-2 through 1.467-8 (the section 467 regulations), if it
specifies equal amounts of rent for each month (or other similar
period) throughout the lease term and all payments of rent are due in
the year to which the rent relates (or in the preceding or succeeding
year). In addition, the section 467 regulations do not apply to a
rental agreement that requires total rents of $250,000 or less
determined, for this purpose, by disregarding any adjustments based on
a reasonable price index and the amount of any rent resulting from the
lessee's obligation to pay certain third-party expenses of the lessor.
(3) Limited effect for rental agreements with total rents between
$250,000 and $2,000,000. A rental agreement is a section 467 rental
agreement, and, therefore, the section 467 regulations generally apply,
if the agreement requires total rents of more than $250,000 and does
not specify equal amounts of rent for each month (or other similar
period) throughout the lease term. If, however, the rental agreement
requires total rents of $2,000,000 or less (determined by disregarding
adjustments and excluding the same types of rent that are disregarded
or excluded for purposes of the $250,000 threshold requirement) and all
payments of rent are due in the year to which the rent relates (or in
the preceding or succeeding year), the only effect of the section 467
regulations is to require the lessor and lessee to take rent into
account in the year to which the rent relates.
(4) Summary of rules--(i) Basic rules. Paragraph (c) of this
section provides rules for determining whether a rental agreement is a
section 467 rental agreement. Paragraphs (d) and (e) of this section
provide rules for determining the amount of rent and interest,
respectively, required to be taken into account by a lessor and lessee
under a section 467 rental agreement. Paragraphs (f) through (h) and
(j) of this section provide various definitions and special rules
relating to the application of the section 467 regulations.
(ii) Special rules. Section 1.467-2 provides rules for section 467
rental agreements that have deferred or prepaid rents without providing
for adequate interest. Section 1.467-3 provides rules for application
of the constant rental accrual requirement, including criteria for
determining whether an agreement is subject to this requirement.
Section 1.467-4 provides rules for establishing and adjusting a section
467 loan, the amount that a lessor is deemed to have loaned to the
lessee, or vice versa, pursuant to the application of the section 467
regulations. Sections 1.467-5 and 1.467-6 provide rules for applying
the section 467 regulations where a rental agreement requires variable
interest or certain contingent payments. Section 1.467-7 provides rules
for the treatment of dispositions by a lessor of property subject to a
section 467 rental agreement and the treatment of assignments by
lessees and certain lessee- financed renewals of a section 467 rental
agreement. Finally, Sec. 1.467-8 provides the effective date rules for
the section 467 regulations.
(b) Method of accounting for section 467 rental agreements. If a
rental agreement is a section 467 rental agreement, as described in
paragraph (c) of this section, the lessor and lessee must each take
into account for any taxable year--
(1) The section 467 rent for the taxable year (as defined in
paragraph (d) of this section); and
(2) The section 467 interest for the taxable year (as defined in
paragraph (e) of this section).
(c) Section 467 rental agreements--(1) In general. Except as
otherwise provided in paragraph (c)(4) of this section, the term
section 467 rental agreement means a rental agreement, as defined in
paragraph (h) of this section, that has increasing or decreasing rents
(as described in paragraph (c)(2) of this section), or prepaid or
deferred rents (as described in paragraph (c)(3) of this section).
(2) Increasing or decreasing rent--(i) Fixed rent--(A) In general.
A rental agreement has increasing or decreasing rent if the annualized
fixed rent, as described in paragraph (j)(3) of this section, allocated
to any rental period exceeds the annualized fixed rent allocated to any
other rental period in the lease term.
(B) Certain rent holidays disregarded. Notwithstanding the
provisions of paragraph (c)(2)(i)(A) of this section, a rental
agreement does not have
[[Page 27840]]
increasing or decreasing rent if the increasing or decreasing rent is
solely attributable to a rent holiday provision allowing reduced rent
(including no rent) for a period at the beginning of the lease term,
but only if the duration of the rent holiday does not exceed three
months.
(ii) Fixed rent allocated to a rental period--(A) Specific
allocation--(1) In general. If a rental agreement provides a specific
allocation of fixed rent, as described in paragraph (c)(2)(ii)(A)(2) of
this section, the amount of fixed rent allocated to each rental period
during the lease term is the amount of fixed rent allocated to that
period by the rental agreement.
(2) Rental agreements specifically allocating fixed rent. A rental
agreement specifically allocates fixed rent if the rental agreement
unambiguously specifies, for periods no longer than a year, a fixed
amount of rent for which the lessee becomes liable on account of the
use of the property during that period, and the total amount of fixed
rent specified is equal to the total amount of fixed rent payable under
the lease. For example, a rental agreement providing that rent is
$100,000 per calendar year, and that provides for total payments of
fixed rent equal to the total amount specified, specifically allocates
rent. Similarly, a rental agreement that states the amount of rent
accruing each month or the amount of rent allocated to each year
contains a specific allocation if the total payments of fixed rent
equal the total amount specified. A rental agreement stating only when
rent is payable does not specifically allocate rent.
(B) No specific allocation. If a rental agreement does not provide
a specific allocation of fixed rent (for example, because the total
amount of fixed rent specified is not equal to the total amount of
fixed rent payable under the lease), the amount of fixed rent allocated
to a rental period is the amount of fixed rent payable during that
rental period. If an amount of fixed rent is payable before the
beginning of the lease term, it is allocated to the first rental period
in the lease term. If an amount of fixed rent is payable after the end
of the lease term, it is allocated to the last rental period in the
lease term.
(iii) Contingent rent--(A) In general. A rental agreement has
increasing or decreasing rent if it requires (or may require) the
payment of contingent rent (as defined in paragraph (h) of this
section), other than contingent rent described in paragraph
(c)(2)(iii)(B) of this section.
(B) Certain contingent rent disregarded. Contingent rent is
disregarded for purposes of this paragraph (c)(2)(iii) to the extent--
(1) The rent is contingent solely as the result of a provision
pursuant to which the rent is equal to a percentage of the lessee's
receipts (gross or net), but only if the percentage does not vary
throughout the term of the lease;
(2) The rent is contingent solely as the result of an adjustment
based on a reasonable price index, as defined in paragraph (h) of this
section; or
(3) The rent is contingent solely as the result of a provision
requiring the lessee to pay third-party costs, as defined in paragraph
(h) of this section.
(3) Deferred or prepaid rent--(i) Deferred rent. A rental agreement
has deferred rent under this paragraph (c)(3) if the amount of rent
allocated to a calendar year (determined under paragraph (c)(3)(iii) of
this section), when added to the rent allocated to all preceding
calendar years, exceeds the cumulative amount of rent payable as of the
close of the succeeding calendar year.
(ii) Prepaid rent. A rental agreement has prepaid rent under this
paragraph (c)(3) if the amount of rent allocated to a calendar year
(determined under paragraph (c)(3)(iii) of this section), when added to
the rent allocated to all preceding calendar years, is less than the
cumulative amount of rent payable before the beginning of the preceding
calendar year.
(iii) Rent allocated to a calendar year. For purposes of this
paragraph (c)(3), the rent allocated to a calendar year is the sum of--
(A) The fixed rent allocated to any rental period (determined under
paragraph (c)(2)(ii) of this section) that begins and ends in the
calendar year;
(B) A ratable portion of the fixed rent allocated to any other
rental period that begins or ends in the calendar year; and
(C) Any contingent rent that accrues during the calendar year as
provided in Sec. 1.467-6.
(iv) Examples. The following examples illustrate the application of
this paragraph (c)(3):
Example 1. (i) A and B enter into a rental agreement that
provides for the lease of property to begin on January 1, 1997, and
end on December 31, 2000. The rental agreement provides that rent of
$100,000 accrues during each year of the lease term. Under the
rental agreement, no rent is payable during calendar year 1997, a
payment of $100,000 is to be made on December 31, 1998, and December
31, 1999, and a payment of $200,000 is to be made on December 31,
2000. A and B both select the calendar year as their rental period.
Thus, under paragraph (c)(3)(iii) of this section, the amount of
rent allocated to each rental period under paragraph (c)(2)(ii) of
this section is $100,000. Therefore, the rental agreement does not
have increasing or decreasing rent as described in paragraph
(c)(2)(i) of this section.
(ii) Under paragraph (c)(3)(i) of this section, a rental
agreement has deferred rent if, at the close of a calendar year, the
cumulative amount of rent allocated under paragraph (c)(3)(iii) of
this section exceeds the cumulative amount of rent payable as of the
close of the succeeding year. In this example, there is no deferred
rent: the rent allocated to 1997 ($100,000) does not exceed the
cumulative rent payable as of December 31, 1998 ($100,000); the rent
allocated to 1998 and preceding years ($200,000) does not exceed the
cumulative rent payable as of December 31, 1999 ($200,000); the rent
allocated to 1999 and preceding years ($300,000) does not exceed the
cumulative rent payable as of December 31, 2000 ($400,000); and the
rent allocated to 2000 and preceding years ($400,000) does not
exceed the cumulative rent payable as of December 31, 2001
($400,000). Therefore, because the rental agreement does not have
increasing or decreasing rent and does not have prepaid or deferred
rent, the rental agreement is not a section 467 rental agreement.
Example 2. (i) A and B enter into a rental agreement that
provides for the lease of personal property for ten years, beginning
on January 1, 1997, and ending on December 31, 2006. The rental
agreement provides for accruals of rent of $10,000 during each month
of the lease term. Under paragraph (c)(3)(iii) of this section,
$120,000 is allocated to each calendar year. The rental agreement
provides for a $1,200,000 payment on December 31, 1997.
(ii) The rental agreement does not have increasing or decreasing
rent as described in paragraph (c)(2)(i) of this section. The rental
agreement provides prepaid rent under paragraph (c)(3)(ii) of this
section because an amount of rent allocated to a calendar year, when
added to the rent allocated to all preceding calendar years, is less
than the cumulative amount of rent payable before the beginning of
the preceding calendar year. For example, the rent allocated to 1999
and preceding calendar years ($360,000) is less than the cumulative
amount of rent payable before the beginning of the preceding
calendar year ($1,200,000 is payable on December 31, 1997).
Accordingly, the rental agreement is a section 467 rental agreement.
(4) Rental agreements involving total payments of $250,000 or
less--(i) In general. A rental agreement is not a section 467 rental
agreement if, taking into account any payments of contingent rent, and
any other contingent consideration, the sum of the aggregate amount of
rental payments under the rental agreement and the aggregate value of
other consideration to be received for the use of property is not
reasonably expected, as of the agreement date (as defined in paragraph
(h) of this section), to exceed $250,000.
(ii) Special rules in computing amount described in paragraph
(c)(4)(i). The following rules apply in
[[Page 27841]]
determining the amount described in paragraph (c)(4)(i) of this
section--
(A) Stated interest on deferred rent is not taken into account.
However, the Commissioner may recharacterize a portion of stated
interest as additional rent if a rental agreement provides for interest
on deferred rent at a rate that, in light of all of the facts and
circumstances, is clearly greater than the arm's-length rate of
interest that would have been charged in a lending transaction between
the lessor and lessee.
(B) Consideration that does not involve a cash payment is taken
into account at its fair market value. A liability that is either
assumed or secured by property acquired subject to the liability is
taken into account at its remaining principal amount or, in the case of
an obligation originally issued at a discount, at its adjusted issue
price.
(C) All leases that are part of the same transaction or a series of
related transactions are treated as a single lease. Whether two or more
leases are part of the same transaction or a series of related
transactions depends on all the facts and circumstances.
(D) Any increase or decrease in rent payable solely as a result of
an adjustment based on a reasonable price index is not taken into
account.
(E) Contingent rent described in paragraph (c)(2)(iii)(B)(3) of
this section is not taken into account.
(d) Section 467 rent--(1) In general. The section 467 rent for a
taxable year is the sum of--
(i) The fixed rent for any rental period (determined under
paragraph (d)(2) of this section) that begins and ends in the taxable
year;
(ii) A ratable portion of the fixed rent for any other rental
period beginning or ending in the taxable year; and
(iii) In the case of a section 467 rental agreement that provides
for contingent rent, the contingent rent that accrues during the
taxable year as provided in Sec. 1.467-6.
(2) Fixed rent for a rental period--(i) Constant rental accrual. In
the case of a section 467 rental agreement that is a disqualified
leaseback or long-term agreement (as described in Sec. 1.467-3(b)), the
fixed rent for a rental period is the constant rental amount (as
determined under Sec. 1.467-3(d)).
(ii) Proportional rental accrual. In the case of a section 467
rental agreement that is not described in paragraph (d)(2)(i) of this
section, and does not provide adequate interest on fixed rent (as
determined under Sec. 1.467-2(b)), the fixed rent for a rental period
is the proportional rental amount (as determined under Sec. 1.467-
2(c)).
(iii) Section 467 rental agreement accrual. In the case of a
section 467 rental agreement that is not described in paragraph
(d)(2)(i) or (ii) of this section, the fixed rent for a rental period
is the amount of fixed rent allocated to the rental period under the
rental agreement, as determined under paragraph (c)(2)(ii) of this
section.
(e) Section 467 interest--(1) In general. The section 467 interest
for a taxable year is the sum of--
(i) The interest on fixed rent for any rental period that begins
and ends in the taxable year;
(ii) A ratable portion of the interest on fixed rent for any other
rental period beginning or ending in the taxable year; and
(iii) In the case of a section 467 rental agreement that provides
for contingent rent, any interest that accrues on the contingent rent
during the taxable year as provided in Sec. 1.467-6.
(2) Interest on fixed rent for a rental period--(i) In general.
Except as provided in paragraph (e)(2)(ii) of this section and
Sec. 1.467-5(b)(1)(ii), the interest on fixed rent for a rental period
is equal to the product of--
(A) The principal balance of the section 467 loan (as described in
Sec. 1.467-4(b)) at the beginning of the rental period; and
(B) The yield of the section 467 loan (as described in Sec. 1.467-
4(c)).
(ii) Section 467 rental agreements with adequate interest. Except
in the case of a section 467 rental agreement that is a disqualified
leaseback or long-term agreement, if a section 467 rental agreement
provides adequate interest under Sec. 1.467-2(b)(1)(i) (agreements with
no deferred or prepaid rent) or Sec. 1.467-2(b)(1)(ii) (agreements with
adequate stated interest at a single fixed rate), the interest on fixed
rent for a rental period is the amount of interest provided in the
rental agreement for the period.
(3) Treatment of interest. If the section 467 interest for a rental
period is a positive amount, the lessor has interest income and the
lessee has an interest expense. If the section 467 interest for a
rental period is a negative amount, the lessee has interest income and
the lessor has an interest expense.
(f) Modification of a rental agreement. If, after the lease date,
the lessor and lessee agree to a substantial modification of the terms
of a lease, the modified lease is treated, except as provided in this
paragraph (f), as a new rental agreement for purposes of this section
and Secs. 1.467-2 through 1.467-8. If a principal purpose of such a
modification is to avoid the purpose or intent of section 467, the
Commissioner may treat the original and modified lease as a single
rental agreement for purposes of this section and Secs. 1.467-2 through
1.467-8.
(g) Treatment of amounts payable by lessor to lessee--(1) Interest.
For purposes of determining present value, any amounts payable by the
lessor to the lessee as interest on prepaid rent are treated as
negative amounts.
(2) Other amounts. [Reserved]
(h) Meaning of terms. The following meanings apply for purposes of
this section and Secs. 1.467-2 through 1.467-8--
(1) Agreement date means the earlier of the lease date or the first
date on which there is a binding written contract that substantially
sets forth the terms under which the property will be leased.
(2) Contingent rent means any rent that is not fixed rent,
including any amount reflecting an adjustment based on a reasonable
price index.
(3) Fixed rent means any rent to the extent its amount and the time
at which it will be paid are fixed and determinable under the terms of
the section 467 rental agreement as of the lease date, as defined in
paragraph (h)(4) of this section. For this purpose, the possibility of
a breach or other early termination of the rental agreement and any
provision that makes adjustments based on a reasonable price index are
disregarded in determining whether amounts specified in the agreement
are fixed rent.
(4) Lease date means the date on which the lessee first has the
right to use property that is the subject of the section 467 rental
agreement.
(5) Lease term means the period during which the lessee has the use
of property subject to the section 467 rental agreement. An option
period is included in the lease term only if it is expected, as of the
agreement date, that the option will be exercised by either the lessor
or the lessee. For this purpose, a lessor is generally expected to
exercise an option if, for example, as of the agreement date, the rent
in effect for the option period exceeds the expected market rental for
the property during such period. Similarly, a lessee is generally
expected to exercise an option if, for example, as of the agreement
date, the rent for the option period is less than the expected market
rental for such period. The lessor's or lessee's determination that an
option period is either included in or excluded from the lease term is
not binding on the Commissioner. If the lessee (or a related person)
agrees that one or both of them will or could be obligated to make
payments in the nature of rent (within
[[Page 27842]]
the meaning of Sec. 1.168(i)-2(b)(2)) for a period when another lessee
(the substitute lessee) or the lessor will have use of the property
subject to the rental agreement, the Commissioner may, in appropriate
cases, treat the period when the substitute lessee or lessor will have
use of the property as part of the lease term. See paragraph
Sec. 1.467-7(f) for special rules applicable to the lessee, substitute
lessee, and lessor.
(6) An adjustment is based on a reasonable price index if the
adjustment reflects inflation or deflation occurring over a period
during the lease term and is determined consistently under any
generally recognized index for measuring inflation or deflation.
(7) Except as otherwise provided in this paragraph (h)(7), two
persons are related persons if they either have a relationship to each
other that is specified in section 267(b) or section 707(b)(1) or are
related entities within the meaning of sections 168(h)(4) (A), (B), or
(C). For purposes of determining whether a section 467 rental agreement
is a leaseback within the meaning of Sec. 1.467-3(b)(2), two persons
are related persons if they are related persons within the meaning of
section 465(b)(3)(C).
(8) Rental agreement includes any agreement, whether written or
oral, that provides for the use of tangible property and is treated as
a lease for Federal income tax purposes.
(9) Third-party costs include any real estate taxes, insurance
premiums, maintenance costs, or any other cost (other than a debt
service cost) that relates to the leased property and is not within the
control of the lessor or lessee or any related person.
(i) [Reserved].
(j) Computational rules. For purposes of this section and
Secs. 1.467-2 through 1.467-8, the following rules apply--
(1) Counting conventions. Any reasonable counting convention may be
used (e.g., 30 days per month/360 days per year) to determine the
length of a rental period or to perform any computation. Rental periods
of the same descriptive length, for example annual, semiannual,
quarterly, or monthly, may be treated as being of equal length.
(2) Conventions regarding timing of rent and payments--(i) In
general. For purposes of determining present values and yield--
(A) Except as otherwise provided in this section and Secs. 1.467-2
through 1.467-7, the rent allocated to a rental period is taken into
account on the last day of the rental period;
(B) Any amount payable during the first half of the first rental
period is treated as payable on the first day of that rental period;
(C) Any amount payable during the first half of any other rental
period is treated as payable on the last day of the preceding rental
period; and
(D) Any amount payable during the second half of a rental period is
treated as payable on the last day of the rental period.
(ii) Time amount is payable. For purposes of this paragraph (j)(2),
an amount is payable on the last day for timely payment (that is, the
last day such amount may be paid without incurring interest, computed
at an arm's-length rate, or a substantial penalty charge) and an amount
payable at the midpoint of a rental period is treated as payable during
the first half of the rental period.
(3) Annualized fixed rent. Annualized fixed rent is determined by
multiplying the fixed rent allocated to the rental period under
paragraph (c)(2)(ii) of this section by a number that represents the
ratio of one year to the length of the rental period. Thus, if the
fixed rent allocated to a rental period is $100,000 and the rental
period is one month, the annualized fixed rent allocated to the rental
period is $1,200,000.
(4) Allocation of fixed rent within a period. A rental agreement
that allocates fixed rent to any period is treated as allocating fixed
rent ratably within that period. Thus, if a rental agreement provides
that $120,000 is allocated to each calendar year in the lease term,
$10,000 of rent is allocated to each calendar month.
(5) Rental period length. Except as provided in Sec. 1.467-3(d)(1)
(relating to agreements for which constant rental accrual is required),
rental periods may be of any length and may vary in length as long as--
(i) The rental periods are one year or less, cover the entire lease
term, and do not overlap;
(ii) Each scheduled payment under the rental agreement (other than
a payment scheduled to occur before or after the lease term) occurs
within 30 days of the beginning or end of a rental period; and
(iii) In the case of a rental agreement that does not provide a
specific allocation of fixed rent, the rental periods selected do not
cause the agreement to be treated as a section 467 rental agreement
unless all alternative rental period schedules would result in such
treatment.
Sec. 1.467-2 Rent accrual for section 467 rental agreements without
adequate interest.
(a) Section 467 rental agreement for which proportional rental
accrual is required. Under Sec. 1.467-1(d)(2)(ii), the fixed rent for
each rental period is the proportional rental amount, defined under
paragraph (c) of this section, if--
(1) The section 467 rental agreement is not a disqualified
leaseback or long-term agreement under Sec. 1.467-3(b); and
(2) The section 467 rental agreement does not provide adequate
interest on fixed rent under paragraph (b) of this section.
(b) Adequate interest on fixed rent--(1) In general. A section 467
rental agreement provides adequate interest on fixed rent if,
disregarding any contingent rent--
(i) The rental agreement has no prepaid or deferred rent as
described in Sec. 1.467-1(c)(3);
(ii) The rental agreement has prepaid or deferred rent, and--
(A) The rental agreement provides interest (the stated rate of
interest) on deferred or prepaid fixed rent at a single fixed rate (as
defined in Sec. 1.1273-1(c)(1)(iii));
(B) The stated rate of interest on fixed rent is no lower than 110
percent of the applicable Federal rate (as defined in paragraph (e)(3)
of this section);
(C) The amount of deferred or prepaid fixed rent on which interest
is charged is adjusted at least annually to reflect the amount of
deferred or prepaid fixed rent as of a date no earlier than the date of
the preceding adjustment and no later than the date of the succeeding
adjustment; and
(D) The rental agreement requires interest to be paid or compounded
at least annually;
(iii) The rental agreement provides for deferred rent but no
prepaid rent, and the sum of the present values of all amounts payable
by the lessee as fixed rent (and interest, if any, thereon) is equal to
or greater than the sum of the present values of the fixed rent
allocated to each rental period; or
(iv) The rental agreement provides for prepaid rent but no deferred
rent, and the sum of the present values of all amounts payable by the
lessee as fixed rent, plus the sum of the negative present values of
all amounts payable by the lessor as interest, if any, on prepaid fixed
rent, is equal to or less than the sum of the present values of the
fixed rent allocated to each rental period.
(2) Section 467 rental agreements that provide for a variable rate
of interest. For purposes of the adequate interest test under paragraph
(b)(1) of this section, if a section 467 rental
[[Page 27843]]
agreement provides for variable interest, the rental agreement is
treated as providing for fixed rates of interest on deferred or prepaid
fixed rent equal to the fixed rate substitutes (determined in the same
manner as under Sec. 1.1275-5(e) treating the agreement date as the
issue date) for the variable rates called for by the rental agreement.
For purposes of this section, a rental agreement provides for variable
interest if the rental agreement provides for stated interest that is
paid or compounded at least annually at a rate or rates that meet the
requirements of Sec. 1.1275-5(a)(3)(i)(A) or (B) and Sec. 1.1275-
5(a)(4).
(c) Computation of proportional rental amount--(1) In general. The
proportional rental amount for a rental period is the amount of fixed
rent allocated to the rental period under Sec. 1.467-1(c)(2)(ii),
multiplied by a fraction. The numerator of the fraction is the sum of
the present values of the amounts payable under the terms of the
section 467 rental agreement as fixed rent and interest thereon. The
denominator of the fraction is the sum of the present values of the
fixed rent allocated to each rental period under the rental agreement.
(2) Section 467 rental agreements that provide for a variable rate
of interest. To calculate the proportional rental amount for a section
467 rental agreement that provides for a variable rate of interest, see
Sec. 1.467-5.
(d) Present value. For purposes of determining adequate interest
under paragraph (b) of this section or the proportional rental amount
under paragraph (c) of this section, present values are determined as
of the first day a fixed rent payment is called for by the section 467
rental agreement if the rental agreement calls for payments of fixed
rent prior to the lease term. Otherwise, present values are determined
as of the first day of the first rental period in the lease term. The
present value of any amount is determined using a discount rate equal
to 110 percent of the applicable Federal rate. For purposes of the
present value determination under paragraph (b)(1)(iv) of this section,
the fixed rent allocated to a rental period must be discounted from the
first day of the rental period. For other conventions and rules
relating to the determination of present value, see Sec. 1.467-1(g) and
(j).
(e) Applicable Federal rate--(1) In general. The applicable Federal
rate for a section 467 rental agreement is the applicable Federal rate
in effect on the agreement date. Except as otherwise provided in this
section, the applicable Federal rate for a rental agreement means--
(i) The Federal short-term rate if the term of the rental agreement
is not over 3 years;
(ii) The Federal mid-term rate if the term of the rental agreement
is over 3 years but not over 9 years; and
(iii) The Federal long-term rate if the term of the rental
agreement is over 9 years.
(2) Source of applicable Federal rates. The Internal Revenue
Service publishes the applicable Federal rates, based on annual,
semiannual, quarterly, and monthly compounding, each month in the
Internal Revenue Bulletin (see Sec. 601.601(d) of this chapter.
However, the applicable Federal rates may be based on any compounding
assumption. To convert a rate based on one compounding assumption to an
equivalent rate based on a different compounding assumption, see
Sec. 1.1272-1(j), Example 1.
(3) 110 percent of applicable Federal rate. For purposes of
Sec. 1.467-1, this section and Secs. 1.467-3 through 1.467-8, 110
percent of the applicable Federal rate means 110 percent of the
applicable Federal rate based on semiannual compounding, or any rate
based on a different compounding assumption that is equivalent to 110
percent of the applicable Federal rate based on semiannual compounding.
(4) Term of the section 467 rental agreement--(i) In general. For
purposes of determining 110 percent of the applicable Federal rate
under this paragraph (e), the term of the section 467 rental agreement
includes the lease term, any period before the lease term beginning
with the first day an amount of fixed rent is payable under the terms
of the rental agreement, and any period after the lease term ending
with the last day an amount of fixed rent or interest thereon is
payable under the rental agreement.
(ii) Section 467 rental agreements with variable interest. If a
section 467 rental agreement provides variable interest on prepaid or
deferred fixed rent, the term of the rental agreement for purposes of
calculating 110 percent of the applicable Federal rate is determined in
accordance with paragraph (e)(4)(i) of this section by substituting for
the term of the rental agreement, the longest period between interest
rate adjustment dates, or, if the rental agreement provides an initial
fixed rate of interest on prepaid or deferred fixed rent, the period
between the agreement date and the last day the fixed rate applies, if
this period is longer. If, as described in Sec. 1.1274-4(c)(2)(ii), the
rental agreement provides for a qualified floating rate (as defined in
Sec. 1.1275-5(b)) that in substance resembles a fixed rate, 110 percent
of the applicable Federal rate is determined by reference to the lease
term.
(f) Examples. The following examples illustrate the application of
this section. In each of these examples it is assumed that constant
rental accrual does not apply:
Example 1. (i) C agrees to lease property from D for five years
beginning on January 1, 1998, and ending on December 31, 2002. The
section 467 rental agreement provides that rent of $100,000 accrues
in each calendar year in the lease term and that rent of $500,000
plus $120,000 of interest is payable on December 31, 2002. Assume
that the parties select the calendar year as the rental period and
that 110 percent of the applicable Federal rate based on annual
compounding is 10 percent.
(ii) The rental agreement has deferred rent under Sec. 1.467-
1(c)(3)(i) because the fixed rent allocated to calendar years 1998,
1999, and 2000 is not paid until 2002. In addition, because the
rental agreement does not state an interest rate, the rental
agreement does not satisfy the requirements of paragraph (b)(1)(ii)
of this section. Thus, the adequacy of interest must be determined
under paragraph (b)(1)(iii) of this section.
(iii)(A) Because the rental agreement has deferred fixed rent
and no prepaid rent, the agreement has adequate interest only if the
present value rules provided in paragraph (b)(1)(iii) are met. The
present value of all fixed rent and interest payable under the
rental agreement is $384,971.22, determined as follows: $384,971.22
= $620,000/(1.10)\5\. The present value of all fixed rent allocated
under the rental agreement (discounting the amount of fixed rent
allocated to a rental period from the last day of the rental period)
is $379,078.68, determined as follows:
[GRAPHIC] [TIFF OMITTED] TP03JN96.008
(B) Accordingly, the sum of the present values of amounts
payable exceeds the sum of the present values of fixed rent
allocated. The rental agreement provides adequate interest on fixed
rent.
(iv) For an example illustrating the computation of the yield on
the rental agreement and the allocation of the interest and rent
provided for under the rental agreement, see Sec. 1.467-4(f),
Example 2.
Example 2. (i) E and F enter into a section 467 rental agreement
for the lease of equipment beginning on January 1, 1998, and ending
on December 31, 2002. The rental agreement provides that rent of
$100,000 accrues for each calendar month during the lease term. All
rent is payable on December 31, 2002, together with interest on
accrued rent at a qualified floating rate set at a current value (as
defined in Sec. 1.1275-5(a)(4)) that is compounded at the end of
each calendar month and adjusted at the beginning of each calendar
month throughout the lease term. Therefore, the rental agreement
provides for variable interest within the meaning of paragraph
(b)(2) of this section.
[[Page 27844]]
(ii) On the agreement date the qualified floating rate is 7.5
percent, and 110 percent of the applicable Federal rate, as defined
in paragraph (e)(3) of this section, based on monthly compounding,
is 7 percent. Under paragraph (b)(2) of this section, the fixed rate
substitute for the qualified floating rate is 7.5 percent and the
agreement is treated as providing for interest at this fixed rate
for purposes of determining whether adequate interest is provided
under paragraph (b) of this section. Accordingly, the requirements
of paragraph (b)(1)(ii) of this section are satisfied, and the
rental agreement has adequate interest.
Example 3. (i) X and Y enter into a section 467 rental agreement
for the lease of real property beginning on January 1, 1998, and
ending on December 31, 2000. The rental agreement provides that rent
of $80,000 is allocable to 1998, $100,000 is allocable to 1999, and
$120,000 is allocable to 2000. Under the rental agreement, Y must
make a $300,000 payment on December 31, 2000. Assume that both X and
Y choose the calendar year as the rental period, X and Y are
calendar year taxpayers, and 110 percent of the applicable Federal
rate is 8.5 percent compounded annually. Assume further that the
rental agreement fails to provide adequate interest under paragraph
(b)(1) of this section. Therefore, under Sec. 1.467-1(d)(2)(ii), the
fixed rent for each rental period is the proportional rental amount.
(ii)(A) The proportional rental amount is computed under
paragraph (c) of this section. Because the rental agreement does not
call for any fixed rent payments prior to the lease term, under
paragraph (d) of this section, present value is determined as of the
first day of the first rental period in the lease term. The sum of
the present values of the amounts payable by the lessee under the
rental agreement is computed as follows:
[GRAPHIC] [TIFF OMITTED] TP03JN96.009
(B) The sum of the present values of the fixed rent allocated to
each rental period (discounting the fixed rent allocated to a rental
period from the last day of such rental period) is computed as
follows:
[GRAPHIC] [TIFF OMITTED] TP03JN96.010
(C) Thus, the fraction for determining the proportional rental
amount is .9297194 ($234,872.43/$252,627.22). The section 467 fixed
rents for the taxable years within the lease term are:
------------------------------------------------------------------------
Taxable year Section 467 rent
------------------------------------------------------------------------
1998............................. $74,377.55 ($80,000 x .9297194)
1999............................. 92,971.94 ($100,000 x .9297194)
2000............................. 111,566.33 ($120,000 x .9297194)
------------------------------------------------------------------------
Sec. 1.467-3 Disqualified leasebacks and long-term agreements.
(a) General rule. Under Sec. 1.467-1(d)(2)(i), constant rental
accrual (as described under paragraph (d) of this section) must be used
to determine the fixed rent for each rental period in the lease term if
the section 467 rental agreement is a disqualified leaseback or long-
term agreement within the meaning of paragraph (b) of this section.
(b) Disqualified leaseback or long-term agreement--(1) In general.
A leaseback (as defined in paragraph (b)(2) of this section) or a long-
term agreement (as defined in paragraph (b)(3) of this section) is
disqualified only if--
(i) The amount determined with respect to the section 467 rental
agreement under Sec. 1.467-1(c)(4) (relating to the exception for
rental agreements involving total payments of $250,000 or less) exceeds
$2,000,000;
(ii) A principal purpose for providing increasing or decreasing
rent is the avoidance of Federal income tax (as described in paragraph
(c) of this section); and
(iii) The Commissioner determines that it is appropriate to treat
the section 467 rental agreement as a disqualified leaseback or long-
term agreement.
(2) Leaseback. A section 467 rental agreement is a leaseback if the
lessee (or a related person) had any interest (other than a de minimis
interest) in the property at any time during the two-year period ending
on the agreement date. For this purpose, interests in property include
options and agreements to purchase the property (whether or not the
lessee or related person was considered the owner of the property for
Federal income tax purposes) and, in the case of subleased property,
any interest as a sublessor.
(3) Long-term agreement--(i) In general. A section 467 rental
agreement is a long-term agreement if the lease term exceeds 75 percent
of the statutory recovery period for the property.
(ii) Statutory recovery period--(A) In general. The term statutory
recovery period means--
(1) In the case of property depreciable under section 168, the
applicable period determined under section 467(e)(3)(A);
(2) In the case of land, 19 years; and
(3) In the case of any other tangible property, the period that
would apply under section 467(e)(3)(A) if the property were property to
which section 168 applied.
(B) Special rule for leases of properties having different
statutory recovery periods. In the case of a lease of two or more
related properties that have different statutory recovery periods, the
statutory recovery period for purposes of paragraph (b)(3)(ii)(A) of
this section is the weighted average, based on the fair market values
of the properties on the lease date, of the statutory recovery periods
of each of the properties.
(c) Tax avoidance as principal purpose for increasing or decreasing
rent--(1) In general. Whether tax avoidance is a principal purpose for
providing increasing or decreasing rent in a leaseback or long-term
agreement is based on all of the facts and circumstances. However, if
either the lessee or the lessor is not subject to Federal income tax on
its income or is a tax- exempt entity (within the meaning of section
168(h)(2)), the agreement will be closely scrutinized and clear and
convincing evidence will be required to establish that tax avoidance is
not a principal purpose for providing increasing or decreasing rent.
(2) Safe harbors. Tax avoidance is not considered to be a principal
purpose for providing increasing or decreasing rent if--
(i) The rent allocated to each calendar year (determined without
regard to any increase or decrease attributable to a provision
described in paragraph (c)(2)(ii)(C) of this section) does not vary
from the average rent allocated to all calendar years by more than 10
percent (for this purpose, the rent allocated to a partial calendar
year is adjusted by
[[Page 27845]]
multiplying the rent by the number of partial years in a full calendar
year); or
(ii) All of the increases and decreases in rent are attributable to
one or more of the following provisions--
(A) A provision requiring an increase in rent equal to a percentage
of the lessee's receipts (gross or net) if the percentage does not vary
throughout the term of the lease;
(B) A provision requiring an adjustment based on a reasonable price
index as described in Sec. 1.467-1(h);
(C) A provision requiring the lessee to pay third-party costs as
described in Sec. 1.467-1(h); or
(D) A rent holiday provision allowing reduced rent (including no
rent) for an interim period at the beginning of the lease term, but
only if the duration of the rent holiday does not exceed the lesser of
24 months or 10 percent of the lease term and there is a substantial
business purpose for the rent holiday provision.
(d) Calculating constant rental amount--(1) In general. Except as
provided in paragraph (d)(2) of this section, the constant rental
amount is the amount that, if paid at the end of each rental period,
would result in a present value equal to the present value of all
amounts payable under the disqualified leaseback or long-term agreement
as rent and interest. In computing the constant rental amount, the
rules for determining present value are the same as those provided in
Sec. l.467-2(d) for computing the proportional rental amount. If
constant rental accrual is required, all rental periods (other than an
initial or final short period of not more than one month) must be equal
in length and satisfy the requirements of Sec. 1.467-1(j)(5).
(2) Initial or final short periods. If a disqualified leaseback or
long-term agreement has an initial or final short rental period, the
constant rental amount for the initial or final short period may be
determined under any reasonable method. However, the sum of the present
values of all the constant rental amounts must equal the present values
of all amounts payable under the disqualified leaseback or long-term
agreement as rent and interest. Any adjustment necessary to eliminate
the section 467 loan balance because of the method used to determine
the constant rental amount for short periods must be taken into account
as section 467 rent for the final rental period.
(3) Method to determine constant rental amount; no short periods--
(i) Step 1. Determine the present value of amounts payable under the
disqualified leaseback or long-term agreement as rent or interest.
(ii) Step 2. Determine the present value of $1 to be received at
the end of each rental period during the lease term as of the first day
of the first rental period during the lease term (or, if earlier, the
first day a rent payment is required under the rental agreement).
(iii) Step 3. Divide the amount determined in paragraph (d)(3)(i)
of this section (Step 1) by the number of dollars determined in
paragraph (d)(3)(ii) of this section (Step 2).
(e) Example. The following example illustrates the application of
paragraph (d) of this section:
Example. (i) X and Y enter into a disqualified leaseback for a
5-year lease of personal property beginning on January 1, 1998, and
ending on December 31, 2002. The rental agreement provides that $0
of rent is allocated to years 1998, 1999, and 2000, and that rent of
$17,500,000 is allocated to years 2001 and 2002. The rental
agreement provides that the rent allocated to each year is payable
on December 31 of that year. Assume all rental periods are the
calendar year. Assume also that 110 percent of the applicable
Federal rate based on annual compounding is 12 percent.
(ii) Step 1 in calculating the constant rental amount is to
determine the present value of the two payments due under the rental
agreement as follows:
[GRAPHIC] [TIFF OMITTED] TP03JN96.011
(iii) Because no amounts of rent are payable before the lease
term, Step 2 in calculating the constant rental amount is to
determine the present value as of the first day of the lease term of
$1 to be received at the end of each rental period during the lease
term. This results in a present value of $3.6047762. In Step 3 the
amount determined in Step 1 is divided by the number of dollars
determined in Step 2. Thus, the constant rental amount is $5,839,901
for each calendar year during the lease term computed as follows:
[GRAPHIC] [TIFF OMITTED] TP03JN96.012
Sec. 1.467-4 Section 467 loan.
(a) In general--(1) Overview. Except as provided in paragraph
(a)(2) of this section, the section 467 loan rules of this section
apply to a section 467 rental agreement if, as of the first day of that
period, there is a difference between the amount of fixed rent payable
under the rental agreement on or before the first day and the amount of
fixed rent required to be accrued in accordance with Sec. 1.467-1(d)(2)
before the first day. Paragraph (b) of this section provides rules for
computing the principal balance of a section 467 loan at the beginning
of any rental period. The principal balance of a section 467 loan may
be positive or negative. For purposes of the Code, if the principal
balance is positive, the amount represents a loan from the lessor to
the lessee and, if the principal balance is negative, the amount
represents a loan from the lessee to the lessor.
(2) No section 467 loan in the case of certain section 467 rental
agreements. Except as provided in paragraph (a)(3) and (4) of this
section, this section does not apply to section 467 rental agreements
that provide adequate interest under Sec. 1.467-2(b)(1)(i) (agreements
with no deferred or prepaid rent) or Sec. 1.467-2(b)(1)(ii) (agreements
with deferred or prepaid rent that provide adequate stated interest at
a single fixed rate).
(3) Rental agreements subject to constant rental accrual.
Notwithstanding the provisions of paragraph (a)(2) of this section,
this section applies to rental agreements subject to constant rental
accrual under Sec. 1.467-3.
(4) Special rule in applying the provisions of Sec. 1.467-7(e) or
(f). Notwithstanding the provisions of paragraph (a)(2) of this
section, this section applies to rental agreements that provide
adequate interest under Sec. 1.467-2(b)(1) (i) or (ii), but only for
purposes of applying the provisions of
[[Page 27846]]
Sec. 1.467-7(e) (relating to dispositions of property subject to a
section 467 rental agreement) or Sec. 1.467-7(f) (relating to
assignments by lessees and lessee-financed renewals) to a transaction
described therein. Further, for section 467 rental agreements that
provide adequate interest under Sec. 1.467-2(b)(1)(i) or (ii), the
section 467 interest that accrues on the section 467 loan balance after
the sale, exchange, or other disposition under Sec. 1.467-7(e) or the
assignment or renewal under Sec. 1.467-7(f) is the section 467 interest
that accrues under the terms of the rental agreement (if any).
(b) Principal balance--(1) In general. Except as provided in
paragraph (b)(2) of this section or in Sec. 1.467-7(e) or (f), the
principal balance of the section 467 loan at the beginning of a rental
period equals the fixed rent accrued in preceding rental periods--
(i) Increased by the interest on fixed rent includible in the gross
income of the lessor for preceding rental periods and any amount
payable by the lessor on or before the first day of the rental period
as interest on prepaid fixed rent; and
(ii) Decreased by the interest on prepaid fixed rent includible in
the gross income of the lessee for preceding rental periods and any
amount payable by the lessee on or before the first day of the rental
period as fixed rent or interest thereon.
(2) Section 467 rental agreements that provide for prepaid fixed
rent and adequate stated interest. If a section 467 rental agreement
calls for prepaid fixed rent and provides adequate interest under
Sec. 1.467-2(b)(1)(iv), the principal balance of the section 467 loan
at the beginning of a rental period equals the principal balance
determined under paragraph (b)(1) of this section, plus the fixed rent
accrued for that rental period.
(3) Timing of payments. For purposes of this paragraph (b), the day
on which an amount is payable is determined under the rules of
Sec. 1.467-1(j)(2).
(c) Yield--(1) In general--(i) Method of determining yield. Except
as provided in paragraph (c)(2) of this section, the yield of a section
467 loan is the discount rate at which the sum of the present values of
all amounts payable by the lessee as fixed rent and interest on fixed
rent, plus the sum of the present values of all amounts payable by the
lessor as interest on prepaid fixed rent, equals the sum of the present
values of the fixed rent that accrues in accordance with Sec. 1.467-
1(d)(2). The yield must be constant over the term of the section 467
rental agreement, and, when expressed as a percentage, must be
calculated to at least two decimal places.
(ii) Method of stating yield. In determining the section 467
interest for a rental period, the yield of the section 467 loan must be
stated appropriately by taking into account the length of the rental
period. Section 1.1272-1(j) Example 1 provides a formula for converting
a yield based on a period of one length to an equivalent yield based on
a period of a different length.
(iii) Rounding adjustments. Any adjustment necessary to eliminate
the section 467 loan because of rounding the yield to two or more
decimal places must be taken into account as section 467 interest for
the final rental period determined as provided in paragraph (e) of this
section.
(2) Yield of section 467 rental agreements for which constant
rental amount or proportional rental amount is computed. In the case of
a section 467 rental agreement to which Sec. 1.467- 1(d)(2) (i) or (ii)
applies, the yield of the section 467 loan equals 110 percent of the
applicable Federal rate (based on a compounding period equal to the
rental period).
(3) Determination of present values. The rules for determining
present value in computing the yield of a section 467 loan are the same
as those provided in Sec. 1.467-2(d) for computing the proportional
rental amount.
(d) Contingent payments. Except as otherwise required under
Sec. 1.467-6, contingent payments are not taken into account in
calculating either the yield or the principal balance of a section 467
loan.
(e) Section 467 rental agreements that call for payments before or
after the lease term. If a section 467 rental agreement calls for the
payment of fixed rent or interest thereon before the beginning of the
lease term, this section must be applied by treating the period
beginning on the first day an amount is payable and ending on the day
before the beginning of the first rental period of the lease term as
one or more rental periods. If a rental agreement calls for the payment
of fixed rent or interest thereon after the end of the lease term, this
section must be applied by treating the period beginning on the day
after the end of the last rental period of the lease term and ending on
the last day an amount of fixed rent or interest thereon is payable as
one or more rental periods. Rental period length for the period before
the lease term or after the lease term is determined in accordance with
the rules of Sec. 1.467-1(j)(5).
(f) Examples. The following examples illustrate the application of
this section:
Example 1. (i)(A) A leases property to B for a three-year period
beginning on January 1, 1998, and ending on December 31, 2000. The
section 467 rental agreement has the following rent allocation
schedule and payment schedule:
------------------------------------------------------------------------
Rent
allocation Payment
------------------------------------------------------------------------
1998.......................................... $400,000 ............
1999.......................................... 600,000 ............
2000.......................................... 800,000 $1,800,000
------------------------------------------------------------------------
(B) The rental agreement requires a $1.8 million payment to be
made on December 31, 2000, but does not provide for interest on
deferred rent. Assume A and B choose the calendar year as the rental
period length. Assume further that 110 percent of the applicable
Federal rate based on annual compounding is 10 percent.
(ii) The rental agreement is not a disqualified leaseback or
long-term agreement because it does not provide for the payment of
more than $2,000,000 in rent (determined pursuant to Sec. 1.467-
3(b)(1)(i)). Because the section 467 rental agreement does not
provide adequate interest under Sec. 1.467-2(b) and is not subject
to constant rental accrual, the fixed rent that accrues during each
rental period is the proportional rental amount as described in
Sec. 1.467-2(c). The proportional rental amounts for each rental
period are as follows:
1998 $370,370.37
1999 555,555.56
2000 740,740.74
(iii) A section 467 loan arises at the beginning of the second
rental period because the rent payable on or before that day (zero)
is less than the fixed rent accrued under Sec. 1.467-1(d)(2) in all
preceding rental periods ($370,370.37). Under paragraph (c)(2) of
this section, the yield of the loan is equal to 110 percent of the
applicable Federal rate (10 percent compounded annually). Because no
payments are treated as made on or before the first day of the
second rental period, the principal balance of the loan at the
beginning of the second rental period is $370,370.37. The interest
for the second rental period on fixed rent is $37,037.04 (.10 x
$370,370.37) and, under Sec. 1.467-1(e)(3), is treated as interest
income of the lessor and as an interest expense of the lessee.
(iv) Because no payments are made on or before the first day of
the third rental period, the principal balance of the loan at the
beginning of the third rental period is equal to the fixed rent
accrued during the first and second rental periods plus the lessor's
interest income on fixed rent for the second rental period
($962,962.97 = $370,370.37 + $555,555.56 + $37,037.04). The interest
for the third rental period on fixed rent is $96,296.30 (.10 x
$962,962.97). Thus, the sum of the fixed rent and interest on fixed
rent for the three rental periods is equal to the total amount paid
over the lease term (first year fixed rent accrual, $370,370.37,
plus second year fixed rent and interest accrual, $555,555.56 +
$37,037.04, plus third year fixed rent and interest accrual,
$740,740.74 + $96,296.30, equals $1,800,000). B takes the amounts of
interest and rent into account as expense and A takes such amounts
into account as income for the
[[Page 27847]]
calendar years identified above, regardless of their respective
methods of accounting.
Example 2. (i) The facts are the same as in Example 1,
Sec. 1.467-2(f).
(ii)(A) Pursuant to paragraph (c)(1) of this section, the yield
of the section 467 loan is 10.775078%, compounded annually. The
following is a schedule of the rent allocable to each rental period
during the lease term, the balance of the section 467 loan as of the
end of each rental period (determined, in the case of the calendar
year 2002, without regard to the single payment of rent and interest
in the amount of $620,000 payable on the last day of the lease
term), and the interest on the section 467 loan allocable to each
rental period:
----------------------------------------------------------------------------------------------------------------
Section 467 Section 467 Section 467
Calendar year interest rent loan balance
----------------------------------------------------------------------------------------------------------------
1998............................................................ $0 $100,000.00 $100,000.00
1999............................................................ 10,775.08 100,000.00 210,775.08
2000............................................................ 22,711.18 100,000.00 333,486.26
2001............................................................ 35,933.41 100,000.00 469,419.67
2002............................................................ 50,580.33 100,000.00 620,000.00
----------------------------------------------------------------------------------------------------------------
(B) C takes the amounts of interest and rent into account as
expense and D takes such amounts into account as income for the
calendar years identified above, regardless of their respective
methods of accounting.
Sec. 1.467-5 Section 467 rental agreements with variable interest.
(a) Variable interest on deferred or prepaid rent--(1) In general.
This section provides rules for computing section 467 rent and interest
in the case of section 467 rental agreements providing variable
interest. For purposes of this section, a rental agreement provides for
variable interest if the rental agreement provides for stated interest
that is paid or compounded at least annually at a rate or rates that
meet the requirements of Sec. 1.1275-5(a)(3)(i) (A) or (B) and
Sec. 1.1275-5(a)(4). If a section 467 rental agreement provides for
interest that is neither variable interest nor determined by reference
to a fixed rate, the amount of any interest will be treated as a
contingent payment subject to Sec. 1.467-6.
(2) Exceptions. This section is not applicable to section 467
rental agreements that provide adequate interest under Sec. 1.467-
2(b)(1)(i) (agreements with no deferred or prepaid rent) or Sec. 1.467-
2(b)(1)(ii) (rental agreements with stated interest at a single fixed
rate). The exceptions in this paragraph (a)(2) do not apply to rental
agreements subject to constant rental accrual under Sec. 1.467-3.
(b) Variable rate treated as fixed--(1) In general. If a section
467 rental agreement provides variable interest--
(i) The fixed rate substitutes (determined in the same manner as
under Sec. 1.1275-5(e) treating the agreement date as the issue date)
for the variable rates of interest on prepaid or deferred fixed rent
provided by the rental agreement must be used in computing the
proportional rental amount under Sec. 1.467-2(c), the constant rental
amount under Sec. 1.467-3(d), the principal balance of a section 467
loan under Sec. 1.467-4(b), and the yield of a section 467 loan under
Sec. 1.467-4(c); and
(ii) The interest on fixed rent for any rental period is equal to
the amount that would be determined under Sec. 1.467-1(e)(2) if the
section 467 rental agreement did not provide variable interest, using
the fixed rate substitutes determined under paragraph (b)(1)(i) of this
section in place of the variable rates called for by the rental
agreement, plus the variable interest adjustment amount provided in
paragraph (b)(2) of this section.
(2) Variable interest adjustment amount--(i) In general. The
variable interest adjustment amount for a rental period equals the
difference between--
(A) The amount of interest that, without regard to section 467,
would have accrued during the rental period under the terms of the
section 467 rental agreement; and
(B) The amount of interest that, without regard to section 467,
would have accrued during the rental period under the terms of the
section 467 rental agreement using the fixed rate substitutes
determined under paragraph (b)(1)(i) of this section in place of the
variable interest rates called for by the rental agreement.
(ii) Sign of adjustment. If the amount determined under paragraph
(b)(2)(i)(A) of this section is greater than the amount determined
under paragraph (b)(2)(i)(B) of this section, the variable interest
adjustment amount is positive. If the amount determined under paragraph
(b)(2)(i)(A) of this section is less than the amount determined under
paragraph (b)(2)(i)(B) of this section, the variable interest
adjustment amount is negative.
(3) Section 467 loan balance. The variable interest adjustment
amount is not taken into account in determining the principal balance
of a section 467 loan under Sec. 1.467-4(b). Instead, the section 467
loan balance is computed as if all amounts payable under the section
467 rental agreement were based on the fixed rate substitutes
determined under paragraph (b)(1)(i) of this section.
(c) Examples. The following examples illustrate the application of
this section:
Example 1. (i) X and Y enter into a section 467 rental agreement
for the lease of personal property beginning on January 1, 1998, and
ending on December 31, 2000. It allocates $100,000 of rent to 1998,
$200,000 to 1999, and $100,000 to 2000, and requires the lessee to
pay all $400,000 of rent on December 31, 2000. The rental agreement
requires the accrual of interest on unpaid accrued rent at two
different qualified floating rates (as defined in Sec. 1.1275-5(b)),
one for 1999 and the other for 2000, such interest to be paid on
December 31 of the year it accrues. The rental agreement provides
that the qualified floating rate is set at a current value within
the meaning of Sec. 1.1275-5(a)(4). Assume that on the agreement
date, 110 percent of the applicable Federal rate is 10 percent,
compounded annually.
(ii) The rental agreement is not a disqualified leaseback or
long-term agreement because it does not provide for the payment of
more than $2,000,000 in rent (determined pursuant to Sec. 1.467-
3(b)(1)(i)). To determine if the section 467 rental agreement
provides for adequate interest under Sec. 1.467-2(b), Sec. 1.467-
2(b)(2) requires the use of fixed rate substitutes (in this example
determined in the same manner as under Sec. 1.1275-5(e)(3)(i)
treating the agreement date as the issue date) in place of the
variable rates called for by the rental agreement. Assume that on
the agreement date the qualified floating rates, and therefore the
fixed rate substitutes, relating to 1999 and 2000 are 10 and 15
percent compounded annually. Taking into account the fixed rate
substitutes, the sum of the present values of all amounts payable by
the lessee as fixed rent and interest thereon is greater than the
sum of the present values of the fixed rent allocated to each rental
period. Accordingly, the rental agreement provides adequate interest
under Sec. 1.467-2(b)(1)(iii) and the fixed rent accruing in each
calendar year during the rental agreement is the fixed rent
allocated under the rental agreement.
(iii) Because the section 467 rental agreement provides for
variable interest on unpaid accrued fixed rent at qualified floating
rates and the qualified floating rates are set at a current value,
the requirements of Sec. 1.1275-5(a)(3)(i)(A) and (4) are met and
the rental agreement provides for variable
[[Page 27848]]
interest within the meaning of paragraph (a)(1) of this section.
Therefore, under paragraph (b)(1)(i) of this section, the yield of
the section 467 loan is computed based on the fixed rate
substitutes. Under Sec. 1.467-4(c), the constant yield (rounded to
two decimal places) equals 13.63 percent compounded annually. Based
on the fixed rate substitutes, the fixed rent, interest on fixed
rent, and the principal balance of the section 467 loan, for each
calendar year during the lease term, are as follows:
----------------------------------------------------------------------------------------------------------------
Accrued Accrued Projected Cumulative
rent interest payment loan
----------------------------------------------------------------------------------------------------------------
1998.................................................... $100,000 $0 $0 $100,000
1999.................................................... 200,000 13,630 (10,000) 303,630
2000.................................................... 100,000 41,370 (445,000) 0
----------------------------------------------------------------------------------------------------------------
(iv) To compute the actual reported interest on fixed rent for
each calendar year, the variable interest adjustment amount, as
described in paragraph (b)(2) of this section, must be added to the
accrued interest determined in paragraph (iii) of this Example 1.
Assume that the variable rates for 1999 and 2000 are actually 11 and
14 percent, respectively. Without regard to section 467, the
interest that would have accrued during each calendar year under the
terms of the section 467 rental agreement, and the interest that
would have accrued under the terms of the rental agreement using the
fixed rate substitutes determined under paragraph (b)(1)(i) are as
follows:
------------------------------------------------------------------------
Accrued Accrued
interest interest
under using fixed
rental rate
agreement substitutes
------------------------------------------------------------------------
1998.......................................... $0 $0
1999.......................................... 11,000 10,000
2000.......................................... 42,000 45,000
------------------------------------------------------------------------
(v) Under paragraph (b)(2) of this section, the variable
interest adjustment amount is $1,000 ($11,000-$10,000) for 1999 and
is -$3,000 ($42,000-$45,000) for 2000. Thus, under paragraph
(b)(1)(ii) of this section, the actual interest on fixed rent for
1999 is $14,630 ($13,630+$1,000) and for 2000 is $38,370
($41,370-$3,000).
Example 2. (i) The facts are the same as in Example 1 except
that 110 percent of the applicable Federal rate is 15 percent
compounded annually and the section 467 rental agreement does not
provide adequate interest under Sec. 1.467-2(b). Consequently, the
fixed rent for each calendar year during the lease is the
proportional rental amount.
(ii) The sum of the present values of the fixed rent provided
for each calendar year during the lease term, discounted at 15
percent compounded annually, equals $303,936.87.
(iii)(A) Paragraph (b)(1)(i) of this section requires the
proportional rental amount to be computed based on the assumption
that interest will accrue and be paid based on the fixed rate
substitutes. Thus, the sum of the present values of the projected
payments under the section 467 rental agreement equals $300,156.16,
computed as follows:
$10,000/(1.15)2.............. = $7,561.44
445,000/(1.15)3.............. = 292,594.72
--------------------------
........................... 300,156.16
(B) The fraction for computing the proportional rental amount
equals .9875609 ($300,156.16/$303,936.87).
(iv) Based on the fixed rate substitutes, the fixed rent,
interest on fixed rent, and the balance of the section 467 loan for
each calendar year during the lease term are as follows:
----------------------------------------------------------------------------------------------------------------
Proportional Accrued Projected Cumulative
rent interest payment loan
----------------------------------------------------------------------------------------------------------------
1998................................................... $98,756.09 $0.00 $0 $98,756.09
1999................................................... 197,512.18 14,813.41 (10,000) 301,081.68
2000................................................... 98,756.09 45,162.23 (445,000) 0.00
----------------------------------------------------------------------------------------------------------------
(v) The variable interest adjustment amount in this example is
the same as in Example 1. Under paragraph (b)(1)(ii) of this
section, the actual interest on fixed rent for 1999 is $15,813.41
($14,813.41+$1,000) and for 2000 is $42,162.23 ($45,162.23-$3,000).
Sec. 1.467-6 Section 467 rental agreements with contingent payments.
[Reserved]
Sec. 1.467-7 Section 467 recapture and other rules relating to
dispositions.
(a) Section 467 recapture. Notwithstanding any other provision of
the Code, except as provided in paragraph (c) of this section, a lessor
disposing of property in a transaction to which this section applies
must recognize the recapture amount (determined under paragraph (b) of
this section) and treat that amount as ordinary income. This section
applies to any disposition of property subject to a section 467 rental
agreement that--
(1) Is a leaseback (as defined in Sec. 1.467-3(b)(2)) or a long-
term agreement (as defined in Sec. 1.467-3(b)(3));
(2) Is not disqualified under Sec. 1.467-3(b)(1); and
(3) Allocates to any rental period fixed rent that, when
annualized, exceeds the annualized fixed rent allocated to any
preceding rental period.
(b) Recapture amount--(1) In general. The recapture amount for a
disposition is the lesser of--
(i) The prior understated inclusions (determined under paragraph
(b)(2) of this section); or
(ii) The section 467 gain (determined under paragraph (b)(3) of
this section).
(2) Prior understated inclusions--(i) In general. The prior
understated inclusions are the excess (if any) of--
(A) The aggregate amount of section 467 rent and section 467
interest for the period during which the lessor held the property,
determined as if the section 467 rental agreement were a disqualified
leaseback or long-term agreement; over
(B) The aggregate amount of section 467 rent and section 467
interest accrued by the lessor during that period.
(ii) Partial rental periods. For purposes of this paragraph (b)(2),
the aggregate amounts described in paragraph (b)(2)(i)(A) and (B) of
this section include a ratable portion of the section 467 rent and
section 467 interest for any partial rental period during which the
lessor held the property.
(3) Section 467 gain--(i) In general. Except as otherwise provided
in paragraph (b)(3)(ii) of this section, the section 467 gain is the
excess (if any) of--
(A) The amount realized from the disposition; over
(B) The sum of the adjusted basis of the property and the amount of
any gain from the disposition that is treated as ordinary income under
any provision of subtitle A of the Code other than section 467(c)
(e.g., section 1245 or 1250).
[[Page 27849]]
(ii) Certain dispositions. In the case of a disposition that is not
a sale, exchange, or involuntary conversion, the section 467 gain is
the excess (if any) of the fair market value of the property on the
date of disposition over the amount determined under paragraph
(b)(3)(i)(B) of this section.
(c) Special rules--(1) Gifts. Paragraph (a) of this section does
not apply to a disposition by gift. However, see paragraph (c)(4) of
this section for dispositions by transferees.
(2) Dispositions at death. Paragraph (a) of this section does not
apply to a disposition if the basis of the property in the hands of the
transferee is determined under section 1014(a). In the case of items
constituting income in respect of a decedent, see section 691.
(3) Certain tax-free exchanges--(i) In general. The recapture
amount in the case of a disposition to which this paragraph (c)(3)
applies is limited to the amount of gain recognized to the transferor
(determined without regard to paragraph (a) of this section), reduced
by the amount of any gain from the disposition that is treated as
ordinary income under any provision of subtitle A of the Code other
than section 467(c).
(ii) Dispositions covered. This paragraph (c)(3) applies to a
disposition of property if the basis of the property in the hands of
the transferee is determined by reference to its basis in the hands of
the transferor by reason of the application of section 332, 351, 361,
721, or 731.
(4) Dispositions by transferee. If the recapture amount with
respect to a disposition of property (the first disposition) is limited
under paragraph (c)(1) or (3) of this section and the transferee
subsequently disposes of the property in a transaction to which this
section applies, the amount described in paragraph (b)(2)(i)(A) of this
section must be increased for purposes of determining the recapture
amount for such subsequent disposition by the excess (if any) of--
(i) The recapture amount on the first disposition, determined
without regard to the limitations of paragraphs (c)(1) and (3) of this
section; over
(ii) The recapture amount on the first disposition determined after
application of such limitations.
(5) Like-kind exchanges and involuntary conversions. If property is
disposed of or converted and, before the application of paragraph (a)
of this section, gain is not recognized in whole or in part under
section 1031 or 1033, then the amount of section 467 gain taken into
account by the lessor is limited to the sum of--
(i) The amount of gain recognized on the disposition or conversion
of the property (determined without regard to paragraph (a) of this
section); plus
(ii) The fair market value of property acquired that is not subject
to a section 467 rental agreement and that is not taken into account
under paragraph (c)(5)(i) of this section.
(6) Installment sales. In the case of an installment sale of
property to which paragraph (a) of this section applies--
(i) The recapture amount is recognized and treated as ordinary
income in the year of the disposition; and
(ii) Any gain in excess of the recapture amount shall be reported
under the installment method of accounting if and to the extent that
method is otherwise available under section 453.
(7) Dispositions covered by sections 170(e), 341(e)(12), or 751(c).
For purposes of sections 170(e), 341(e)(12), and 751(c), amounts
treated as ordinary income under paragraph (a) of this section must be
treated in the same manner as amounts treated as ordinary income under
section 1245 or 1250.
(d) Examples. The following examples illustrate the application of
this section:
Example 1. (i) X and Y enter into a section 467 rental agreement
for a 5-year lease of personal property beginning on January 1,
1997, and ending on December 31, 2001. The rental agreement provides
that $0 of rent is allocated to 1997, 1998, and 1999, and $175,000
is allocated to each of the years 2000 and 2001. The rental
agreement provides that the calendar year will be the rental period
and that the rent allocated to each calendar year is payable on the
last day of that calendar year. Assume that both X and Y are
calendar year taxpayers and that 110 percent of the applicable
Federal rate is 11 percent, compounded annually. Assume further that
the rental agreement is a long- term agreement (as defined in
Sec. 1.467-3(b)(3)). The rental agreement is not a disqualified
leaseback or long-term agreement because it does not provide for the
payment of more than $2,000,000 in rent (determined pursuant to
Sec. 1.467-3(b)(1)(i)). Therefore, the fixed rent allocated under
Sec. 1.467-1(c)(2)(ii) is zero for the first three rental periods
and $175,000 for the fourth and fifth rental periods.
(ii) On December 31, 1999, X sells the property subject to the
section 467 rental agreement to an unrelated person for $990,000. At
the time of the sale, X's adjusted basis in the property is
$550,000. Thus, X's gain on the sale of the property is $440,000.
Assume that none of this gain would be treated as ordinary income
under any provision of the Internal Revenue Code other than section
467(c). Under paragraph (a) of this section, X is required to take
the recapture amount into account as ordinary income. Under
paragraph (b) of this section, the recapture amount is the lesser of
the prior understated inclusions or the section 467 gain.
(iii) (A) In computing the prior understated inclusions under
paragraph (b)(2), assume that the section 467 rent and section 467
interest (based on constant rental accrual) would be taken into
account as follows if the section 467 rental agreement were a
disqualified long-term agreement:
------------------------------------------------------------------------
Section 467 Section 467
rent interest
------------------------------------------------------------------------
1997........................................ $59,290.59 $0
1998........................................ 59,290.59 6,521.96
1999........................................ 59,290.59 13,761.35
2000........................................ 59,290.59 21,797.06
2001........................................ 59,290.59 11,466.68
------------------------------------------------------------------------
(B) The aggregate amount of the section 467 rent and section 467
interest (based on constant rental accrual) for 1997, 1998, and 1999
is $198,155.08 ((3 x $59,290.59) + $6,521.96 + $13,761.35). Since X
did not take any section 467 rent or section 467 interest into
account in 1997, 1998, and 1999, the prior understated inclusions
are also $198,155.08. Since none of the gain is treated as ordinary
income under any provision of the Code other than section 467(c),
the entire amount of gain ($440,000) is section 467 gain.
Accordingly, the recapture amount (, the lesser of the prior
understated inclusions or the section 467 gain) treated as ordinary
income is $198,155.08.
Example 2. (i) The facts are the same as in Example 1 except
that the section 467 rental agreement specifies that rents accrue
and are paid in the following pattern:
------------------------------------------------------------------------
Allocation Payment
------------------------------------------------------------------------
1997........................................ $60,000 $0
1998........................................ 65,000 0
1999........................................ 70,000 0
2000........................................ 75,000 175,000
2001........................................ 80,000 175,000
------------------------------------------------------------------------
(ii) (A) Assume the section 467 rental agreement does not
provide for adequate interest under Sec. 1.467-2(b), and, therefore,
the fixed rent for a rental period is the proportional rental
amount. See Sec. 1.467-1(d)(2)(ii). Assume that, under Sec. 1.467-
2(c), the following amounts would be required to be taken into
account:
------------------------------------------------------------------------
Section 467 Section 467
rent interest
------------------------------------------------------------------------
1997........................................ $51,585.97 $0
1998........................................ 55,884.80 5,674.46
1999........................................ 60,183.63 12,445.98
2000........................................ 64,482.46 20,435.23
2001........................................ 68,781.28 10,526.19
------------------------------------------------------------------------
(B) The amount of section 467 rent and section 467 interest
taken into account by A for 1997, 1998, and 1999 is $185,774.84.
Thus, the prior understated inclusions are $12,380.24 (the excess of
the aggregate amount of section 467 rent and section 467 interest,
based on constant rental accrual, for these three years, ,
$198,155.08, over the aggregate amount of section 467 rent and
section 467 interest actually taken into
[[Page 27850]]
account, $185,774.84). Since this amount is less than the section
467 gain, the recapture amount treated as ordinary income is also
$12,380.24.
(e) Other rules relating to dispositions--(1) In general. If
property subject to a section 467 rental agreement is sold,
exchanged, or otherwise disposed of, the section 467 rent for a
period is taken into account by the owner of the property during the
period. The lessee, however, must continue to take section 467 rent
and section 467 interest into account without regard to the change
of ownership.
(2) Treatment of section 467 loan. If there is a sale, exchange, or
other disposition of property subject to a section 467 rental agreement
(the transfer), the following rules apply in determining the amount of
the section 467 loan for the period after the transfer, the amount
realized by the transferor, and the transferee's basis in the property:
(i) The beginning balance of the transferor's section 467 loan is
equal to the net present value at the time of the transfer of all
subsequent amounts payable as fixed rent and interest on fixed rent to
the transferor and all subsequent amounts payable as interest on
prepaid fixed rent by the transferor. The transferor must continue to
take into account interest on the transferor's section 467 loan balance
after the date of the transfer.
(ii) The beginning balance of the transferee's section 467 loan is
equal to the principal balance of the section 467 loan immediately
before the transfer reduced (below zero, if appropriate) by the
beginning balance of the transferor's section 467 loan. Amounts payable
to the transferor are not taken into account in adjusting the
transferee's section 467 loan balance.
(iii) If the beginning balance of the transferee's section 467 loan
is negative, the transferor and transferee must treat the balance as a
liability that is either assumed in connection with the transfer of the
property or secured by the property acquired subject to the liability.
If the beginning balance of the transferee's section 467 loan is
positive, the transferor and transferee must treat the balance as an
additional asset acquired in connection with the transfer of the
property. In the case of a positive beginning balance of the
transferee's section 467 loan, the transferee will have an initial cost
basis in the section 467 loan equal to the lesser of the beginning
balance of the loan or the aggregate consideration for the transfer of
the property subject to the section 467 rental agreement and the
transfer of the transferor's interest in the section 467 loan.
(3) Special rules for transfers in certain nonrecognition
transactions. [Reserved]
(f) Treatment of assignments by lessee and lessee-financed
renewals--(1) Substitute lessee use. If a lessee assigns its interest
in a section 467 rental agreement to a substitute lessee or a period
when a substitute lessee has the use of property subject to a rental
agreement is otherwise included in the lease term under Sec. 1.467-
1(h), the section 467 rent for a period is taken into account by the
person having the use of the property during the period. In addition,
the following rules apply in determining the amount of the section 467
loan for the period when the substitute lessee has use of the property
and in computing the taxable income of the lessee and substitute
lessee--
(i) The beginning balance of the lessee's section 467 loan is equal
to the net present value, as of the date on which the substitute lessee
first has use of the property, of all amounts subsequently payable by
the lessee as fixed rent and interest on fixed rent and all amounts
subsequently payable as interest on prepaid fixed rent to the lessee.
For purposes of this paragraph (f), any amount otherwise payable by the
lessee shall not be treated as an amount subsequently payable by the
lessee to the extent that such payment, if made by the lessee, would
give rise to a right of contribution or other similar claim against the
substitute lessee or any other person. The lessee must continue to take
into account interest on the lessee's section 467 loan balance after
the substitute lessee first has use of the property.
(ii) The beginning balance of the substitute lessee's section 467
loan is equal to the principal balance of the section 467 loan
immediately before the substitute lessee first has use of the property
reduced (below zero, if appropriate) by the beginning balance of the
lessee's section 467 loan. Amounts payable by the lessee to any person
other than the substitute lessee (or a related person) or payable to
the lessee by any person other than the substitute lessee (or a related
person) are not taken into account in adjusting the substitute lessee's
section 467 loan balance.
(iii) If the beginning balance of the substitute lessee's section
467 loan is positive, the beginning balance is treated as--
(A) Gross income of the lessee for the taxable year in which the
substitute lessee first has use of the property; and
(B) A liability that is either assumed in connection with the
transfer of the leasehold interest to the substitute lessee or secured
by property acquired subject to the liability.
(iv) If the beginning balance of the substitute lessee's section
467 loan is negative--
(A) The beginning balance is treated as an amount incurred by the
lessee for the taxable year in which the substitute lessee first has
use of the property; and
(B) Repayments of the beginning balance are items of gross income
of the substitute lessee in the taxable year in which the repayment
occurs (determined by applying any repayment first to the beginning
balance of the substitute lessee's section 467 loan).
(v) For purposes of paragraph (f)(1)(iv)(B) of this section,
repayments occur as the negative balance is amortized through the net
accrual of rent and negative interest.
(2) Lessor use. If a period when the lessor has the use of property
subject to a section 467 rental agreement is included in the lease term
under Sec. 1.467-1(h), the section 467 rent for the period is not taken
into account and the lessor is treated as a substitute lessee for
purposes of paragraph (f)(1) of this section.
(3) Special rules for transfers in certain nonrecognition
transactions. [Reserved]
Sec. 1.467-8 Effective date.
Sections 1.467-1 through 1.467-7 are effective for--
(a) Rental agreements entered into after the date these regulations
are published as final regulations in the Federal Register; and
(b) Disqualified leasebacks and long-term agreements entered into
after June 3, 1996.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-13719 Filed 5-31-96; 8:45 am]
BILLING CODE 4830-01-U
