[Federal Register Volume 66, Number 4 (Friday, January 5, 2001)]
[Rules and Regulations]
[Pages 1038-1040]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-253]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8917]
RIN 1545-AW75


Section 467 Rental Agreements Involving Payments of $2,000,000 or 
Less

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations concerning section 
467 rental agreements. The regulations provide amendments to the 
regulations under section 467, including the removal of the exception 
to constant rental accrual for rental agreements involving payments of 
$2,000,000 or less. The regulations affect taxpayers that are parties 
to a section 467 rental agreement.

DATES:  Effective Date: These regulations are effective January 5, 
2001.
    Dates of Applicability: For dates of applicability of these 
regulations, see Effective Dates under SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Forest Boone, (202) 622-4960 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR Part 1 under section 
467 of the Internal Revenue Code (Code). Section 467 was added to the 
Code by section 92(a) of the Tax Reform Act of 1984 (Public Law 98-369; 
98 Stat. 609).
    On May 18, 1999, a notice of proposed rulemaking (REG-103694-99, 
1999-24, I.R.B. 49) under section 467 was published in the Federal 
Register (64 FR 26924). The notice proposed to amend the section 467 
regulations relating to constant rental accrual by treating section 467 
rental agreements involving payments of $2,000,000 or less in the same 
manner as agreements involving payments of more than $2,000,000. 
Although comments and requests for a public hearing were solicited, no 
comments were received and no public hearing was requested or held. 
Accordingly, the amendment to the constant rental accrual rules called 
for by the proposed regulations is adopted without revision.
    In addition, the IRS and Treasury Department have identified three 
provisions in the section 467 regulations (TD 8820), published on May 
18, 1999, at 64 FR 26845, that require clarification. Accordingly, 
these final regulations also provide clarifying amendments to the 
section 467 regulations.

Explanation of Provisions

A. Removal of the $2,000,000 Constant Rental Accrual Exception

    Section 467 includes an anti-abuse rule applicable to certain 
section 467 rental agreements. Under this rule, a constant rental 
amount must be taken into account by a lessor and lessee for each 
rental period during the lease term. 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 agreement.
    Constant rental accrual applies only with respect to leasebacks and 
long-term agreements that provide for increasing or decreasing rent and 
only if the Commissioner determines that the agreement is disqualified 
because tax avoidance is a principal purpose for providing increasing 
or decreasing rent. In addition, however, the regulations provide that 
a rental agreement will not be disqualified and, consequently, will not 
be subject to constant rental accrual unless it requires more than 
$2,000,000 in rental payments and other consideration.
    These final regulations remove the $2,000,000 exception from 
constant rental accrual for section 467 rental agreements entered into 
on or after July 19, 1999. Consequently, for section 467 rental 
agreements entered into on or after July 19, 1999, the Commissioner may 
determine that the agreement is a disqualified leaseback or long-term 
agreement subject to constant rental accrual, even if the agreement 
requires $2,000,000 or less in rental payments and other consideration.

B. Definition of Lease Term

    Section 1.467-1(h)(6) defines lease term to mean ``the period 
during which the lessee has use of the property subject to the rental 
agreement, including any option to renew or extend the term of the 
agreement other than an option, exercisable by the lessee, as to which 
it is reasonably expected, as of the agreement date, that the option 
will not be exercised.'' [Emphasis added]. By contrast, the proposed 
regulations preceding the section 467 final regulations stated that an 
option period, whether exercisable by the lessor or lessee, is included 
in the lease term only if it is expected, as of the agreement date, 
that the option will be exercised. The purpose of the broader rule in 
the

[[Page 1039]]

final regulations was to include all lessor option periods in the lease 
term. The IRS and Treasury Department recognize, however, that the 
broader rule has caused some uncertainty as to whether a change in the 
treatment of lessee options, particularly those exercisable at fair 
market value rental, was also intended. These regulations clarify that 
a change in the treatment of lessee options was not intended. They 
provide, in language similar to that of the proposed section 467 
regulations, that lessee options are to be included in the lease term 
only if it is expected, as of the agreement date, that the option will 
be exercised. For this purpose, 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 fair market value 
rental for such period. It should be noted, however, that factors other 
than the relationship between rent and expected fair market value 
rental for the option period may be relevant in determining whether it 
is expected that a lessee option will be exercised. Thus, even in the 
case of a lessee option exercisable at fair market value rental, it 
may, on account of such other relevant factors, be expected that the 
option will be exercised.

C. When an Amount Is Considered Payable

    Section 1.467-1(j)(2)(ii) provides that, for purposes of 
determining present value and yield under the regulations, an amount is 
payable on the last day for timely payment (the last day for timely 
payment rule). The last day for timely payment is the last day such 
amount may be paid without incurring interest, computed at an arm's-
length rate, a substantial penalty, or other substantial detriment 
(such as giving the lessor the right to terminate the agreement, bring 
an action to enforce payment, or exercise other similar remedies under 
the terms of the agreement or applicable law).
    The IRS and Treasury Department believe that the last day for 
timely payment rule, applicable to the computation of present value and 
yield, should also apply to other cases in which the date on which an 
amount is payable is relevant for purposes of section 467. Accordingly, 
the section 467 regulations have been amended to provide that, for 
purposes of applying all of the section 467 rules, not just those 
dealing with present value and yield, an amount is payable on the last 
day for timely payment.

D. Adequate Interest for Agreements With Both Deferred and Prepaid Rent

    Under the section 467 regulations, the fixed rent for each rental 
period is the proportional rental amount if the section 467 rental 
agreement is not a disqualified leaseback or long-term agreement and if 
the agreement does not provide adequate interest on fixed rent. The 
regulations set forth rules for determining whether an agreement has 
adequate interest on fixed rent. These regulations clarify how these 
rules apply in the case of agreements with both deferred and prepaid 
rent.

E. Effective Dates

    The removal of the exception from constant rental accrual for 
rental agreements involving payments of $2,000,000 or less is 
applicable for section 467 rental agreements entered into on or after 
July 19, 1999. The other amendments in these regulations are applicable 
to rental agreements entered into after March 6, 2001. However, 
taxpayers may choose to apply these amendments to rental agreements 
entered into on or before March 6, 2001.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting Information

    The principal author of the regulations is Forest Boone, Office of 
Associate Chief Counsel (Income Tax and Accounting). However, other 
personnel from the IRS and Treasury Department participated in the 
development of the regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


    Par 2. Section 1.467-0 is amended by adding an entry for 
Sec. 1.467-2(b)(3) to read as follows:


Sec. 1.467-0  Table of contents.

* * * * *


Sec. 1.467-2  Rent accrual for section 467 rental agreements without 
adequate interest.

* * * * *
    (b) * * *
    (3) Agreements with both deferred and prepaid rent.
* * * * *

    Par 3. Section 1.467-1 is amended by revising paragraphs (h)(6) and 
(j)(2)(ii) to read as follows:


Sec. 1.467-1  Treatment of lessors and lessees generally.

* * * * *
    (h) * * *
    (6) Lease term means the period during which the lessee has use of 
the property subject to the rental agreement, including any option of 
the lessor to renew or extend the term of the agreement. An option of 
the lessee to renew or extend the term of the agreement is included in 
the lease term only if it is expected, as of the agreement date, that 
the option will be exercised. For this purpose, 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 fair 
market value 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 the meaning of 
Sec. 1.168(i)-2(b)(2)) for a period when another lessee (the substitute 
lessee) or the lessor will have use of the property subject to the 
rental agreement, the Commissioner may, in appropriate cases, treat the 
period when the substitute lessee or lessor will have use of the 
property as part of the lease term. See Sec. 1.467-7(f) for special 
rules applicable to the lessee, substitute lessee, and lessor. This 
paragraph (h)(6) applies to section 467 rental agreements entered into 
after March 6, 2001. However, taxpayers may choose to apply this 
paragraph (h)(6) to any rental agreement that is described in 
Sec. 1.467-

[[Page 1040]]

9(a) and is entered into on or before March 6, 2001.
* * * * *
    (j) * * *
    (2) * * *
    (ii) Time amount is payable. For purposes of this section and 
Secs. 1.467-2 through 1.467-9, 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, a substantial 
penalty, or other substantial detriment (such as giving the lessor the 
right to terminate the agreement, bring an action to enforce payment, 
or exercise other similar remedies under the terms of the agreement or 
applicable law)). This paragraph (j)(2)(ii) applies to section 467 
rental agreements entered into after March 6, 2001. However, taxpayers 
may choose to apply this paragraph (j)(2)(ii) to any rental agreement 
that is described in Sec. 1.467-9(a) and is entered into on or before 
March 6, 2001.
* * * * *

    Par 4. In Sec. 1.467-2, paragraph (b)(3) is added to read as 
follows:


Sec. 1.467-2  Rent accrual for section 467 rental agreements without 
adequate interest.

* * * * *
    (b) * * *
    (3) Agreements with both deferred and prepaid rent. If an agreement 
has both deferred and prepaid rent, the agreement provides adequate 
interest under paragraph (b)(1) of this section if the conditions set 
forth in paragraph (b)(1)(ii)(A) through (D) of this section are met 
for both the prepaid and the deferred rent. For purposes of this 
paragraph (b)(3), an agreement will be considered to meet the condition 
set forth in paragraph (b)(1)(ii)(A) of this section if the agreement 
provides a single fixed rate of interest on the deferred rent and a 
single fixed rate of interest on the prepaid rent, even if those rates 
are not the same. This paragraph (b)(3) applies to section 467 rental 
agreements entered into after March 6, 2001. However, taxpayers may 
choose to apply this paragraph (b)(3) to any rental agreement that is 
described in Sec. 1.467-9(a) and is entered into on or before March 6, 
2001.
* * * * *

    Par 5. In Sec. 1.467-3, paragraph (b)(1)(iii) is revised to read as 
follows:


Sec. 1.467-3  Disqualified leasebacks and long-term agreements.

* * * * *
    (b) * * * (1) * * *
    (iii) For section 467 rental agreements entered into before July 
19, 1999, the amount determined with respect to the rental agreement 
under Sec. 1.467-1(c)(4) (relating to the exception for rental 
agreements involving total payments of $250,000 or less) exceeds 
$2,000,000.
* * * * *

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: December 12, 2000.
Jonathan Talisman,
Acting Assistant Secretary of the Treasury.
[FR Doc. 01-253 Filed 1-4-01; 8:45 am]
BILLING CODE 4830-01-P