Sec. 1.467-2 Rent accrual for section 467 rental agreements without adequate interest.
(a) Section 467 rental agreements for which proportional rental accrual is required. Under section 1.467-1(d)(2)(ii), the fixed rent for each rental period is the proportional rental amount, computed under paragraph (c) of this section, if --
(1) The section 467 rental agreement is not a disqualified leaseback or long-term agreement under section 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 deferred or prepaid rent as described in section 1.467-1(c)(3);
(ii) The rental agreement has deferred or prepaid 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 section 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 (within the meaning of paragraph (d) of this section) 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 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 section 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 all stated interest provided by the agreement is paid or compounded at least annually at a rate or rates that meet the requirements of section 1.1275-5(a)(3)(i)(A) or (B) and (a)(4).
(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 section 1.467-9(a) and is entered into on or before March 6, 2001.
(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 section 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 section 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, the present value of any amount is determined using a discount rate equal to 110 percent of the applicable Federal rate. In general, present values are determined as of the first day of the first rental period in the lease term. However, if a section 467 rental agreement calls for payments of fixed rent prior to the lease term, present values are determined as of the first day a fixed rent payment is called for by the agreement. 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 section 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. 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 section 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 section 1.1272-1(j), Example 1.
(3) 110 percent of applicable Federal rate. For purposes of section 1.467-1, this section and sections 1.467-3 through 1.467-9, 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. The Internal Revenue Service publishes 110 percent of the applicable Federal rates, based on annual, semiannual, quarterly, and monthly compounding, each month in the Internal Revenue Bulletin (see section 601.601(d)(2) of this chapter).
(4) Term of the section 467 rental agreement.
(i) In general. For purposes of determining 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 deferred or prepaid fixed rent, the term of the rental agreement for purposes of calculating the applicable Federal rate is the longest period between interest rate adjustment dates, or, if the rental agreement provides an initial fixed rate of interest on deferred or prepaid 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 section 1.1274-4(c)(2)(ii), the rental agreement provides for a qualified floating rate (as defined in section 1.1275-5(b)) that in substance resembles a fixed rate, 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 the rental agreement is not a disqualified leaseback or long- term agreement subject to constant rental accrual. The examples are as follows:
Example 1. (i) C agrees to lease property from D for five years beginning on January 1, 2000, and ending on December 31, 2004. 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, 2004. Assume that the parties select the calendar year as the rental period and that 110 percent of the applicable Federal rate is 10 percent, compounded annually.
(ii) The rental agreement has deferred rent under section 1.467-1(c)(3)(i) because the fixed rent allocated to calendar years 2000, 2001, and 2002 is not paid until 2004. 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.
(iii) (A) Because the rental agreement has deferred fixed rent and no prepaid rent, the agreement has adequate interest only if the present value test provided in paragraph (b)(1)(iii) of this section is met. The present value of all fixed rent and interest payable under the rental agreement is $384,971.22, determined as follows: $620,000/(1.10)5 = $384,971.22. 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:
$379,078.68 = $100,000 x 1-(1.10)5 / .10
(B) The rental agreement provides adequate interest on fixed rent because the present value of the single amount payable under the section 467 rental agreement exceeds the sum of the present values of fixed rent allocated.
(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 section 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, 2000, and ending on December 31, 2004. 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, 2004, together with interest on accrued rent at a qualified floating rate set at a current value (as defined in section 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.
(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, 2000, and ending on December 31, 2002. The rental agreement provides that rent of $800,000 is allocable to 2000, $1,000,000 is allocable to 2001, and $1,200,000 is allocable to 2002. Under the rental agreement, Y must make a $3,000,000 payment on December 31, 2002. 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.
(ii) The rental agreement fails to provide adequate interest under paragraph (b)(1) of this section. Therefore, under section 1.467-1(d)(2)(ii), the fixed rent for each rental period is the proportional rental amount.
(iii) (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, the present value is determined as of the first day of the first rental period in the lease term. The present value of the single amount payable by the lessee under the rental agreement is computed as follows:
$2,348,724.30 = $3,000,000 / (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:
$2,526,272.20 = $800,000 / (1 + .085) + $1,000,000 / (1 + .085)2 + $1,200,000 / (1 + .085)3
(C) Thus, the fraction for determining the proportional rental amount is .9297194 ($2,348,724.30/$2,526,272.20). The section 467 interest for each of the taxable years within the lease term is computed and taken into account as provided in section 1.467-4. The section 467 rent for each of the taxable years within the lease term is as follows:
Taxable year | Section 467 rent |
|---|---|
2000 | $743,775.52 |
2001 | 929,719.40 |
2002 | 1,115,663.28 |
[T.D. 8820, 64 FR 26845-26876, May 18, 1999, as amended by T.D. 8917, 66 FR 1038-1040, Jan. 5, 2001.]
