Rev. Rul. 72-408

Advice has been requested as to certain of the Federal income tax consequences resulting from a conclusion that a transaction the parties thereto have cast in the form of a lease of property is, for Federal income tax purposes, a sale of such property.

and therefore, for Federal income tax

In 1968, A, an individual and a calendar year taxpayer, acquired new "section 38 property" and claimed the investment credit on his 1968 Federal income tax return based on a useful life of ten years. On August 31, 1971, A entered into an agreement with M, a corporation reporting its income on a calendar year accounting period, whereby A "leased" the property to M. The agreement provided that, in addition to the specified "rent" for the property, M would pay to A amounts sufficient to cover specific items of expense arising from M's use of the property.

It was determined that, under the agreement, M has the benefits and burdens of ownership of the property and therefore for Federal income tax purposes, the transaction is considered a sale of the property.

Based solely on the foregoing facts, certain of the Federal income tax consequences are as follows:

(1) The sale by A to M occurred on the earlier of the date on which M took possession of the property or the date on which M was entitled to take possession of the property under the terms of the agreement, and the holding period of the property will be determined accordingly.

(2) The amounts received by A as "rent" under the agreement are considered payments on the sale price of the property to the extent such amounts do not represent interest or other charges. See Rev. Rul. 55-540, C.B. 1955-2, 39, 43.

(3) Any gain realized by A upon the sale of the property to M is subject to the provisions of sections 1231 and 1245 of the Internal Revenue Code of 1954.

(4) Since the agreement between A and M is treated as a sale of property for purposes of the Code, it is a "contract for the sale or exchange of property" for purposes of applying section 483 of the Code with respect to the treatment as interest of a portion of the periodic payments received by A as "rent" under the agreement.

(5) The provisions of section 47(a)(1) of the Code, relating to the recomputation of the investment credit upon early disposition of section 38 property, are applicable to A in 1971 with respect to investment credit claimed by A on his 1968 Federal income tax return.

(6) Since the property in the hands of M is property described in section 50 of the Code, M will be entitled to an investment credit with respect to such property if the property has a useful life of at least 3 years. Furthermore, in the hands of M, the property will constitute used section 38 property as described in section 48(c) of the Code.

(7) The basis of the property in the hands of M will be the sum of all amounts payable over the term of the agreement that are considered to be payments for the purchase of the property by M, to the extent such amounts do not represent interest or other charges.

(8) M will not be entitled to rental deductions under section 162(a)(3) of the Code and the regulations thereunder.

(9) M will be entitled to deduct all ordinary and necessary expenses paid or incurred in respect of the property pursuant to section 162 of the Code and the regulations thereunder. (10) M will be entitled to deduct under section 163 of the Code that portion of the "rent" that represents interest determined pursuant to section 483 and the regulations thereunder.

(11) M will be entitled to deductions for state and local taxes imposed with respect to the property, pursuant to section 164 of the Code and the regulations thereunder.

(12) M will be entitled to depreciation deductions with respect to the property, pursuant to section 167 of the Code and the regulations thereunder. Since the original use of the property did not commence with M, it may not determine depreciation by use of the methods described in paragraphs (2), (3), and (4) of section 167(b) of the Code. See section 167(c)(2) of the Code. M may elect, however, to compute depreciation by use of the declining balance method with the rate limited to 150% of the applicable straight line rate if it satisfies the requirements of Revenue Ruling 57-352, C.B. 1957-2, 150, or of section 1.167(a)-11(c)(1)(iv) of the Income Tax Regulations if an election is made under section 1.167(a)-11 of the regulations for the calendar year 1971.

With respect to A, he may report the gain, if any, on the installment method of accounting, provided he has made a valid election to do so and otherwise complies with the provisions of section 453 of the Code. In determining the validity of an election to report gain on the sale of property on the installment method made other than on a timely-filed Federal income tax return for the year of sale (1971), the provisions of Revenue Ruling 65.297, C.B. 1965-2, 152, are applicable.