Section 467 Rental Agreements

Federal RegisterJun 3, 1996

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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.

(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.

(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.

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]]

(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.

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.

(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).

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

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.

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;

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);

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).

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

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

(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.

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);

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).

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.

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.

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

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.