--- kind: "range" citation: "26 C.F.R. §§ 1.467-1–1.467-5" title: "26" from: "1.467-1" to: "1.467-5" count: 5 url: "https://uscodex.org/cfr/26/1.467-1..1.467-5" --- # §1.467-1. Treatment of lessors and lessees generally. - (a) **Overview—** - (1) **In general.** When applicable, [section 467](/cfr/26/467.md) requires a lessor and lessee of tangible property to treat rents consistently and to use the accrual method of accounting (and time value of money principles) 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 accrual method, pursuant to which the rent is treated as accruing ratably over the entire lease term. - (2) **Cases in which rules are inapplicable.** [Section 467](/cfr/26/467.md) applies only to leases (or other similar arrangements) that constitute [section 467](/cfr/26/467.md) rental agreements as defined in [paragraph (c)](#c) of this section. For example, a rental agreement is not a [section 467](/cfr/26/467.md) rental agreement, and, therefore, is not subject to the provisions of this section and [§§ 1.467-2 through 1.467-9](/cfr/26/1.467-2..1.467-9.md) (the [section 467](/cfr/26/467.md) regulations), if it specifies equal amounts of rent for each month throughout the lease term and all payments of rent are due in the calendar year to which the rent relates (or in the preceding or succeeding calendar year). In addition, the [section 467](/cfr/26/467.md) regulations do not apply to a rental agreement that requires total rents of $250,000 or less. For purposes of determining whether the agreement has total rents of $250,000 or less, certain specified contingent rent is disregarded. - (3) **Summary of rules—** - (i) **Basic rules.** [Paragraph (c)](#c) of this section provides rules for determining whether a rental agreement is a [section 467](/cfr/26/467.md) rental agreement. Paragraphs [(d)](#d) and [(e)](#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](/cfr/26/467.md) rental agreement. Paragraphs [(f) through (h)](#f..h) and [(j)](#j) of this section provide various definitions and special rules relating to the application of the [section 467](/cfr/26/467.md) regulations. Paragraph (i) of this section is reserved. - (ii) **Special rules.** [Section 1.467-2](/cfr/26/1.467-2.md) provides rules for [section 467](/cfr/26/467.md) rental agreements that have deferred or prepaid rents without providing for adequate interest. [Section 1.467-3](/cfr/26/1.467-3.md) provides rules for application of the constant rental accrual method, including criteria for determining whether an agreement is subject to this method. [Section 1.467-4](/cfr/26/1.467-4.md) provides rules for establishing and adjusting a [section 467](/cfr/26/467.md) 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](/cfr/26/467.md) regulations). [Section 1.467-5](/cfr/26/1.467-5.md) provides rules for applying the [section 467](/cfr/26/467.md) regulations where a rental agreement requires payments of interest at a variable rate. [Section 1.467-6](/cfr/26/1.467-6.md), relating to the treatment of certain [section 467](/cfr/26/467.md) rental agreements with contingent payments, is reserved. [Section 1.467-7](/cfr/26/1.467-7.md) provides rules for the treatment of dispositions by a lessor of property subject to a [section 467](/cfr/26/467.md) rental agreement and the treatment of assignments by lessees and certain lessee-financed renewals of a [section 467](/cfr/26/467.md) rental agreement. [Section 1.467-7](/cfr/26/1.467-7.md) also provides rules for the treatment of modified rental agreements. [Section 1.467-8](/cfr/26/1.467-8.md) provides special transitional rules relating to the method of accounting for certain rental agreements entered into on or before May 18, 1999. Finally, [§ 1.467-9](/cfr/26/1.467-9.md) provides the effective date rules for the [section 467](/cfr/26/467.md) regulations. - (4) **Scope of rules.** No inference should be drawn from any provision of this section or [§§ 1.467-2 through 1.467-9](/cfr/26/1.467-2..1.467-9.md) concerning whether— - (i) For Federal tax purposes, an arrangement constitutes a lease; or - (ii) **For Federal tax purposes, any obligation of the lessee under a rental agreement is treated as rent.** - (5) **Application of other authorities.** Notwithstanding [section 467](/cfr/26/467.md) and the regulations thereunder, other authorities such as [section 446(b)](/cfr/26/446.md?p=b) clear-reflection-of-income principles, [section 482](/cfr/26/482.md), and the substance-over-form doctrine, may be applied by the Commissioner to determine the income and expense from a rental agreement (including the proper allocation of fixed rent under a rental agreement). - (b) **Method of accounting for section 467 rental agreements.** If a rental agreement is a [section 467](/cfr/26/467.md) rental agreement, as described in [paragraph (c)](#c) of this section, the lessor and lessee must each take into account for any taxable year the sum of— - (1) The [section 467](/cfr/26/467.md) rent for the taxable year (as defined in [paragraph (d)](#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)](#c-4) of this section, the term [section 467](/cfr/26/467.md) rental agreement means a rental agreement, as defined in [paragraph (h)(12)](#h-12) of this section, that has increasing or decreasing rents (as described in [paragraph (c)(2)](#c-2) of this section), or deferred or prepaid rents (as described in [paragraph (c)(3)](#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)](#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)](#c-2-i-A) of this section, a rental agreement does not have increasing or decreasing rent if the increasing or decreasing rent is solely attributable to a rent holiday provision allowing reduced rent (or no rent) for a period of three months or less at the beginning of the lease term. - (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 providing for total payments of fixed rent equal to the total amount specified, specifically allocates rent. 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)(2)](#h-2) of this section), other than contingent rent described in [paragraph (c)(2)(iii)(B)](#c-2-iii-B) of this section. - (B) **Certain contingent rent disregarded.** For purposes of this [paragraph (c)(2)(iii)](#c-2-iii), rent is disregarded to the extent it is contingent as the result of one or more of the following provisions— (1) A qualified percentage rents provision, as defined in [paragraph (h)(8)](#h-8) of this section; (2) An adjustment based on a reasonable price index, as defined in [paragraph (h)(10)](#h-10) of this section; (3) A provision requiring the lessee to pay third-party costs, as defined in [paragraph (h)(15)](#h-15) of this section; (4) A provision requiring the payment of late payment charges, as defined in [paragraph (h)(4)](#h-4) of this section; (5) A loss payment provision, as defined in [paragraph (h)(7)](#h-7) of this section; (6) A qualified TRAC provision, as defined in [paragraph (h)(9)](#h-9) of this section; (7) A residual condition provision, as defined in [paragraph (h)(13)](#h-13) of this section; (8) A tax indemnity provision, as defined in [paragraph (h)(14)](#h-14) of this section; (9) A variable interest rate provision, as defined in [paragraph (h)(16)](#h-16) of this section; or (10) Any other provision provided in regulations or other published guidance issued by the Commissioner, but only if the provision is designated as contingent rent to be disregarded for purposes of this [paragraph (c)(2)(iii)](#c-2-iii). - (3) **Deferred or prepaid rent—** - (i) **Deferred rent.** A rental agreement has deferred rent under this [paragraph (c)(3)](#c-3) if the cumulative amount of rent allocated as of the close of a calendar year (determined under [paragraph (c)(3)(iii)](#c-3-iii) of this section) 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)](#c-3) if the cumulative amount of rent payable as of the close of a calendar year exceeds the cumulative amount of rent allocated as of the close of the succeeding calendar year (determined under [paragraph (c)(3)(iii)](#c-3-iii) of this section). - (iii) **Rent allocated to a calendar year.** For purposes of this [paragraph (c)(3)](#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)](#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. - (iv) **Examples.** The following examples illustrate the application of this [paragraph (c)(3)](#c-3): - (4) **Rental agreements involving total payments of $250,000 or less—** - (i) **In general.** A rental agreement is not a [section 467](/cfr/26/467.md) rental agreement if, as of the agreement date (as defined in [paragraph (h)(1)](#h-1) of this section), it is not reasonably expected that the sum of the aggregate amount of rental payments under the rental agreement and the aggregate value of all other consideration to be received for the use of property (taking into account any payments of contingent rent, and any other contingent consideration) will exceed $250,000. - (ii) **Special rules in computing amount described in paragraph (c)(4)(i) of this section of this section.** The following rules apply in determining the amount described in [paragraph (c)(4)(i)](#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 the sum of its remaining principal amount and accrued interest (if any) thereon or, in the case of an obligation originally issued at a discount, at the sum of its adjusted issue price and accrued qualified stated interest (if any), within the meaning of [§ 1.1273-1(c)(1)](/cfr/26/1.1273-1.md?p=c-1). - (C) All rental agreements that are part of the same transaction or a series of related transactions involving the same lessee (or any related person) and the same lessor (or any related person) are treated as a single rental agreement. Whether two or more rental agreements are part of the same transaction or a series of related transactions depends on all the facts and circumstances. - (D) If an agreement includes a provision increasing or decreasing rent payable solely as a result of an adjustment based on a reasonable price index, the amount described in [paragraph (c)(4)(i)](#c-4-i) of this section must be determined as if the applicable price index did not change during the lease term. - (E) If an agreement includes a variable interest rate provision (as defined in [paragraph (h)(16)](#h-16) of this section), the amount described in [paragraph (c)(4)(i)](#c-4-i) of this section must be determined by using fixed rate substitutes (determined in the same manner as under [§ 1.1275-5(e)](/cfr/26/1.1275-5.md?p=e), treating the agreement date as the issue date) for the variable rates of interest applicable to the lessor's indebtedness. - (F) Contingent rent described in [paragraphs (c)(2)(iii)(B)(3) through (8)](#c-2-iii-B-3..c-2-iii-B-8) of this section is not taken into account. - (d) **Section 467 rent—** - (1) **In general.** The [section 467](/cfr/26/467.md) rent for a taxable year is the sum of— - (i) The fixed rent for any rental period (determined under [paragraph (d)(2)](#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](/cfr/26/467.md) rental agreement that provides for contingent rent, the contingent rent that accrues during the taxable year. - (2) **Fixed rent for a rental period—** - (i) **Constant rental accrual.** In the case of a [section 467](/cfr/26/467.md) rental agreement that is a disqualified leaseback or long-term agreement (as described in [§ 1.467-3(b)](/cfr/26/1.467-3.md?p=b)), the fixed rent for a rental period is the constant rental amount (as determined under [§ 1.467-3(d)](/cfr/26/1.467-3.md?p=d)). - (ii) **Proportional rental accrual.** In the case of a [section 467](/cfr/26/467.md) rental agreement that is not described in [paragraph (d)(2)(i)](#d-2-i) of this section, and does not provide adequate interest on fixed rent (as determined under [§ 1.467-2(b)](/cfr/26/1.467-2.md?p=b)), the fixed rent for a rental period is the proportional rental amount (as determined under [§ 1.467-2(c)](/cfr/26/1.467-2.md?p=c)). - (iii) **Section 467 rental agreement accrual.** In the case of a [section 467](/cfr/26/467.md) rental agreement that is not described in either paragraph [(d)(2)(i)](#d-2-i) or [(ii)](#d-2-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)](#c-2-ii) of this section. - (e) **Section 467 interest—** - (1) **In general.** The [section 467](/cfr/26/467.md) 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](/cfr/26/467.md) rental agreement that provides for contingent rent, any interest that accrues on the contingent rent during the taxable year. - (2) **Interest on fixed rent for a rental period—** - (i) **In general.** Except as provided in [paragraph (e)(2)(ii)](#e-2-ii) of this section and [§ 1.467-5(b)(1)(ii)](/cfr/26/1.467-5.md?p=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](/cfr/26/467.md) loan (as described in [§ 1.467-4(b)](/cfr/26/1.467-4.md?p=b)) at the beginning of the rental period; and - (B) The yield of the [section 467](/cfr/26/467.md) loan (as described in [§ 1.467-4(c)](/cfr/26/1.467-4.md?p=c)). - (ii) **Section 467 rental agreements with adequate interest.** Except in the case of a [section 467](/cfr/26/467.md) rental agreement that is a disqualified leaseback or long-term agreement, if a [section 467](/cfr/26/467.md) rental agreement provides adequate interest under [§ 1.467-2(b)(1)(i)](/cfr/26/1.467-2.md?p=b-1-i) (agreements with no deferred or prepaid rent) or [§ 1.467-2(b)(1)(ii)](/cfr/26/1.467-2.md?p=b-1-ii) (agreements with adequate interest stated 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](/cfr/26/467.md) 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](/cfr/26/467.md) interest for a rental period is a negative amount, the lessee has interest income and the lessor has an interest expense. [Section 467](/cfr/26/467.md) interest is treated as interest for all purposes of the Internal Revenue Code. - (f) **Substantial modification of a rental agreement—** - (1) **Treatment as new agreement—** - (i) **In general.** If a substantial modification of a rental agreement occurs after June 3, 1996, the post-modification agreement is treated as a new agreement and the date on which the modification occurs is treated as the agreement date in applying [section 467](/cfr/26/467.md) and the regulations thereunder to the post-modification agreement. Thus, for example, the post-modification agreement is treated as a new agreement entered into on the date the modification occurs for purposes of determining whether it is a [section 467](/cfr/26/467.md) rental agreement under this section, whether it is a disqualified leaseback or long-term agreement under [§ 1.467-3](/cfr/26/1.467-3.md), and whether it is entered into after the applicable effective date in [§ 1.467-9](/cfr/26/1.467-9.md). - (ii) **Limitation.** In the case of a substantial modification of a rental agreement occurring on or before May 18, 1999, this [paragraph (f)](#f) applies only if— - (A) The rental agreement was a disqualified leaseback or long-term agreement before the modification and the agreement date, determined without regard to the modification, is after June 3, 1996; or - (B) The post-modification agreement would, after application of the rules in this [paragraph (f)](#f) (other than the special rule for disqualified agreements in [paragraph (f)(4)(iii)](#f-4-iii) of this section), be a disqualified leaseback or long-term agreement. - (2) **Post-modification agreement; in general.** For purposes of determining whether a post-modification agreement is a [section 467](/cfr/26/467.md) rental agreement or a disqualified leaseback or long-term agreement under [paragraph (f)(1)](#f-1) of this section, the terms of the post-modification agreement are, except as provided in [paragraph (f)(4)](#f-4) of this section, only those terms that provide for rights and obligations relating to post-modification items (within the meaning of [paragraph (f)(5)(iv)](#f-5-iv) of this section). - (3) **Other effects of a modification.** For rules relating to amounts that must be taken into account following certain modifications, see [§ 1.467-7(g)](/cfr/26/1.467-7.md?p=g). - (4) **Special rules—** - (i) **Carryover of character; leasebacks.** If an agreement is a leaseback prior to its modification and the lessee prior to the modification (or a related person) is the lessee after the modification, the post-modification agreement is a leaseback even if the post-modification lessee did not have an interest in the property at any time during the two-year period ending on the date on which the modification occurs. - (ii) **Carryover of character; long-term agreements.** If an agreement is a long-term agreement prior to its modification and the entire agreement (as modified) would be a long-term agreement, the post-modification agreement is a long-term agreement. - (iii) **Carryover of character; disqualified agreements.** If an agreement (as in effect before its modification) is a disqualified leaseback or long-term agreement as the result of a determination (whether occurring before or after the modification) under [§ 1.467-3(b)(1)(ii)](/cfr/26/1.467-3.md?p=b-1-ii) and the post-modification agreement is a [section 467](/cfr/26/467.md) rental agreement (or the entire agreement (as modified) would be a [section 467](/cfr/26/467.md) rental agreement), the post-modification agreement will, notwithstanding its treatment as a new agreement under [paragraph (f)(1)(i)](#f-1-i) of this section, be subject to constant rental accrual unless the Commissioner determines that, because of the absence of tax avoidance potential, the post-modification agreement should not be treated as a disqualified leaseback or long-term agreement. - (iv) **Allocation of rent.** If the entire agreement (as modified) provides a specific allocation of fixed rent, as described in paragraph (c)(2)(ii)(A)(2) of this section, the post-modification agreement is treated as an agreement that provides a specific allocation of fixed rent. If the entire agreement (as modified) does not provide a specific allocation of fixed rent, the fixed rent allocated to rental periods during the lease term of the post-modification agreement is determined by applying the rules of [paragraph (c)(2)(ii)(B)](#c-2-ii-B) of this section to the entire agreement (as modified). - (v) **Difference between aggregate rent and interest and aggregate payments—** - (A) **In general.** Except as provided in [paragraph (f)(4)(v)(B)](#f-4-v-B) of this section, a post-modification agreement described in [paragraph (f)(4)(v)(C)](#f-4-v-C) of this section is treated as a [section 467](/cfr/26/467.md) rental agreement subject to proportional rental accrual (determined under [§ 1.467-2(c)](/cfr/26/1.467-2.md?p=c)). - (B) **Constant rental accrual prior to the modification.** A post-modification agreement described in [paragraph (f)(4)(v)(C)](#f-4-v-C) of this section is treated as a [section 467](/cfr/26/467.md) rental agreement subject to constant rental accrual if— (1) Constant rental accrual is required under [paragraph (f)(4)(iii)](#f-4-iii) of this section; or (2) The post-modification agreement involves total payments of more than $250,000 (as described in [paragraph (c)(4)](#c-4) of this section), and the Commissioner determines that the post-modification agreement is a disqualified leaseback or long-term agreement. - (C) **Agreements described in this paragraph—** - (f) - (4) - (v) - (C) . A post-modification agreement is described in this [paragraph (f)(4)(v)(C)](#f-4-v-C) if the aggregate amount of fixed rent and stated interest treated as post-modification items does not equal the aggregate amount of payments treated as post-modification items. - (vi) **Principal purpose of tax avoidance.** If a principal purpose of a substantial modification is to avoid the purpose or intent of [section 467](/cfr/26/467.md) or the regulations thereunder, the Commissioner may treat the entire agreement (as modified) as a single agreement for purposes of [section 467](/cfr/26/467.md) and the regulations thereunder. - (5) **Definitions.** The following definitions apply for purposes of this [paragraph (f)](#f) and [§ 1.467-7(g)](/cfr/26/1.467-7.md?p=g): - (i) A modification of a rental agreement is any alteration, including any deletion or addition, in whole or in part, of a legal right or obligation of the lessor or lessee thereunder, whether the alteration is evidenced by an express agreement (oral or written), conduct of the parties, or otherwise. - (ii) A modification is substantial only if, based on all of the facts and circumstances, the legal rights or obligations that are altered and the degree to which they are altered are economically substantial. A modification of a rental agreement will not be treated as substantial solely because it is not described in [paragraph (f)(6)](#f-6) of this section. - (iii) A modification occurs on the earlier of the first date on which there is a binding contract that substantially sets forth the terms of the modification or the date on which agreement to such terms is otherwise evidenced. - (iv) **Post-modification items—** with respect to any modification of a rental agreement are all items (other than pre-modification items) provided under the terms of the entire agreement (as modified). - (v) **Pre-modification items—** with respect to any modification of a rental agreement are pre-modification rent, interest thereon, and payments allocable thereto (whether payable before or after the modification.) For this purpose— - (A) Pre-modification rent is rent allocable to periods before the effective date of the modification, but only to the extent such rent is payable under the entire agreement (as modified) at the time such rent was due under the agreement in effect before the modification; and - (B) Pre-modification items are identified by applying payments, in the order payable under the entire agreement (as modified) unless the agreement specifies otherwise, to rent and interest thereon in the order in which amounts accrue. - (vi) The entire agreement (as modified) with respect to any modification is the agreement consisting of pre-modification terms providing for rights and obligations that are not affected by the modification and post-modification terms providing for rights and obligations that differ from the rights and obligations under the agreement in effect before the modification. For example, if a 10-year rental agreement that provides for rent of $25,000 per year is modified at the end of the 5th year to provide for rent of $30,000 per year in subsequent years, the entire agreement (as modified) provides for a 10-year lease term and provides for rent of $25,000 per year in years 1 through 5 and rent of $30,000 per year in years 6 through 10. The result would be the same if the modification provided for both the increase in rent and the substitution of a new lessee. - (6) **Safe harbors.** Notwithstanding the provisions of [paragraph (f)(5)](#f-5) of this section, a modification of a rental agreement is not a substantial modification if the modification occurs solely as the result of one or more of the following— - (i) The refinancing of any indebtedness incurred by the lessor to acquire the property subject to the rental agreement and secured by such property (or any refinancing thereof) but only if all of the following conditions are met— - (A) Neither the amount, nor the time for payment, of the principal amount of the new indebtedness differs from the amount and time for payment of the remaining principal amount of the refinanced indebtedness, except for de minimis changes; - (B) For each of the remaining rental periods, the rent allocation schedule, the payments of rent and interest, and the amount accrued under [section 467](/cfr/26/467.md) are changed only to the extent necessary to take into account the change in financing costs, and such changes are made pursuant to the terms of the rental agreement in effect before the modification; - (C) The lessor and the lessee are not related persons to each other or to any lender to the lessor with respect to the property (whether under the refinanced indebtedness or the new indebtedness); and - (D) With respect to the indebtedness being refinanced, the lessor was granted a unilateral option (within the meaning of [§ 1.1001-3(c)(3)](/cfr/26/1.1001-3.md?p=c-3)) by the creditor to repay the refinanced indebtedness, exercisable with or without the lessee's consent; - (ii) A change in the obligation of the lessee to make any of the contingent payments described in [paragraphs (c)(2)(iii)(B)(3) through (8)](#f-c-2-iii-B-3..f-c-2-iii-B-8) of this section; or - (iii) A change in the amount of fixed rent allocated to a rental period that, when combined with all previous changes in the amount of fixed rent allocated to the rental period, does not exceed one percent of the fixed rent allocated to that rental period prior to the modification. - (7) **Special rules for certain transfers—** - (i) **In general.** For purposes of this [paragraph (f)](#f), a substitution of a new lessee or a sale, exchange, or other disposition by a lessor of property subject to a rental agreement will not, by itself, be treated as a substantial modification unless a principal purpose of the transaction giving rise to the modification is the avoidance of Federal income tax. In determining whether a principal purpose of the transaction giving rise to the modification is the avoidance of Federal income tax— - (A) The safe harbors and other principles of [§ 1.467-3(c)](/cfr/26/1.467-3.md?p=c) are taken into account; and - (B) The Commissioner may treat the post-modification agreement as a new agreement or treat the entire agreement (as modified) as a single agreement. - (ii) **Exception.** Notwithstanding the provisions of [paragraph (f)(7)(i)](#f-7-i) of this section, the continuing lessor and the new lessee (in the case of a substitution of a new lessee) or the new lessor and the continuing lessee (in the case of a sale, exchange, or other disposition by a lessor of property subject to a rental agreement) may, in appropriate cases, request the Commissioner to treat the transaction as if it were a substantial modification in order to have the provisions of [paragraph (f)(4)(iii)](#f-4-iii) of this section and [§ 1.467-7(g)(1)](/cfr/26/1.467-7.md?p=g-1) apply to the transaction. - (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 1.467-9](/cfr/26/1.467-2..1.467-9.md): - (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 (as defined in [paragraph (h)(10)](#h-10) of this section) or a variable interest rate provision (as defined in [paragraph (h)(16)](#h-16) of this section). - (3) Fixed rent means any rent to the extent its amount and the time at which it is required to be paid are fixed and determinable under the terms of the rental agreement as of the lease date. The following rules apply for the purpose of determining the extent to which rent is fixed rent: - (i) The possibility of a breach, default, or other early termination of the rental agreement and any adjustments based on a reasonable price index or a variable interest rate provision are disregarded. - (ii) Rent will not fail to be treated as fixed rent merely because of the possibility of impairment by insolvency, bankruptcy, or other similar circumstances. - (iii) If the lease term (as defined in [paragraph (h)(6)](#h-6) of this section) includes one or more periods as to which either the lessor or the lessee has an option to renew or extend the term of the agreement, rent will not fail to be treated as fixed rent merely because the option has not been exercised. - (iv) If the lease term includes one or more periods during which a substitute lessee or lessor may have use of the property, rent will not fail to be treated as fixed rent merely because the contingencies relating to the obligation of the lessee (or a related person) to make payments in the nature of rent have not occurred. - (v) If either the lessor or the lessee has an unconditional option or options, exercisable on one or more dates during the lease term, that, if exercised, require payments of rent to be made under an alternative payment schedule or schedules, the amount of fixed rent and the dates on which such rent is required to be paid are determined on the basis of the payment schedule that, as of the agreement date, is most likely to occur. If payments of rent are made under an alternative payment schedule that differs from the payment schedule assumed in applying the preceding sentence, then, for purposes of [paragraph (f)](#f) of this section, the rental agreement is treated as having been modified at the time the option to make payments on such alternative schedule is exercised. - (4) Late payment charge means any amount required to be paid by the lessee to the lessor as additional compensation for the lessee's failure to make any payment of rent under a rental agreement when due. - (5) Lease date means the date on which the lessee first has the right to use of the property that is the subject of the rental agreement. - (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 [§ 1.168(i)-2(b)(2)](/cfr/26/1.168..2.md)) 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 [§ 1.467-7(f)](/cfr/26/1.467-7.md?p=f) for special rules applicable to the lessee, substitute lessee, and lessor. This [paragraph (h)(6)](#h-6) applies to [section 467](/cfr/26/467.md) rental agreements entered into after March 6, 2001. However, taxpayers may choose to apply this [paragraph (h)(6)](#h-6) to any rental agreement that is described in [§ 1.467-9(a)](/cfr/26/1.467-9.md?p=a) and is entered into on or before March 6, 2001. - (7) A loss payment provision means a provision that requires the lessee to pay the lessor a sum of money (which may be either a stipulated amount or an amount determined by reference to a formula or other objective measure) if the property subject to the rental agreement is lost, stolen, damaged or destroyed, or otherwise rendered unsuitable for any use (other than for scrap purposes). - (8) A qualified percentage rents provision means a provision pursuant to which the rent is equal to a fixed percentage of the lessee's receipts or sales (whether or not receipts or sales are adjusted for returned merchandise or Federal, state, or local sales taxes), but only if the percentage does not vary throughout the lease term. A provision will not fail to be treated as a qualified percentage rents provision solely by reason of one or more of the following additional terms: - (i) Differing percentages of receipts or sales apply to different departments or separate floors of a retail store, but only if the percentage applicable to a particular department or floor does not vary throughout the lease term. - (ii) The percentage is applied to receipts or sales in excess of determinable dollar amounts, but only if the determinable dollar amounts are fixed and do not vary throughout the lease term. - (9) A qualified TRAC provision means a terminal rental adjustment clause (as defined in [section 7701(h)(3)](/cfr/26/7701.md?p=h-3)) contained in a qualified motor vehicle operating agreement (as defined in [section 7701(h)(2)](/cfr/26/7701.md?p=h-2)), but only if the adjustment to the rental price is based on a reasonable estimate, determined as of any date between the agreement date and the lease date (or, in the event the agreement date is the same as or later than the lease date, determined as of the agreement date), of the fair market value of the motor vehicle (including any trailer) at the end of the lease term. - (10) 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 a generally recognized index for measuring inflation or deflation (for example, the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), which is published by the Bureau of Labor Statistics of the Department of Labor). An adjustment will not fail to be treated as one that is based on a reasonable price index merely because the adjustment may be limited to a fixed percentage, but only if the parties reasonably expect, as of any date between the agreement date and the lease date (or, in the event the agreement date is the same as the lease date, as of such date), that the fixed percentage will actually limit the amount of the rent payable during less than 50 percent of the lease term. - (11) For purposes of determining whether a [section 467](/cfr/26/467.md) rental agreement is a leaseback within the meaning of [§ 1.467-3(b)(2)](/cfr/26/1.467-3.md?p=b-2), two persons are related persons if they are related persons within the meaning of [section 465(b)(3)(C)](/cfr/26/465.md?p=b-3-C). In all other cases, two persons are related persons if they either have a relationship to each other that is specified in [section 267(b)](/cfr/26/267.md?p=b) or [section 707(b)(1)](/cfr/26/707.md?p=b-1) or are related entities within the meaning of sections [168(h)(4)(A)](/cfr/26/168.md?p=h-4-A), [(B)](/cfr/26/168.md?p=h-4-B), or [(C)](/cfr/26/168.md?p=h-4-C). - (12) **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. - (13) A residual condition provision means a provision in a rental agreement that requires a payment to be made by either the lessor or the lessee to the other party based on the difference between the actual condition of the property subject to the agreement, determined as of the expiration of the lease term, and the expected condition of the property at the expiration of the lease term, as set forth in the rental agreement. The amount of any such payment may be determined by reference to any objective measure relating to the use or condition of the property, such as miles, hours or other duration of use, units of production, or similar measure. A provision will be treated as a residual condition provision only if the payment represents compensation for the use of, or wear and tear on, the property in excess of, or below, a standard set forth in the rental agreement, and the standard is reasonably expected, as of any date between the agreement date and the lease date (or, in the event the agreement date is the same as or later than the lease date, as of the agreement date), to be met at the expiration of the lease term. - (14) A tax indemnity provision means a provision in a rental agreement that may require the lessee to make one or more payments to the lessor in the event that the Federal, foreign, state, or local income tax consequences actually realized by a lessor from owning the property subject to the rental agreement and leasing it to the lessee differ from the consequences reasonably expected by the lessor, but only if the differences in such consequences result from a misrepresentation, act, or failure to act on the part of the lessee, or any other factor not within the control of the lessor or any related person. - (15) **Third-party costs—** include any real estate taxes, insurance premiums, maintenance costs, and any other costs (excluding a debt service cost) that relate to the leased property and are not within the control of the lessor or lessee or any person related to the lessor or lessee. - (16) A variable interest rate provision means a provision in a rental agreement that requires the rent payable by the lessee to the lessor to be adjusted by the dollar amount of changes in the amount of interest payable by the lessor on any indebtedness that was incurred to acquire the property subject to the rental agreement (or any refinancing thereof), but— - (i) Only to the extent the changes are attributable to changes in the interest rate; and - (ii) Only if the indebtedness provides for interest at one or more qualified floating rates (within the meaning of [§ 1.1275-5(b)](/cfr/26/1.1275-5.md?p=b)), or the changes are attributable to a refinancing at a fixed rate or one or more qualified floating rates. - (i) [Reserved] - (j) **Computational rules.** For purposes of this section and [§§ 1.467-2 through 1.467-9](/cfr/26/1.467-2..1.467-9.md), the following rules apply— - (1) **Counting conventions.** Any reasonable counting convention may be used (for example, 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 only, except as otherwise provided in this section and [§§ 1.467-2 through 1.467-8](/cfr/26/1.467-2..1.467-8.md)— - (A) 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; - (D) Any amount payable during the second half of a rental period is treated as payable on the last day of the rental period; and - (E) Any amount payable at the midpoint of a rental period is treated, in applying this [paragraph (j)(2)](#j-2), as an amount payable during the first half of the rental period. - (ii) **Time amount is payable.** For purposes of this section and [§§ 1.467-2 through 1.467-9](/cfr/26/1.467-2..1.467-9.md), 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)](#j-2-ii) applies to [section 467](/cfr/26/467.md) rental agreements entered into after March 6, 2001. However, taxpayers may choose to apply this [paragraph (j)(2)(ii)](#j-2-ii) to any rental agreement that is described in [§ 1.467-9(a)](/cfr/26/1.467-9.md?p=a) and is entered into on or before March 6, 2001. - (3) **Annualized fixed rent.** Annualized fixed rent is determined by multiplying the fixed rent allocated to the rental period under [paragraph (c)(2)(ii)](#c-2-ii) of this section by the number of periods of the rental period's length in a calendar year. Thus, if the fixed rent allocated to a rental period is $10,000 and the rental period is one month, the annualized fixed rent for that rental period is $120,000 ($10,000 times 12). - (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)](/cfr/26/1.467-3.md?p=d-1) (relating to agreements for which constant rental accrual is required), rental periods may be of any length, may vary in length, and may be different as between the lessor and the lessee 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](/cfr/26/467.md) 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 agreements for which proportional rental accrual is required.** Under [§ 1.467-1(d)(2)(ii)](/cfr/26/1.467-1.md?p=d-2-ii), the fixed rent for each rental period is the proportional rental amount, computed under [paragraph (c)](#c) of this section, if— - (1) The [section 467](/cfr/26/467.md) rental agreement is not a disqualified leaseback or long-term agreement under [§ 1.467-3(b)](/cfr/26/1.467-3.md?p=b); and - (2) The [section 467](/cfr/26/467.md) rental agreement does not provide adequate interest on fixed rent under [paragraph (b)](#b) of this section. - (b) **Adequate interest on fixed rent—** - (1) **In general.** A [section 467](/cfr/26/467.md) 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 [§ 1.467-1(c)(3)](/cfr/26/1.467-1.md?p=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 [§ 1.1273-1(c)(1)(iii)](/cfr/26/1.1273-1.md?p=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)](#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)](#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)](#b-1) of this section, if a [section 467](/cfr/26/467.md) 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 [§ 1.1275-5(e)](/cfr/26/1.1275-5.md?p=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 § [1.1275-5(a)(3)(i)(A)](/cfr/26/1.1275-5.md?p=a-3-i-A) or [(B)](/cfr/26/1.1275-5.md?p=a-3-i-B) and [(a)(4)](/cfr/26/1.1275-5.md?p=a-3-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)](#b-1) of this section if the conditions set forth in [paragraph (b)(1)(ii)(A) through (D)](#b-1-ii-A..b-1-ii-D) of this section are met for both the prepaid and the deferred rent. For purposes of this [paragraph (b)(3)](#b-3), an agreement will be considered to meet the condition set forth in [paragraph (b)(1)(ii)(A)](#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)](#b-3) applies to [section 467](/cfr/26/467.md) rental agreements entered into after March 6, 2001. However, taxpayers may choose to apply this [paragraph (b)(3)](#b-3) to any rental agreement that is described in [§ 1.467-9(a)](/cfr/26/1.467-9.md?p=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 [§ 1.467-1(c)(2)(ii)](/cfr/26/1.467-1.md?p=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](/cfr/26/467.md) 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](/cfr/26/467.md) rental agreement that provides for a variable rate of interest, see [§ 1.467-5](/cfr/26/1.467-5.md). - (d) **Present value.** For purposes of determining adequate interest under [paragraph (b)](#b) of this section or the proportional rental amount under [paragraph (c)](#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](/cfr/26/467.md) 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)](#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)](/cfr/26/1.467-1.md?p=g) and [(j)](/cfr/26/1.467-1.md?p=j). - (e) **Applicable Federal rate—** - (1) **In general.** The applicable Federal rate for a [section 467](/cfr/26/467.md) 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 [§ 601.601(d)](/cfr/26/601.601.md?p=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)](/cfr/26/1.1272-1.md?p=j), Example 1. - (3) **110 percent of applicable Federal rate.** For purposes of [§ 1.467-1](/cfr/26/1.467-1.md), this section and §§ [1.467-3 through 1.467-9](/cfr/26/1.467-3..1.467-9.md), [110](/cfr/26/110.md) 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 [§ 601.601(d)(2)](/cfr/26/601.601.md?p=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)](#e), the term of the [section 467](/cfr/26/467.md) 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](/cfr/26/467.md) 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 [§ 1.1274-4(c)(2)(ii)](/cfr/26/1.1274-4.md?p=c-2-ii), the rental agreement provides for a qualified floating rate (as defined in [§ 1.1275-5(b)](/cfr/26/1.1275-5.md?p=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: # §1.467-3. Disqualified leasebacks and long-term agreements. - (a) **General rule.** Under [§ 1.467-1(d)(2)(i)](/cfr/26/1.467-1.md?p=d-2-i), constant rental accrual (as described under [paragraph (d)](#d) of this section) must be used to determine the fixed rent for each rental period in the lease term if the [section 467](/cfr/26/467.md) rental agreement is a disqualified leaseback or long-term agreement within the meaning of [paragraph (b)](#b) of this section. Constant rental accrual may not be used in the absence of a determination by the Commissioner, pursuant to [paragraph (b)(1)(ii)](#b-1-ii) of this section, that the rental agreement is disqualified. Such determination may be made either on a case-by-case basis or in regulations or other guidance published by the Commissioner (see [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter) providing that a certain type or class of leaseback or long-term agreement will be treated as disqualified and subject to constant rental accrual. - (b) **Disqualified leaseback or long-term agreement—** - (1) **In general.** A leaseback (as defined in [paragraph (b)(2)](#b-2) of this section) or a long-term agreement (as defined in [paragraph (b)(3)](#b-3) of this section) is disqualified only if— - (i) A principal purpose for providing increasing or decreasing rent is the avoidance of Federal income tax (as described in [paragraph (c)](#c) of this section); - (ii) The Commissioner determines that, because of the tax avoidance purpose, the agreement should be treated as a disqualified leaseback or long-term agreement; and - (iii) For [section 467](/cfr/26/467.md) rental agreements entered into before July 19, 1999, the amount determined with respect to the rental agreement under [§ 1.467-1(c)(4)](/cfr/26/1.467-1.md?p=c-4) (relating to the exception for rental agreements involving total payments of $250,000 or less) exceeds $2,000,000. - (2) **Leaseback.** A [section 467](/cfr/26/467.md) 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](/cfr/26/467.md) rental agreement is a long-term agreement if the lease term exceeds 75 percent of the property's statutory recovery period. - (ii) **Statutory recovery period—** - (A) **In general.** The term statutory recovery period means— (1) In the case of property depreciable under [section 168](/cfr/26/168.md), the applicable period determined under [section 467(e)(3)(A)](/cfr/26/467.md?p=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)](/cfr/26/467.md?p=e-3-A) if the property were property to which [section 168](/cfr/26/168.md) applied. - (B) **Special rule for rental agreements relating to properties having different statutory recovery periods.** In the case of a rental agreement relating to two or more related properties that have different statutory recovery periods, the statutory recovery period for purposes of [paragraph (b)(3)(ii)(A)](#b-3-ii-A) of this section is the weighted average, based on the fair market values of the properties on the agreement 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.** In determining whether a principal purpose for providing increasing or decreasing rent is the avoidance of Federal income tax, all relevant facts and circumstances are taken into account. However, an agreement will not be treated as a disqualified leaseback or long-term agreement if either of the safe harbors set forth in [paragraph (c)(3)](#c-3) of this section is met. The mere failure of a leaseback or long-term agreement to meet one of these safe harbors will not, by itself, cause the agreement to be treated as one in which tax avoidance was a principal purpose for providing increasing or decreasing rent. - (2) **Tax avoidance—** - (i) **In general.** If, as of the agreement date, a significant difference between the marginal tax rates of the lessor and lessee can reasonably be expected at some time during the lease term, 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. The term “marginal tax rate” means the percentage determined by dividing one dollar into the amount of the increase or decrease in the Federal income tax liability of the taxpayer that would result from an additional dollar of rental income or deduction. - (ii) **Significant difference in tax rates.** A significant difference between the marginal tax rates of the lessor and lessee is reasonably expected if— - (A) The rental agreement has increasing rents and the lessor's marginal tax rate is reasonably expected to exceed the lessee's marginal tax rate by more than 10 percentage points during any rental period to which the rental agreement allocates annualized fixed rent that is less than the average rent allocated to all calendar years (determined by taking into account the rules set forth in [paragraph (c)(4)(iii)](#c-4-iii) of this section); or - (B) The rental agreement has decreasing rents and the lessee's marginal tax rate is reasonably expected to exceed the lessor's marginal tax rate by more than 10 percentage points during any rental period to which the rental agreement allocates annualized fixed rent that is greater than the average rent allocated to all calendar years (determined by taking into account the rules set forth in [paragraph (c)(4)(iii)](#c-4-iii) of this section). - (iii) **Special circumstances.** In determining the expected marginal tax rates of the lessor and lessee, net operating loss and credit carryovers and any other attributes or special circumstances reasonably expected to affect the Federal income tax liability of the taxpayer (including the alternative minimum tax) are taken into account. For example, in the case of a partnership or S corporation, the amount of rental income or deduction that would be allocable to the partners or shareholders, respectively, is taken into account. - (3) **Safe harbors.** Tax avoidance will not be considered a principal purpose for providing increasing or decreasing rent if— - (i) The uneven rent test (as defined in [paragraph (c)(4)](#c-4) of this section) is met; or - (ii) **The increase or decrease in rent is wholly attributable to one or more of the following provisions—** - (A) A contingent rent provision set forth in [§ 1.467-1(c)(2)(iii)(B)](/cfr/26/1.467-1.md?p=c-2-iii-B); or - (B) A single rent holiday provision allowing reduced rent (or no rent) for one consecutive period during the lease term, but only if— (1) The rent holiday is for a period of three months or less at the beginning of the lease term and for no other period; or (2) The duration of the rent holiday is reasonable, determined by reference to commercial practice (as of the agreement date) in the locality where the use of the property occurs, and does not exceed the lesser of 24 months or 10 percent of the lease term. - (4) **Uneven rent test—** - (i) **In general.** The uneven rent test is met if the rent allocated to each calendar year does not vary from the average rent allocated to all calendar years (determined in accordance with the rules set forth in [paragraph (c)(4)(iii)](#c-4-iii) of this section) by more than 10 percent. - (ii) **Special rule for real estate.** [Paragraph (c)(4)(i)](#c-4-i) of this section is applied by substituting “15 percent” for “10 percent” if the rental agreement is a long-term agreement and at least 90 percent of the property subject to the agreement (determined on the basis of fair market value as of the agreement date) consists of real property (as defined in [§ 1.856-3(d)](/cfr/26/1.856-3.md?p=d)). - (iii) **Operating rules.** In determining whether the uneven rent test has been met, the following rules apply: - (A) Any contingent rent attributable to a provision set forth in [§ 1.467-1(c)(2)(iii)(B)(3) through (9)](/cfr/26/1.467-1.md?p=c-2-iii-B-3..c-2-iii-B-9) is disregarded. - (B) If the lease term includes one or more partial calendar years (a period less than a complete calendar year), the average rent allocated to each calendar year is the total rent allocated under the rental agreement, divided by the actual length (in years) of the lease term. The rent allocated to a partial calendar year is annualized by multiplying the allocated rent by the number of periods of the partial calendar year's length in a full calendar year and the annualized rent is treated as the amount of rent allocated to that year in determining whether the uneven rent test is met. - (C) In the case of a rental agreement not described in [paragraph (c)(4)(ii)](#c-4-ii) of this section, an initial rent holiday period and any rent allocated to such period are disregarded for purposes of this [paragraph (c)(4)](#c-4) if taking such period and rent into account would cause the agreement to fail to meet the uneven rent test. For purposes of this [paragraph (c)(4)](#c-4), an initial rent holiday period is any period of three months or less at the beginning of the lease term during which annualized fixed rent (determined by treating such period as a rental period for purposes of [§ 1.467-1(j)(3)](/cfr/26/1.467-1.md?p=j-3)) is less than the average rent allocated to all calendar years (determined before the application of this [paragraph (c)(4)(iii)(C)](#c-4-iii-C)). - (D) In the case of a rental agreement described in [paragraph (c)(4)(ii)](#c-4-ii) of this section, one qualified rent holiday period and any rent allocated to such period are disregarded for purposes of this [paragraph (c)(4)](#c-4) if taking such period and rent into account would cause the agreement to fail the uneven rent test. For this purpose, a qualified rent holiday period is a consecutive period that is an initial rent holiday period or that meets the following conditions: (1) The period does not exceed the lesser of 24 months or 10 percent of the lease term (determined before the application of this [paragraph (c)(4)(iii)(D)](#c-4-iii-D)). (2) Annualized fixed rent during the period (determined by treating the period as a rental period for purposes of [§ 1.467-1(j)(3)](/cfr/26/1.467-1.md?p=j-3)) is less than the average rent allocated to all calendar years (determined before the application of this [paragraph (c)(4)(iii)(D)](#c-4-iii-D)). (3) Providing less than average rent for the period is reasonable, determined by reference to commercial practice (as of the agreement date) in the locality where the use of the property occurs. - (E) If the rental agreement contains a variable interest rate provision, the uneven rent test is applied by treating the rent as having been fixed under the terms of the rental agreement for the entire lease term using fixed rate substitutes (determined in the same manner as [§ 1.1275-5(e)](/cfr/26/1.1275-5.md?p=e), treating the agreement date as the issue date) for the variable rates of interest provided under the terms of the lessor's indebtedness. - (d) **Calculating constant rental amount—** - (1) **In general.** Except as provided in [paragraph (d)(2)](#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 [§ 1.467-2(d)](/cfr/26/1.467-2.md?p=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)](/cfr/26/1.467-1.md?p=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](/cfr/26/467.md) loan balance because of the method used to determine the constant rental amount for short periods must be taken into account as [section 467](/cfr/26/467.md) 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)](#d-3-i) of this section (Step 1) by the number of dollars determined in [paragraph (d)(3)(ii)](#d-3-ii) of this section (Step 2). - (e) **Examples.** The following examples illustrate the application of this section: # §1.467-4. Section 467 loan. - (a) **In general—** - (1) **Overview.** Except as provided in [paragraph (a)(2)](#a-2) of this section, the [section 467](/cfr/26/467.md) loan rules of this section apply to a [section 467](/cfr/26/467.md) rental agreement if, as of the first day of a rental 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)](/cfr/26/1.467-1.md?p=d-2) before the first day. [Paragraph (b)](#b) of this section provides rules for computing the principal balance of a [section 467](/cfr/26/467.md) loan at the beginning of any rental period. The principal balance of a [section 467](/cfr/26/467.md) loan may be positive or negative. For Federal tax purposes, 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 paragraphs [(a)(3)](#a-3) and [(4)](#a-4) of this section, this section does not apply to [section 467](/cfr/26/467.md) rental agreements that provide adequate interest under [§ 1.467-2(b)(1)(i)](/cfr/26/1.467-2.md?p=b-1-i) (agreements with no deferred or prepaid rent) or [§ 1.467-2(b)(1)(ii)](/cfr/26/1.467-2.md?p=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)](#a-2) of this section, this section applies to rental agreements subject to constant rental accrual under [§ 1.467-3](/cfr/26/1.467-3.md) (relating to disqualified leasebacks or long-term agreements). - (4) **Special rule in applying the provisions of § 1.467-7(e), (f), or (g).** Notwithstanding the provisions of [paragraph (a)(2)](#a-2) of this section, [section 467](/cfr/26/467.md) loan balances must be computed for [section 467](/cfr/26/467.md) rental agreements that are not subject to constant rental accrual under [§ 1.467-3](/cfr/26/1.467-3.md) and that provide adequate interest under § [1.467-2(b)(1)(i)](/cfr/26/1.467-2.md?p=b-1-i) or [(ii)](/cfr/26/1.467-2.md?p=b-1-ii), but only for purposes of applying the provisions of [§ 1.467-7(e)](/cfr/26/1.467-7.md?p=e) (relating to dispositions of property subject to a [section 467](/cfr/26/467.md) rental agreement), [§ 1.467-7(f)](/cfr/26/1.467-7.md?p=f) (relating to assignments by lessees and lessee-financed renewals), and [§ 1.467-7(g)](/cfr/26/1.467-7.md?p=g) (relating to modifications of rental agreements). - (b) **Principal balance—** - (1) **In general.** Except as provided in [paragraph (b)(2)](#b-2) of this section or in § [1.467-7(e)](/cfr/26/1.467-7.md?p=e), [(f)](/cfr/26/1.467-7.md?p=f), or [(g)](/cfr/26/1.467-7.md?p=g), the principal balance of the [section 467](/cfr/26/467.md) loan at the beginning of a rental period equals— - (i) The fixed rent accrued in preceding rental periods; - (ii) **Increased by the sum of—** - (A) The interest on fixed rent includible in the gross income of the lessor for preceding rental periods; and - (B) Any amount payable by the lessor on or before the first day of the rental period as interest on prepaid fixed rent; and - (iii) **Decreased by the sum of—** - (A) The interest on prepaid fixed rent includible in the gross income of the lessee for preceding rental periods; and - (B) 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 interest.** If a [section 467](/cfr/26/467.md) rental agreement calls for prepaid fixed rent and provides adequate interest under [§ 1.467-2(b)(1)(iv)](/cfr/26/1.467-2.md?p=b-1-iv), the principal balance of the [section 467](/cfr/26/467.md) loan at the beginning of a rental period equals the principal balance determined under [paragraph (b)(1)](#b-1) of this section, plus the fixed rent accrued for that rental period. - (3) **Timing of payments.** For purposes of this [paragraph (b)](#b), the day on which an amount is payable is determined under the rules of [§ 1.467-1(j)(2)(i)(B) through (E)](/cfr/26/1.467-1.md?p=j-2-i-B..j-2-i-E) and [§ 1.467-1(j)(2)(ii)](/cfr/26/1.467-1.md?p=j-2-ii). - (c) **Yield—** - (1) **In general—** - (i) **Method of determining yield.** Except as provided in paragraphs [(c)(2)](#c-2) and [(3)](#c-3) of this section, the yield of a [section 467](/cfr/26/467.md) 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)](/cfr/26/1.467-1.md?p=d-2). The yield must be constant over the term of the [section 467](/cfr/26/467.md) 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](/cfr/26/467.md) interest for a rental period, the yield of the [section 467](/cfr/26/467.md) loan must be stated appropriately by taking into account the length of the rental period. [Section 1.1272-1(j)](/cfr/26/1.1272-1.md?p=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](/cfr/26/467.md) loan because of rounding the yield to two or more decimal places must be taken into account as an adjustment to the [section 467](/cfr/26/467.md) interest for the final rental period determined as provided in [paragraph (e)](#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](/cfr/26/467.md) rental agreement to which § [1.467-1(d)(2)(i)](/cfr/26/1.467-1.md?p=d-2-i) or [(ii)](/cfr/26/1.467-1.md?p=d-2-ii) applies, the yield of the [section 467](/cfr/26/467.md) loan equals 110 percent of the applicable Federal rate (based on a compounding period equal to the length of the rental period). - (3) **Yield for purposes of applying paragraph (a)(4) of this section.** For purposes of applying [paragraph (a)(4)](#a-4) of this section, the yield of the [section 467](/cfr/26/467.md) loan balance of any party, or prior party, to a [section 467](/cfr/26/467.md) rental agreement for a period is the same for all parties and is the yield that results in the net accrual of positive or negative interest for that period equal to the amount of such interest that accrues under the terms of the rental agreement for that period. For example, if property subject to a [section 467](/cfr/26/467.md) rental agreement is sold (transferred) and the beginning [section 467](/cfr/26/467.md) loan balance of the transferor (as described in [§ 1.467-7(e)(2)(i)](/cfr/26/1.467-7.md?p=e-2-i)) is positive and the beginning [section 467](/cfr/26/467.md) loan balance of the transferee (as described in [§ 1.467-7(e)(2)(ii)](/cfr/26/1.467-7.md?p=e-2-ii)) is negative, the yield on each of these loan balances for any period is the same for all parties and is the yield that results in the net accrual of positive or negative interest, taking into account the aggregate positive or negative interest on the [section 467](/cfr/26/467.md) loan balances of both the transferor and transferee, equal to the amount of such interest that accrues under the terms of the rental agreement for that period. - (4) **Determination of present values.** The rules for determining present value in computing the yield of a [section 467](/cfr/26/467.md) loan are the same as those provided in [§ 1.467-2(d)](/cfr/26/1.467-2.md?p=d) for computing the proportional rental amount. - (d) **Contingent payments.** Except as otherwise required, contingent payments are not taken into account in calculating either the yield or the principal balance of a [section 467](/cfr/26/467.md) loan. - (e) **Section 467 rental agreements that call for payments before or after the lease term.** If a [section 467](/cfr/26/467.md) rental agreement calls for the payment of fixed rent or interest thereon before the beginning of the lease term, this section is 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 is 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)](/cfr/26/1.467-1.md?p=j-5). - (f) **Examples.** The following examples illustrate the application of this section: # §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](/cfr/26/467.md) rent and interest in the case of [section 467](/cfr/26/467.md) 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)](/cfr/26/1.1275-5.md?p=a-3-i-A) or [(B)](/cfr/26/1.1275-5.md?p=a-3-i-B) and [(a)(4)](/cfr/26/1.1275-5.md?p=a-3-a-4). If a [section 467](/cfr/26/467.md) rental agreement provides for interest that is neither variable interest nor fixed interest, the agreement provides for contingent payments. - (2) **Exceptions.** This section is not applicable to [section 467](/cfr/26/467.md) rental agreements that provide adequate interest under [§ 1.467-2(b)(1)(i)](/cfr/26/1.467-2.md?p=b-1-i) (agreements with no deferred or prepaid rent) or (b)(1)(ii) (rental agreements with stated interest at a single fixed rate). The exceptions in this [paragraph (a)(2)](#a-2) do not apply to rental agreements subject to constant rental accrual under [§ 1.467-3](/cfr/26/1.467-3.md). - (b) **Variable rate treated as fixed—** - (1) **In general.** If a [section 467](/cfr/26/467.md) rental agreement provides variable interest— - (i) The fixed rate substitutes (determined in the same manner as under [§ 1.1275-5(e)](/cfr/26/1.1275-5.md?p=e), treating the agreement date as the issue date) for the variable rates of interest on deferred or prepaid fixed rent provided by the rental agreement must be used in computing the proportional rental amount under [§ 1.467-2(c)](/cfr/26/1.467-2.md?p=c), the constant rental amount under [§ 1.467-3(d)](/cfr/26/1.467-3.md?p=d), the principal balance of a [section 467](/cfr/26/467.md) loan under [§ 1.467-4(b)](/cfr/26/1.467-4.md?p=b), and the yield of a [section 467](/cfr/26/467.md) loan under [§ 1.467-4(c)](/cfr/26/1.467-4.md?p=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)](/cfr/26/1.467-1.md?p=e-2) if the [section 467](/cfr/26/467.md) rental agreement did not provide variable interest, using the fixed rate substitutes determined under [paragraph (b)(1)(i)](#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)](#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](/cfr/26/467.md), would have accrued during the rental period under the terms of the [section 467](/cfr/26/467.md) rental agreement; and - (B) The amount of interest that, without regard to [section 467](/cfr/26/467.md), would have accrued during the rental period under the terms of the [section 467](/cfr/26/467.md) rental agreement using the fixed rate substitutes determined under [paragraph (b)(1)(i)](#b-1-i) of this section in place of the variable interest rates called for by the rental agreement. - (ii) **Positive or negative adjustment.** If the amount determined under [paragraph (b)(2)(i)(A)](#b-2-i-A) of this section is greater than the amount determined under [paragraph (b)(2)(i)(B)](#b-2-i-B) of this section, the variable interest adjustment amount is positive. If the amount determined under [paragraph (b)(2)(i)(A)](#b-2-i-A) of this section is less than the amount determined under [paragraph (b)(2)(i)(B)](#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](/cfr/26/467.md) loan under [§ 1.467-4(b)](/cfr/26/1.467-4.md?p=b). Instead, the [section 467](/cfr/26/467.md) loan balance is computed as if all amounts payable under the [section 467](/cfr/26/467.md) rental agreement were based on the fixed rate substitutes determined under [paragraph (b)(1)(i)](#b-1-i) of this section. - (c) **Examples.** The following examples illustrate the application of this section: