27834 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

SUMMARY: This document changes the

location of the public hearing on

proposed regulations relating to the

determination of the interest expense

deduction of foreign corporations and

branch profits tax.

DATES: The public hearing is being held

on Thursday, June 6, 1996, beginning at

10:00 a.m.

ADDRESSES: The public hearing

originally scheduled in the IRS

Auditorium, Seventh floor, 7400

Corridor, Internal Revenue Building,

1111 Constitution Avenue, NW,

Washington, DC is changed to room

5718, Internal Revenue Building, 1111

Constitution Avenue, NW, Washington,

DC.

FOR FURTHER INFORMATION CONTACT:

Mike Slaughter of the Regulations Unit,

Assistant Chief Counsel (Corporate),

(202) 622–7190, (not a toll-free number).

SUPPLEMENTARY INFORMATION: A notice

of public hearing appearing in the

Federal Register on Friday, March 8,

1996 (61 FR 9377), announced that a

public hearing relating to proposed

regulations under sections 882 and 884

of the Internal Revenue Code will be

held Thursday, June 6, 1996, beginning

at 10:00 a.m. in the IRS Auditorium,

Seventh floor, 7400 Corridor, Internal

Revenue Building, 1111 Constitution

Avenue, NW, Washington, DC and that

requests to speak and outlines of oral

comments should be received by

Thursday, May 23, 1996.

The location of the public hearing has

changed. The hearing is being held in

room 5718 on Thursday, June 6, 1996,

beginning at 10:00 a.m. The requests to

speak and outlines of oral comments

should be received by Thursday, May

23, 1996. Because of controlled access

restrictions, attenders cannot be

admitted beyond the lobby of the

Internal Revenue Building until 9:45

a.m.

Copies of the agenda are available free

of charge at the hearing.

Cynthia E. Grigsby,

Chief, Regulations Unit, Assistant Chief

Counsel (Corporate).

[FR Doc. 96–13723 Filed 5–31–96; 8:45 am]

BILLING CODE 4830–01–U

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.

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
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 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 taxexempt 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
27836 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

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 § 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 § 1.1275–5(a)(3)(i) (A) or (B) and

§ 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 § 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

§ 1.1275–4. The IRS and the Treasury

Department invite comments regarding

the application of the § 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
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 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 § 1.61–8, the first sentence

of paragraph (b) is revised to read as

follows:

§ 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
27838 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

or the method of accounting employed

by the taxpayer. * * *

* * * * *

Par. 3. In § 1.451–1, paragraph (g) is

added to read as follows:

§ 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:

§ 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:

§ 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

§ 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:

§ 1.467–0 Table of contents.

This section lists the major captions

that appear in §§ 1.467–1 through

1.467–8.

§ 1.467–1 Treatment of lessors and lessees

generally.

(a) Overview.

(1) In general.

(2) Cases in which rules are inapplicable.

(3) Limited effect for rental agreements

with total rents between $250,000 and

$2,000,000.

(4) Summary of rules.

(i) Basic rules.

(ii) Special rules.

(b) Method of accounting for section 467

rental agreements.

(c) Section 467 rental agreements.

(1) In general.

(2) Increasing or decreasing rent.

(i) Fixed rent.

(A) In general.

(B) Certain rent holidays disregarded.

(ii) Fixed rent allocated to a rental period.

(A) Specific allocation.

(1) In general.

(2) Rental agreements specifically

allocating fixed rent.

(B) No specific allocation.

(iii) Contingent rent.

(A) In general.

(B) Certain contingent rent disregarded.

(3) Deferred or prepaid rent.

(i) Deferred rent.

(ii) Prepaid rent.

(iii) Rent allocated to a calendar year.

(iv) Examples.

(4) Rental agreements involving total

payments of $250,000 or less.

(i) In general.

(ii) Special rules in computing amount

described in paragraph (c)(4)(i).

(d) Section 467 rent.

(1) In general.

(2) Fixed rent for a rental period.

(i) Constant rental accrual.

(ii) Proportional rental accrual.

(iii) Section 467 rental agreement accrual.

(e) Section 467 interest.

(1) In general.

(2) Interest on fixed rent for a rental period.

(i) In general.

(ii) Section 467 rental agreements with

adequate interest.

(3) Treatment of interest.

(f) Modification of a rental agreement.

(g) Treatment of amounts payable by lessor

to lessee.

(1) Interest.

(2) Other amounts. [Reserved]

(h) Meaning of terms.

(i) [Reserved]

(j) Computational rules.

(1) Counting conventions.

(2) Conventions regarding timing of rent

and payments.

(i) In general.

(ii) Time amount is payable.

(3) Annualized fixed rent.

(4) Allocation of fixed rent within a period.

(5) Rental period length.

§ 1.467–2 Rent accrual for section 467

rental agreements without adequate interest.

(a) Section 467 rental agreement for which

proportional rental accrual is required.

(b) Adequate interest on fixed rent.

(1) In general.

(2) Section 467 rental agreements that

provide for a variable rate of interest.

(c) Computation of proportional rental

amount.

(1) In general.

(2) Section 467 rental agreements that

provide for a variable rate of interest.

(d) Present value.

(e) Applicable Federal rate.

(1) In general.

(2) Source of applicable Federal rates.

(3) 110 percent of applicable Federal rate.

(4) Term of the section 467 rental

agreement.

(i) In general.

(ii) Section 467 rental agreements with

variable interest.

(f) Examples.

§ 1.467–3 Disqualified leasebacks and longterm agreements.

(a) General rule.

(b) Disqualified leaseback or long-term

agreement.

(1) In general.

(2) Leaseback.

(3) Long-term agreement.

(i) In general.

(ii) Statutory recovery period.

(A) In general.

(B) Special rule for leases of properties

having different statutory recovery periods.

(c) Tax avoidance as principal purpose for

increasing or decreasing rent.

(1) In general.

(2) Safe harbors.

(d) Calculating constant rental amount.

(1) In general.

(2) Initial or final short periods.

(3) Method to determine constant rental

amount; no short periods.

(i) Step 1.

(ii) Step 2.

(iii) Step 3.

(e) Example.

§ 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 § 1.467–7(e) or § 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.
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 27839

(c) Yield.

(1) In general.

(i) Method of determining yield.

(ii) Method of stating yield.

(iii) Rounding adjustments.

(2) Yield of section 467 rental agreements

for which constant rental amount or

proportional rental amount is computed.

(3) Determination of present values.

(d) Contingent payments.

(e) Section 467 rental agreements that call

for payments before or after the lease term.

(f) Examples.

§ 1.467–5 Section 467 rental agreements

with variable interest.

(a) Variable interest on deferred or prepaid

rent.

(1) In general.

(2) Exceptions.

(b) Variable rate treated as fixed.

(1) In general.

(2) Variable interest adjustment amount.

(i) In general.

(ii) Sign of adjustment.

(3) Section 467 loan balance.

(c) Examples.

§ 1.467–6 Section 467 rental agreements

with contingent payments.

[Reserved]

§ 1.467–7 Section 467 recapture and other

rules relating to dispositions.

(a) Section 467 recapture.

(b) Recapture amount.

(1) In general.

(2) Prior understated inclusions.

(i) In general.

(ii) Partial rental periods.

(3) Section 467 gain.

(i) In general.

(ii) Certain dispositions.

(c) Special rules.

(1) Gifts.

(2) Dispositions at death.

(3) Certain tax-free exchanges.

(i) In general.

(ii) Dispositions covered.

(4) Dispositions by transferee.

(5) Like-kind exchanges and involuntary

conversions.

(6) Installment sales.

(7) Dispositions covered by sections 170(e),

341(e)(12), or 751(c).

(d) Examples.

(e) Other rules relating to dispositions.

(1) In general.

(2) Treatment of section 467 loan.

(3) Special rules for transfers in certain

nonrecognition transactions. [Reserved]

(f) Treatment of assignments by lessee and

lessee-financed renewals.

(1) Substitute lessee use.

(2) Lessor use.

(3) Special rules for transfers in certain

nonrecognition transactions. [Reserved]

§ 1.467–8 Effective date.

§ 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

§§ 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, § 1.467–8 provides

the effective date rules for the section

467 regulations.

(b) Method of accounting for section

467 rental agreements. If a rental

agreement is a section 467 rental

agreement, as described in paragraph (c)

of this section, the lessor and lessee

must each take into account for any

taxable year—

(1) The section 467 rent for the

taxable year (as defined in paragraph (d)

of this section); and

(2) The section 467 interest for the

taxable year (as defined in paragraph (e)

of this section).

(c) Section 467 rental agreements—(1)

In general. Except as otherwise

provided in paragraph (c)(4) of this

section, the term section 467 rental

agreement means a rental agreement, as

defined in paragraph (h) of this section,

that has increasing or decreasing rents

(as described in paragraph (c)(2) of this

section), or prepaid or deferred rents (as

described in paragraph (c)(3) of this

section).

(2) Increasing or decreasing rent—(i)

Fixed rent—(A) In general. A rental

agreement has increasing or decreasing

rent if the annualized fixed rent, as

described in paragraph (j)(3) of this

section, allocated to any rental period

exceeds the annualized fixed rent

allocated to any other rental period in

the lease term.

(B) Certain rent holidays disregarded.

Notwithstanding the provisions of

paragraph (c)(2)(i)(A) of this section, a

rental agreement does not have
27840 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

increasing or decreasing rent if the

increasing or decreasing rent is solely

attributable to a rent holiday provision

allowing reduced rent (including no

rent) for a period at the beginning of the

lease term, but only if the duration of

the rent holiday does not exceed three

months.

(ii) Fixed rent allocated to a rental

period—(A) Specific allocation—(1) In

general. If a rental agreement provides a

specific allocation of fixed rent, as

described in paragraph (c)(2)(ii)(A)(2) of

this section, the amount of fixed rent

allocated to each rental period during

the lease term is the amount of fixed

rent allocated to that period by the

rental agreement.

(2) Rental agreements specifically

allocating fixed rent. A rental agreement

specifically allocates fixed rent if the

rental agreement unambiguously

specifies, for periods no longer than a

year, a fixed amount of rent for which

the lessee becomes liable on account of

the use of the property during that

period, and the total amount of fixed

rent specified is equal to the total

amount of fixed rent payable under the

lease. For example, a rental agreement

providing that rent is $100,000 per

calendar year, and that provides for total

payments of fixed rent equal to the total

amount specified, specifically allocates

rent. Similarly, a rental agreement that

states the amount of rent accruing each

month or the amount of rent allocated

to each year contains a specific

allocation if the total payments of fixed

rent equal the total amount specified. A

rental agreement stating only when rent

is payable does not specifically allocate

rent.

(B) No specific allocation. If a rental

agreement does not provide a specific

allocation of fixed rent (for example,

because the total amount of fixed rent

specified is not equal to the total

amount of fixed rent payable under the

lease), the amount of fixed rent

allocated to a rental period is the

amount of fixed rent payable during that

rental period. If an amount of fixed rent

is payable before the beginning of the

lease term, it is allocated to the first

rental period in the lease term. If an

amount of fixed rent is payable after the

end of the lease term, it is allocated to

the last rental period in the lease term.

(iii) Contingent rent—(A) In general.

A rental agreement has increasing or

decreasing rent if it requires (or may

require) the payment of contingent rent

(as defined in paragraph (h) of this

section), other than contingent rent

described in paragraph (c)(2)(iii)(B) of

this section.

(B) Certain contingent rent

disregarded. Contingent rent is

disregarded for purposes of this

paragraph (c)(2)(iii) to the extent—

(1) The rent is contingent solely as the

result of a provision pursuant to which

the rent is equal to a percentage of the

lessee’s receipts (gross or net), but only

if the percentage does not vary

throughout the term of the lease;

(2) The rent is contingent solely as the

result of an adjustment based on a

reasonable price index, as defined in

paragraph (h) of this section; or

(3) The rent is contingent solely as the

result of a provision requiring the lessee

to pay third-party costs, as defined in

paragraph (h) of this section.

(3) Deferred or prepaid rent—(i)

Deferred rent. A rental agreement has

deferred rent under this paragraph (c)(3)

if the amount of rent allocated to a

calendar year (determined under

paragraph (c)(3)(iii) of this section),

when added to the rent allocated to all

preceding calendar years, exceeds the

cumulative amount of rent payable as of

the close of the succeeding calendar

year.

(ii) Prepaid rent. A rental agreement

has prepaid rent under this paragraph

(c)(3) if the amount of rent allocated to

a calendar year (determined under

paragraph (c)(3)(iii) of this section),

when added to the rent allocated to all

preceding calendar years, is less than

the cumulative amount of rent payable

before the beginning of the preceding

calendar year.

(iii) Rent allocated to a calendar year.

For purposes of this paragraph (c)(3),

the rent allocated to a calendar year is

the sum of—

(A) The fixed rent allocated to any

rental period (determined under

paragraph (c)(2)(ii) of this section) that

begins and ends in the calendar year;

(B) A ratable portion of the fixed rent

allocated to any other rental period that

begins or ends in the calendar year; and

(C) Any contingent rent that accrues

during the calendar year as provided in

§ 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
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 27841

determining the amount described in

paragraph (c)(4)(i) of this section—

(A) Stated interest on deferred rent is

not taken into account. However, the

Commissioner may recharacterize a

portion of stated interest as additional

rent if a rental agreement provides for

interest on deferred rent at a rate that,

in light of all of the facts and

circumstances, is clearly greater than

the arm’s-length rate of interest that

would have been charged in a lending

transaction between the lessor and

lessee.

(B) Consideration that does not

involve a cash payment is taken into

account at its fair market value. A

liability that is either assumed or

secured by property acquired subject to

the liability is taken into account at its

remaining principal amount or, in the

case of an obligation originally issued at

a discount, at its adjusted issue price.

(C) All leases that are part of the same

transaction or a series of related

transactions are treated as a single lease.

Whether two or more leases are part of

the same transaction or a series of

related transactions depends on all the

facts and circumstances.

(D) Any increase or decrease in rent

payable solely as a result of an

adjustment based on a reasonable price

index is not taken into account.

(E) Contingent rent described in

paragraph (c)(2)(iii)(B)(3) of this section

is not taken into account.

(d) Section 467 rent—(1) In general.

The section 467 rent for a taxable year

is the sum of—

(i) The fixed rent for any rental period

(determined under paragraph (d)(2) of

this section) that begins and ends in the

taxable year;

(ii) A ratable portion of the fixed rent

for any other rental period beginning or

ending in the taxable year; and

(iii) In the case of a section 467 rental

agreement that provides for contingent

rent, the contingent rent that accrues

during the taxable year as provided in

§ 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 § 1.467–3(b)),

the fixed rent for a rental period is the

constant rental amount (as determined

under § 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 § 1.467–2(b)), the

fixed rent for a rental period is the

proportional rental amount (as

determined under § 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 § 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 § 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

§ 1.467–4(b)) at the beginning of the

rental period; and

(B) The yield of the section 467 loan

(as described in § 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 longterm agreement, if a section 467 rental

agreement provides adequate interest

under § 1.467–2(b)(1)(i) (agreements

with no deferred or prepaid rent) or

§ 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 §§ 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 §§ 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 §§ 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
27842 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

the meaning of § 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 § 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

§ 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 §§ 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 §§ 1.467–2 through

1.467–7, the rent allocated to a rental

period is taken into account on the last

day of the rental period;

(B) Any amount payable during the

first half of the first rental period is

treated as payable on the first day of that

rental period;

(C) Any amount payable during the

first half of any other rental period is

treated as payable on the last day of the

preceding rental period; and

(D) Any amount payable during the

second half of a rental period is treated

as payable on the last day of the rental

period.

(ii) Time amount is payable. For

purposes of this paragraph (j)(2), an

amount is payable on the last day for

timely payment (that is, the last day

such amount may be paid without

incurring interest, computed at an

arm’s-length rate, or a substantial

penalty charge) and an amount payable

at the midpoint of a rental period is

treated as payable during the first half

of the rental period.

(3) Annualized fixed rent. Annualized

fixed rent is determined by multiplying

the fixed rent allocated to the rental

period under paragraph (c)(2)(ii) of this

section by a number that represents the

ratio of one year to the length of the

rental period. Thus, if the fixed rent

allocated to a rental period is $100,000

and the rental period is one month, the

annualized fixed rent allocated to the

rental period is $1,200,000.

(4) Allocation of fixed rent within a

period. A rental agreement that allocates

fixed rent to any period is treated as

allocating fixed rent ratably within that

period. Thus, if a rental agreement

provides that $120,000 is allocated to

each calendar year in the lease term,

$10,000 of rent is allocated to each

calendar month.

(5) Rental period length. Except as

provided in § 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.

§ 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 § 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 longterm agreement under § 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

§ 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 § 1.1273–

1(c)(1)(iii));

(B) The stated rate of interest on fixed

rent is no lower than 110 percent of the

applicable Federal rate (as defined in

paragraph (e)(3) of this section);

(C) The amount of deferred or prepaid

fixed rent on which interest is charged

is adjusted at least annually to reflect

the amount of deferred or prepaid fixed

rent as of a date no earlier than the date

of the preceding adjustment and no later

than the date of the succeeding

adjustment; and

(D) The rental agreement requires

interest to be paid or compounded at

least annually;

(iii) The rental agreement provides for

deferred rent but no prepaid rent, and

the sum of the present values of all

amounts payable by the lessee as fixed

rent (and interest, if any, thereon) is

equal to or greater than the sum of the

present values of the fixed rent allocated

to each rental period; or

(iv) The rental agreement provides for

prepaid rent but no deferred rent, and

the sum of the present values of all

amounts payable by the lessee as fixed

rent, plus the sum of the negative

present values of all amounts payable by

the lessor as interest, if any, on prepaid

fixed rent, is equal to or less than the

sum of the present values of the fixed

rent allocated to each rental period.

(2) Section 467 rental agreements that

provide for a variable rate of interest.

For purposes of the adequate interest

test under paragraph (b)(1) of this

section, if a section 467 rental
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 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 § 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 § 1.1275–5(a)(3)(i)(A) or

(B) and § 1.1275–5(a)(4).

(c) Computation of proportional

rental amount—(1) In general. The

proportional rental amount for a rental

period is the amount of fixed rent

allocated to the rental period under

§ 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 § 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 § 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

§ 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 § 1.1272–

1(j), Example 1.

(3) 110 percent of applicable Federal

rate. For purposes of § 1.467–1, this

section and §§ 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 § 1.1274–

4(c)(2)(ii), the rental agreement provides

for a qualified floating rate (as defined

in § 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 § 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:

$379, . $100, ( . )

. 078 68 000

1 110

10

5

= × − −

(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 § 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 § 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.
27844 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

(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 § 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:

$234, . $300,

( . )

872 43

000

1 085 3 = +

(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:

$252, . $80,

( . )

$100,

( . )

$120,

( . )

627 22

000

1 085

000

1 085

000

1 085 2 3 = +

+

+

+

+

(C) Thus, the fraction for determining the

proportional rental amount is .9297194

($234,872.43/$252,627.22). The section 467

fixed rents for the taxable years within the

lease term are:

Taxable

year Section 467 rent

1998 .... $74,377.55 ($80,000 × .9297194)

1999 .... 92,971.94 ($100,000 × .9297194)

2000 .... 111,566.33 ($120,000 × .9297194)

§ 1.467–3 Disqualified leasebacks and

long-term agreements.

(a) General rule. Under § 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 longterm 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 § 1.467–1(c)(4)

(relating to the exception for rental

agreements involving total payments of

$250,000 or less) exceeds $2,000,000;

(ii) A principal purpose for providing

increasing or decreasing rent is the

avoidance of Federal income tax (as

described in paragraph (c) of this

section); and

(iii) The Commissioner determines

that it is appropriate to treat the section

467 rental agreement as a disqualified

leaseback or long-term agreement.

(2) Leaseback. A section 467 rental

agreement is a leaseback if the lessee (or

a related person) had any interest (other

than a de minimis interest) in the

property at any time during the two-year

period ending on the agreement date.

For this purpose, interests in property

include options and agreements to

purchase the property (whether or not

the lessee or related person was

considered the owner of the property for

Federal income tax purposes) and, in

the case of subleased property, any

interest as a sublessor.

(3) Long-term agreement—(i) In

general. A section 467 rental agreement

is a long-term agreement if the lease

term exceeds 75 percent of the statutory

recovery period for the property.

(ii) Statutory recovery period—(A) In

general. The term statutory recovery

period means—

(1) In the case of property depreciable

under section 168, the applicable period

determined under section 467(e)(3)(A);

(2) In the case of land, 19 years; and

(3) In the case of any other tangible

property, the period that would apply

under section 467(e)(3)(A) if the

property were property to which section

168 applied.

(B) Special rule for leases of

properties having different statutory

recovery periods. In the case of a lease

of two or more related properties that

have different statutory recovery

periods, the statutory recovery period

for purposes of paragraph (b)(3)(ii)(A) of

this section is the weighted average,

based on the fair market values of the

properties on the lease date, of the

statutory recovery periods of each of the

properties.

(c) Tax avoidance as principal

purpose for increasing or decreasing

rent—(1) In general. Whether tax

avoidance is a principal purpose for

providing increasing or decreasing rent

in a leaseback or long-term agreement is

based on all of the facts and

circumstances. However, if either the

lessee or the lessor is not subject to

Federal income tax on its income or is

a tax- exempt entity (within the

meaning of section 168(h)(2)), the

agreement will be closely scrutinized

and clear and convincing evidence will

be required to establish that tax

avoidance is not a principal purpose for

providing increasing or decreasing rent.

(2) Safe harbors. Tax avoidance is not

considered to be a principal purpose for

providing increasing or decreasing rent

if—

(i) The rent allocated to each calendar

year (determined without regard to any

increase or decrease attributable to a

provision described in paragraph

(c)(2)(ii)(C) of this section) does not vary

from the average rent allocated to all

calendar years by more than 10 percent

(for this purpose, the rent allocated to a

partial calendar year is adjusted by
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 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 § 1.467–1(h);

(C) A provision requiring the lessee to

pay third-party costs as described in

§ 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

§ 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 § 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:

$21, , $17, ,

( . )

$17, ,

( . )

051 536

500 000

112

500 000

112 4 5 = +

(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:

$5, , $21, ,

. 839 901

051 536

3 6047762 =

§ 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 § 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 § 1.467–2(b)(1)(i)

(agreements with no deferred or prepaid

rent) or § 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

§ 1.467–3.

(4) Special rule in applying the

provisions of § 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

§ 1.467–2(b)(1) (i) or (ii), but only for

purposes of applying the provisions of
27846 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

§ 1.467–7(e) (relating to dispositions of

property subject to a section 467 rental

agreement) or § 1.467–7(f) (relating to

assignments by lessees and lesseefinanced renewals) to a transaction

described therein. Further, for section

467 rental agreements that provide

adequate interest under § 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 § 1.467–7(e) or the

assignment or renewal under § 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 § 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 § 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 § 1.467–1(j)(2).

(c) Yield—(1) In general—(i) Method

of determining yield. Except as provided

in paragraph (c)(2) of this section, the

yield of a section 467 loan is the

discount rate at which the sum of the

present values of all amounts payable by

the lessee as fixed rent and interest on

fixed rent, plus the sum of the present

values of all amounts payable by the

lessor as interest on prepaid fixed rent,

equals the sum of the present values of

the fixed rent that accrues in accordance

with § 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 § 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

§ 1.467–2(d) for computing the

proportional rental amount.

(d) Contingent payments. Except as

otherwise required under § 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 § 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 § 1.467–3(b)(1)(i)).

Because the section 467 rental agreement

does not provide adequate interest under

§ 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 § 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 § 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 § 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
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 27847

calendar years identified above, regardless of

their respective methods of accounting.

Example 2. (i) The facts are the same as in

Example 1, § 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:

Calendar year Section 467

interest

Section 467

rent

Section 467

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.

§ 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

§ 1.1275–5(a)(3)(i) (A) or (B) and

§ 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 § 1.467–

6.

(2) Exceptions. This section is not

applicable to section 467 rental

agreements that provide adequate

interest under § 1.467–2(b)(1)(i)

(agreements with no deferred or prepaid

rent) or § 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 § 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 § 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 § 1.467–2(c), the constant

rental amount under § 1.467–3(d), the

principal balance of a section 467 loan

under § 1.467–4(b), and the yield of a

section 467 loan under § 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 § 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 § 1.467–4(b). Instead, the

section 467 loan balance is computed as

if all amounts payable under the section

467 rental agreement were based on the

fixed rate substitutes determined under

paragraph (b)(1)(i) of this section.

(c) Examples. The following examples

illustrate the application of this section:

Example 1. (i) X and Y enter into a section

467 rental agreement for the lease of personal

property beginning on January 1, 1998, and

ending on December 31, 2000. It allocates

$100,000 of rent to 1998, $200,000 to 1999,

and $100,000 to 2000, and requires the lessee

to pay all $400,000 of rent on December 31,

2000. The rental agreement requires the

accrual of interest on unpaid accrued rent at

two different qualified floating rates (as

defined in § 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 § 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 § 1.467–3(b)(1)(i)).

To determine if the section 467 rental

agreement provides for adequate interest

under § 1.467–2(b), § 1.467–2(b)(2) requires

the use of fixed rate substitutes (in this

example determined in the same manner as

under § 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 § 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 § 1.1275–5(a)(3)(i)(A) and (4) are met and

the rental agreement provides for variable
27848 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

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 § 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

rent

Accrued

interest

Projected

payment

Cumulative

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 interest under

rental

agreement

Accrued interest using

fixed rate

substitutes

1998 .................. $0 $0

1999 .................. 11,000 10,000

Accrued interest under

rental

agreement

Accrued interest using

fixed rate

substitutes

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 § 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

rent

Accrued interestProjected paymentCumulative

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).

§ 1.467–6 Section 467 rental agreements

with contingent payments. [Reserved]

§ 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

§ 1.467–3(b)(2)) or a long-term

agreement (as defined in § 1.467–

3(b)(3));

(2) Is not disqualified under § 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).
Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules 27849

(ii) Certain dispositions. In the case of

a disposition that is not a sale,

exchange, or involuntary conversion,

the section 467 gain is the excess (if

any) of the fair market value of the

property on the date of disposition over

the amount determined under paragraph

(b)(3)(i)(B) of this section.

(c) Special rules—(1) Gifts. Paragraph

(a) of this section does not apply to a

disposition by gift. However, see

paragraph (c)(4) of this section for

dispositions by transferees.

(2) Dispositions at death. Paragraph

(a) of this section does not apply to a

disposition if the basis of the property

in the hands of the transferee is

determined under section 1014(a). In

the case of items constituting income in

respect of a decedent, see section 691.

(3) Certain tax-free exchanges—(i) In

general. The recapture amount in the

case of a disposition to which this

paragraph (c)(3) applies is limited to the

amount of gain recognized to the

transferor (determined without regard to

paragraph (a) of this section), reduced

by the amount of any gain from the

disposition that is treated as ordinary

income under any provision of subtitle

A of the Code other than section 467(c).

(ii) Dispositions covered. This

paragraph (c)(3) applies to a disposition

of property if the basis of the property

in the hands of the transferee is

determined by reference to its basis in

the hands of the transferor by reason of

the application of section 332, 351, 361,

721, or 731.

(4) Dispositions by transferee. If the

recapture amount with respect to a

disposition of property (the first

disposition) is limited under paragraph

(c)(1) or (3) of this section and the

transferee subsequently disposes of the

property in a transaction to which this

section applies, the amount described in

paragraph (b)(2)(i)(A) of this section

must be increased for purposes of

determining the recapture amount for

such subsequent disposition by the

excess (if any) of—

(i) The recapture amount on the first

disposition, determined without regard

to the limitations of paragraphs (c)(1)

and (3) of this section; over

(ii) The recapture amount on the first

disposition determined after application

of such limitations.

(5) Like-kind exchanges and

involuntary conversions. If property is

disposed of or converted and, before the

application of paragraph (a) of this

section, gain is not recognized in whole

or in part under section 1031 or 1033,

then the amount of section 467 gain

taken into account by the lessor is

limited to the sum of—

(i) The amount of gain recognized on

the disposition or conversion of the

property (determined without regard to

paragraph (a) of this section); plus

(ii) The fair market value of property

acquired that is not subject to a section

467 rental agreement and that is not

taken into account under paragraph

(c)(5)(i) of this section.

(6) Installment sales. In the case of an

installment sale of property to which

paragraph (a) of this section applies—

(i) The recapture amount is

recognized and treated as ordinary

income in the year of the disposition;

and

(ii) Any gain in excess of the

recapture amount shall be reported

under the installment method of

accounting if and to the extent that

method is otherwise available under

section 453.

(7) Dispositions covered by sections

170(e), 341(e)(12), or 751(c). For

purposes of sections 170(e), 341(e)(12),

and 751(c), amounts treated as ordinary

income under paragraph (a) of this

section must be treated in the same

manner as amounts treated as ordinary

income under section 1245 or 1250.

(d) Examples. The following examples

illustrate the application of this section:

Example 1. (i) X and Y enter into a section

467 rental agreement for a 5-year lease of

personal property beginning on January 1,

1997, and ending on December 31, 2001. The

rental agreement provides that $0 of rent is

allocated to 1997, 1998, and 1999, and

$175,000 is allocated to each of the years

2000 and 2001. The rental agreement

provides that the calendar year will be the

rental period and that the rent allocated to

each calendar year is payable on the last day

of that calendar year. Assume that both X and

Y are calendar year taxpayers and that 110

percent of the applicable Federal rate is 11

percent, compounded annually. Assume

further that the rental agreement is a longterm agreement (as defined in § 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 § 1.467–3(b)(1)(i)).

Therefore, the fixed rent allocated under

§ 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

rent

Section 467

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 § 1.467–2(b), and, therefore,

the fixed rent for a rental period is the

proportional rental amount. See § 1.467–

1(d)(2)(ii). Assume that, under § 1.467–2(c),

the following amounts would be required to

be taken into account:

Section 467

rent

Section 467

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
27850 Federal Register / Vol. 61, No. 107 / Monday, June 3, 1996 / Proposed Rules

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 § 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

§ 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]

§ 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 longterm 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

DEPARTMENT OF LABOR

Occupational Safety and Health

Administration

29 CFR Parts 1904 and 1952

Recording and Reporting Occupational

Injuries and Illnesses; Extension of

Comment Period

AGENCY: Occupational Safety and Health

Administration (OSHA), Department of

Labor.

ACTION: Proposed Rule; Extension of

comment period.

SUMMARY: OSHA published a Notice of

Proposed Rulemaking covering the