---
kind: "range"
citation: "26 C.F.R. §§ 1.467-2–1.467-8"
title: "26"
from: "1.467-2"
to: "1.467-8"
count: 7
url: "https://uscodex.org/cfr/26/1.467-2..1.467-8"
---

# §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:

# §1.467-6. Section 467 rental agreements with contingent payments. [Reserved]



# §1.467-7. Section 467 recapture and other rules relating to dispositions and modifications.

- (a) **Section 467 recapture.** Notwithstanding any other provision of the Internal Revenue Code, except as provided in [paragraph (c)](#c) of this section, a lessor disposing of property in a transaction to which this [paragraph (a)](#a) applies must recognize the recapture amount (determined under [paragraph (b)](#b) of this section) and treat that amount as ordinary income. This [paragraph (a)](#a) applies to any disposition of property subject to a [section 467](/cfr/26/467.md) rental agreement that—
  - (1) Is a leaseback (as defined in [§ 1.467-3(b)(2)](/cfr/26/1.467-3.md?p=b-2)) or a long-term agreement (as defined in [§ 1.467-3(b)(3)](/cfr/26/1.467-3.md?p=b-3));
  - (2) Is not disqualified under [§ 1.467-3(b)(1)](/cfr/26/1.467-3.md?p=b-1); and
  - (3) Allocates to any rental period fixed rent that, when annualized, exceeds the annualized fixed rent allocated to any preceding rental period.
- (b) **Recapture amount—**
  - (1) **In general.** The recapture amount for a disposition is the lesser of—
    - (i) The prior understated inclusion (determined under [paragraph (b)(2)](#b-2) of this section); or
    - (ii) **The section 467 gain (determined under paragraph (b)(3) of this section).**
  - (2) **Prior understated inclusion.** The prior understated inclusion is the excess (if any) of—
    - (i) The aggregate amount of [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for the period during which the lessor held the property, determined as if the [section 467](/cfr/26/467.md) rental agreement were a disqualified leaseback or long-term agreement subject to constant rental accrual under [§ 1.467-3](/cfr/26/1.467-3.md); over
    - (ii) The aggregate amount of [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest accrued by the lessor during that period.
  - (3) **Section 467 gain—**
    - (i) **In general.** Except as otherwise provided in [paragraph (b)(3)(ii)](#b-3-ii) of this section, the [section 467](/cfr/26/467.md) gain is the excess (if any) of—
      - (A) The amount realized from the disposition; over
      - (B) The sum of the adjusted basis of the property and the amount of any gain from the disposition that is treated as ordinary income under any provision of subtitle A of the Internal Revenue Code other than [section 467(c)](/cfr/26/467.md?p=c) (for example, section [1245](/cfr/26/1245.md) or [1250](/cfr/26/1250.md)).
    - (ii) **Certain dispositions.** In the case of a disposition that is not a sale or exchange, the [section 467](/cfr/26/467.md) gain is the excess (if any) of the fair market value of the property on the date of disposition over the amount determined under [paragraph (b)(3)(i)(B)](#b-3-i-B) of this section.
- (c) **Special rules—**
  - (1) **Gifts.** [Paragraph (a)](#a) of this section does not apply to a disposition by gift. However, see [paragraph (c)(4)](#c-4) of this section for dispositions by transferees. If a disposition is in part a sale or exchange and in part a gift, [paragraph (a)](#a) of this section applies to the disposition but the prior understated inclusion is determined by taking into account only [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest properly allocable to the portion of the property not disposed of by gift.
  - (2) **Dispositions at death.** [Paragraph (a)](#a) of this section does not apply to a disposition if the basis of the property in the hands of the transferee is determined under [section 1014(a)](/cfr/26/1014.md?p=a) or [section 1022](/cfr/26/1022.md). However, see [paragraph (c)(4)](#c-4) of this section for dispositions of property subject to [section 1022](/cfr/26/1022.md) by transferees. This [paragraph (c)(2)](#c-2) does not apply to property that constitutes a right to receive an item of income in respect of a decedent. See sections [691](/cfr/26/691.md), [1014(c)](/cfr/26/1014.md?p=c), and [1022(f)](/cfr/26/1022.md?p=f).
  - (3) **Certain tax-free exchanges—**
    - (i) **In general.** The recapture amount in the case of a disposition to which this [paragraph (c)(3)](#c-3) applies is limited to the amount of gain recognized to the transferor (determined without regard to [paragraph (a)](#a) of this section), reduced by the amount of any gain from the disposition that is treated as ordinary income under any provision of subtitle A of the Internal Revenue Code other than [section 467(c)](/cfr/26/467.md?p=c). However, see [paragraph (c)(4)](#c-4) of this section for dispositions by transferees.
    - (ii) **Dispositions covered—**
      - (A) **In general.** Except as provided in [paragraph (c)(3)(ii)(B)](#c-3-ii-B) of this section, this [paragraph (c)(3)](#c-3) applies to a disposition of property if the basis of the property in the hands of the transferee is determined by reference to its basis in the hands of the transferor by reason of the application of section [332](/cfr/26/332.md), [351](/cfr/26/351.md), [361](/cfr/26/361.md), [721](/cfr/26/721.md), or [731](/cfr/26/731.md).
      - (B) **Transfers to certain tax-exempt organizations.** This [paragraph (c)(3)](#c-3) does not apply to a disposition to an organization (other than a cooperative described in [section 521](/cfr/26/521.md)) which is exempt from tax imposed by chapter 1, subtitle A of the Internal Revenue Code (a tax-exempt entity) except to the extent the property is used in an activity the income from which is subject to tax under [section 511(a)](/cfr/26/511.md?p=a) (a [section 511(a)](/cfr/26/511.md?p=a) activity). However, if assets used to any extent in a [section 511(a)](/cfr/26/511.md?p=a) activity are disposed of by the tax-exempt entity, then, notwithstanding any other provision of law (except [section 1031](/cfr/26/1031.md) or [section 1033](/cfr/26/1033.md)) the recapture amount with respect to such disposition, to the extent attributable under [paragraph (c)(4)](#c-4) of this section to the period of the transferor's ownership of the property prior to the first disposition, shall be included in the tax-exempt entity's unrelated business taxable income. To the extent that the tax-exempt entity ceases to use the property in a [section 511(a)](/cfr/26/511.md?p=a) activity, the entity will be treated for purposes of this [paragraph (c)(3)](#c-3) and [paragraph (c)(4)](#c-4) of this section as having disposed of the property to such extent on the date of the cessation.
  - (4) **Dispositions by transferee.** If the recapture amount with respect to a disposition of property (the first disposition) is limited under paragraph [(c)(1)](#c-1) or [(c)(3)](#c-3) of this section, or under [paragraph (c)(2)](#c-2) of this section because the basis of the property in the hands of the transferee is determined under [section 1022](/cfr/26/1022.md), and the transferee subsequently disposes of the property in a transaction to which [paragraph (a)](#a) of this section applies, the prior understated inclusion determined under [paragraph (b)(2)](#b-2) of this section is computed by taking into account the amounts attributable to the period of the transferor's ownership of the property prior to the first disposition. Thus, for example, the [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest that would have been taken into account by the transferee if the [section 467](/cfr/26/467.md) rental agreement were a disqualified leaseback or long-term agreement subject to constant rental accrual include the amounts that would have been taken into account by the transferor, and the aggregate amount of [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest accrued by the transferee includes the aggregate amount of [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest that was taken into account by the transferor. The prior understated inclusion determined under this [paragraph (c)(4)](#c-4) must be reduced by any recapture amount taken into account under [paragraph (a)](#a) of this section by the transferor.
  - (5) **Like-kind exchanges and involuntary conversions.** If property is disposed of or converted and, before the application of [paragraph (a)](#a) of this section, gain is not recognized in whole or in part under section [1031](/cfr/26/1031.md) or [1033](/cfr/26/1033.md), then the amount of [section 467](/cfr/26/467.md) gain taken into account by the lessor is limited to the sum of—
    - (i) The amount of gain recognized on the disposition or conversion of the property (determined without regard to [paragraph (a)](#a) of this section); and
    - (ii) The fair market value of property acquired that is not subject to the same [section 467](/cfr/26/467.md) rental agreement and that is not taken into account under [paragraph (c)(5)(i)](#c-5-i) of this section.
  - (6) **Installment sales.** In the case of an installment sale of property to which [paragraph (a)](#a) of this section applies—
    - (i) The recapture amount is recognized and treated as ordinary income in the year of the disposition; and
    - (ii) Any gain in excess of the recapture amount is reported under the installment method of accounting if and to the extent that method is otherwise available under [section 453](/cfr/26/453.md).
  - (7) **Dispositions covered by section 170(e), 341(e)(12), or 751(c).** For purposes of sections [170(e)](/cfr/26/170.md?p=e), [341(e)(12)](/cfr/26/341.md?p=e-12), and [751(c)](/cfr/26/751.md?p=c), amounts treated as ordinary income under [paragraph (a)](#a) of this section must be treated in the same manner as amounts treated as ordinary income under section [1245](/cfr/26/1245.md) or [1250](/cfr/26/1250.md).
- (d) **Examples.** The following examples illustrate the application of paragraphs [(a)](#a), [(b)](#b), and [(c)](#c) of this section. In each of these examples the transferor of property subject to a [section 467](/cfr/26/467.md) rental agreement is entitled to the rent for the day of the disposition. The examples are as follows:
- (e) **Other rules relating to dispositions—**
  - (1) **In general.** If there is a sale, exchange, or other disposition of property subject to a [section 467](/cfr/26/467.md) rental agreement (the transfer), the [section 467](/cfr/26/467.md) rent and, if applicable, [section 467](/cfr/26/467.md) interest for a period are taken into account by the owner of the property during the period. The following rules apply in determining the [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for the portion of the rental period ending immediately prior to the transfer:
    - (i) The [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for the portion of the rental period ending immediately prior to the transfer are a pro rata portion of the [section 467](/cfr/26/467.md) rent and the [section 467](/cfr/26/467.md) interest, respectively, for the rental period. Such amounts are also taken into account in determining the transferor's [section 467](/cfr/26/467.md) loan balance, prior to any adjustment thereof that may be required under [paragraph (h)](#h) of this section, immediately before the transfer.
    - (ii) If the transferor of the property is entitled to the rent for the day of transfer, the transfer is treated as occurring at the end of the day of the transfer.
    - (iii) If the transferee of the property is entitled to the rent for the day of transfer, the transfer is treated as occurring at the beginning of the day of the transfer.
  - (2) **Treatment of section 467 loan.** If there is a transfer described in [paragraph (e)(1)](#e-1) of this section, the following rules apply in determining the transferor's and the transferee's [section 467](/cfr/26/467.md) loans for the period after the transfer, the amount realized by the transferor, and the transferee's basis in the property:
    - (i) The beginning balance of the transferor's [section 467](/cfr/26/467.md) loan is equal to the net present value at the time of the transfer (but after giving effect to the transfer) of all subsequent amounts payable as fixed rent and interest on fixed rent to the transferor and all subsequent amounts payable as interest on prepaid fixed rent by the transferor. The transferor must continue to take into account interest on the transferor's [section 467](/cfr/26/467.md) loan balance after the date of the transfer.
    - (ii) The beginning balance of the transferee's [section 467](/cfr/26/467.md) loan is equal to the principal balance of the transferor's [section 467](/cfr/26/467.md) loan immediately before the transfer reduced (below zero, if appropriate) by the beginning balance of the transferor's [section 467](/cfr/26/467.md) loan. Amounts payable to the transferor are not taken into account in adjusting the transferee's [section 467](/cfr/26/467.md) loan balance.
    - (iii) If the beginning balance of the transferee's [section 467](/cfr/26/467.md) loan is negative, the transferor and transferee must treat the balance as a liability that is either assumed in connection with the transfer of the property or secured by the property acquired subject to the liability. If the beginning balance of the transferee's [section 467](/cfr/26/467.md) loan is positive, the transferor and transferee must treat the balance as an additional asset acquired in connection with the transfer of the property. In the case of a positive beginning balance of the transferee's [section 467](/cfr/26/467.md) loan, the transferee will have an initial cost basis in the [section 467](/cfr/26/467.md) loan equal to the lesser of the beginning balance of the loan or the aggregate consideration for the transfer of the property subject to the [section 467](/cfr/26/467.md) rental agreement and the transfer of the transferor's interest in the [section 467](/cfr/26/467.md) loan.
  - (3) [Reserved]
  - (4) **Examples.** The following examples illustrate the application of this [paragraph (e)](#e). In each of these examples the transferor of property subject to a [section 467](/cfr/26/467.md) rental agreement is entitled to the rent for the day of the transfer. The examples are as follows:
- (f) **Treatment of assignments by lessee and lessee-financed renewals—**
  - (1) **Substitute lessee use.** If a lessee assigns its interest in a [section 467](/cfr/26/467.md) rental agreement to a substitute lessee, or if a period when a substitute lessee has the use of property subject to a [section 467](/cfr/26/467.md) rental agreement is otherwise included in the lease term under [§ 1.467-1(h)(6)](/cfr/26/1.467-1.md?p=h-6), the [section 467](/cfr/26/467.md) rent for a period is taken into account by the person having the use of the property during the period. The following rules apply in determining the [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for the portion of the rental period ending immediately prior to the assignment:
    - (i) The [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for the portion of the rental period ending immediately prior to the assignment are a pro rata portion of the [section 467](/cfr/26/467.md) rent and the [section 467](/cfr/26/467.md) interest, respectively, for the rental period. Such amounts are also taken into account in determining the lessee's [section 467](/cfr/26/467.md) loan balance, prior to any adjustment thereof that may be required under [paragraph (h)](#h) of this section, immediately before the substitute lessee first has use of the property.
    - (ii) If the lessee is liable for the rent for the day that the substitute lessee first has use of the property, the substitute lessee's use shall be treated as beginning at the end of that day.
    - (iii) If the substitute lessee is liable for the rent for the day that the substitute lessee first has use of the property, the substitute lessee's use shall be treated as beginning at the beginning of that day.
  - (2) **Treatment of section 467 loan.** If, as described in [paragraph (f)(1)](#f-1) of this section, a lessee assigns its interest in a [section 467](/cfr/26/467.md) rental agreement to a substitute lessee or a period when a substitute lessee has the use of property subject to a [section 467](/cfr/26/467.md) rental agreement is otherwise included in the lease term under [§ 1.467-1(h)(6)](/cfr/26/1.467-1.md?p=h-6), the following rules apply in determining the amount of the lessee's and the substitute lessee's [section 467](/cfr/26/467.md) loans for the period when the substitute lessee has use of the property and in computing the taxable income of the lessee and substitute lessee:
    - (i) The beginning balance of the lessee's [section 467](/cfr/26/467.md) loan is equal to the net present value, as of the time the substitute lessee first has use of the property (but after giving effect to the transfer of the right to use the property), of all amounts subsequently payable by the lessee as fixed rent and interest on fixed rent and all amounts subsequently payable as interest on prepaid fixed rent to the lessee. For purposes of this [paragraph (f)](#f), any amount otherwise payable by the lessee is not treated as an amount subsequently payable by the lessee to the extent that such payment, if made by the lessee, would give rise to a right of contribution or other similar claim against the substitute lessee or any other person. The lessee must continue to take into account interest on the lessee's [section 467](/cfr/26/467.md) loan balance after the substitute lessee first has use of the property.
    - (ii) The beginning balance of the substitute lessee's [section 467](/cfr/26/467.md) loan is equal to the principal balance of the lessee's [section 467](/cfr/26/467.md) loan immediately before the substitute lessee first has use of the property reduced (below zero, if appropriate) by the beginning balance of the lessee's [section 467](/cfr/26/467.md) loan. Amounts payable by the lessee to any person other than the substitute lessee (or a related person) or payable to the lessee by any person other than the substitute lessee (or a related person) are not taken into account in adjusting the substitute lessee's [section 467](/cfr/26/467.md) loan balance.
    - (iii) If the beginning balance of the substitute lessee's [section 467](/cfr/26/467.md) loan is positive, the beginning balance is treated as—
      - (A) Gross receipts of the lessee for the taxable year in which the substitute lessee first has use of the property; and
      - (B) A liability that is either assumed in connection with the transfer of the leasehold interest to the substitute lessee or secured by property acquired subject to the liability.
    - (iv) If the beginning balance of the substitute lessee's [section 467](/cfr/26/467.md) loan is negative, the following rules apply:
      - (A) If the principal balance of the lessee's [section 467](/cfr/26/467.md) loan immediately before the substitute lessee first has use of the property was negative, any consideration paid by the substitute lessee to the lessee in conjunction with the transfer of the use of the property shall be treated as a nontaxable return of capital to the lessee to the extent that—

        (1) The consideration does not exceed the amount owed to the lessee under the lessee's [section 467](/cfr/26/467.md) loan balance immediately before the substitute lessee first has use of the property; and

        (2) The lessee has basis in the principal balance of the lessee's [section 467](/cfr/26/467.md) loan immediately before the substitute lessee first has use of the property.

      - (B) Except as provided in [paragraph (f)(2)(iv)(D)](#f-2-iv-D) of this section, the excess, if any, of the beginning balance of the amount owed to the substitute lessee under the [section 467](/cfr/26/467.md) loan, over any consideration paid by the substitute lessee to the lessee in conjunction with the transfer of the use of the property, is treated as an amount incurred by the lessee for the taxable year in which the substitute lessee first has use of the property.
      - (C) To the extent the beginning balance of the amount owed to the substitute lessee under the [section 467](/cfr/26/467.md) loan exceeds any consideration paid by the substitute lessee to the lessee in conjunction with the transfer of the use of the property, repayments of the beginning balance are items of gross income of the substitute lessee in the taxable year in which repayment occurs (determined by applying any repayment first to the beginning balance of the substitute lessee's [section 467](/cfr/26/467.md) loan).
      - (D) Any amount incurred by the lessee under [paragraph (f)(2)(iv)(B)](#f-2-iv-B) of this section with respect to a transfer of the use of property (the current transfer) shall be reduced (but not below zero) to the extent that the lessee, in its capacity, if any, as a substitute lessee with respect to an earlier transfer of the use of the property would have recognized additional gross income under [paragraph (f)(2)(iv)(C)](#f-2-iv-C) of this section if the current transfer had not occurred.
    - (v) For purposes of [paragraph (f)(2)(iv)(C)](#f-2-iv-C) of this section, repayments occur as the negative balance is amortized through the net accrual of rent and negative interest.
  - (3) **Lessor use.** If a period when the lessor has the use of property subject to a [section 467](/cfr/26/467.md) rental agreement is included in the lease term under [§ 1.467-1(h)(6)](/cfr/26/1.467-1.md?p=h-6), the [section 467](/cfr/26/467.md) rent for the period is not taken into account and the lessor is treated as a substitute lessee for purposes of this [paragraph (f)](#f).
  - (4) **Examples.** The following examples illustrate the application of this [paragraph (f)](#f). In each of these examples, the substitute lessee is liable for the rent for the day on which the substitute lessee first has use of the property subject to the [section 467](/cfr/26/467.md) rental agreement. Further, assume that in each example the lessee assignment is not a substantial modification under [§ 1.467-1(f)](/cfr/26/1.467-1.md?p=f). The examples are as follows:
- (g) **Application of section 467 following a rental agreement modification—**
  - (1) **Substantial modifications.** The following rules apply to any substantial modification of a rental agreement occurring after May 18, 1999 unless the entire agreement (as modified) is treated as a single agreement under [§ 1.467-1(f)(4)(vi)](/cfr/26/1.467-1.md?p=f-4-vi):
    - (i) **Treatment of pre-modification items.** The lessor and lessee must take pre-modification items (within the meaning of [§ 1.467-1(f)(5)(v)](/cfr/26/1.467-1.md?p=f-5-v)) into account under their method of accounting used before the modification to report income and expense attributable to the rental agreement.
    - (ii) **Computations with respect to post-modification items.** In computing [section 467](/cfr/26/467.md) rent, [section 467](/cfr/26/467.md) interest, and the amount of the [section 467](/cfr/26/467.md) loan with respect to post-modification items—
      - (A) Post-modification items are treated as provided under a rental agreement (the post-modification agreement) separate from the agreement under which pre-modification items are provided;
      - (B) The lease term of the post-modification agreement begins at the beginning of the first period for which rent other than pre-modification rent is provided; and
      - (C) The applicable Federal rate for the post-modification agreement is the applicable Federal rate in effect on the day on which the modification occurs.
    - (iii) **Adjustments—**
      - (A) **Adjustment relating to certain prepayments.** If any payments before the beginning of the lease term of the post-modification agreement are post-modification items, the lessor and lessee must take into account, in the taxable year in which the modification occurs, any adjustment necessary to prevent duplication with respect to such payments or the omission of interest thereon for periods before the beginning of the lease term.
      - (B) **Adjustment relating to retroactive beginning of lease term.** If the lease term of a post-modification agreement begins before the date on which the modification occurs, the lessor and lessee must take into account in the taxable year in which the modification occurs any amount necessary to prevent the duplication or omission of rent or interest for the period after the beginning of the lease term of the post-modification agreement and before the beginning of the taxable year in which the modification occurs. For this purpose, the amount necessary to prevent duplication or omission is determined after taking into account any adjustments required by the Commissioner for taxable years ending prior to the beginning of the taxable year in which the modification occurs. In determining any adjustments required by the Commissioner for taxable years ending prior to the beginning of the taxable year in which the modification occurs, the Commissioner will disregard the modification.
    - (iv) **Coordination with rules relating to dispositions and assignments—**
      - (A) **Dispositions.** If the modification involves a sale, exchange, or other disposition of the property subject to the rental agreement—

        (1) Adjustments required under this [paragraph (g)](#g) are taken into account before applying paragraphs [(a)](#a), [(b)](#b), [(c)](#c), and [(e)](#e) of this section;

        (2) The prior understated inclusion for purposes of [paragraph (b)](#b) of this section is the sum of the prior understated inclusion with respect to pre-modification items and the prior understated inclusion with respect to post-modification items; and

        (3) [Paragraph (e)](#e) of this section applies separately with respect to pre-modification items and post-modification items.

      - (B) **Assignments.** If the modification involves an assignment of the lessee's interest in the rental agreement to a substitute lessee or a substitute lessee having use of the property during a period otherwise included in the lease term—

        (1) Adjustments required under this [paragraph (g)](#g) are taken into account before applying [paragraph (f)](#f) of this section; and

        (2) [Paragraph (f)](#f) of this section applies separately with respect to pre-modification items and post-modification items.

  - (2) **Other modifications.** The following rules apply to a modification (other than a substantial modification) of a rental agreement occurring after May 18, 1999:
    - (i) **Computation of section 467 loan for modified agreement.** The amount of the [section 467](/cfr/26/467.md) loan relating to the agreement is computed as of the effective date of the modification. The [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for periods before the effective date of the modification are determined, solely for purposes of computing the amount of the [section 467](/cfr/26/467.md) loan, under the terms of the entire agreement (as modified).
    - (ii) **Change in balance of section 467 loan.**
      - (A) If the balance of the [section 467](/cfr/26/467.md) loan determined under [paragraph (g)(2)(i)](#g-2-i) of this section is greater than the balance of the [section 467](/cfr/26/467.md) loan immediately before the effective date of the modification, the difference is taken into account, in the taxable year in which the modification occurs, as additional rent.
      - (B) If the balance of the [section 467](/cfr/26/467.md) loan determined under [paragraph (g)(2)(i)](#g-2-i) of this section is less than the balance of the [section 467](/cfr/26/467.md) loan immediately before the effective date of the modification, the difference is taken into account, in the taxable year in which the modification occurs, as a reduction of the rent previously taken into account by the lessor and lessee.
      - (C) For purposes of this [paragraph (g)(2)(ii)](#g-2-ii), a negative balance is less than a positive balance, a zero balance, or any other negative balance that is closer to a zero balance.
    - (iii) **Section 467 rent and interest after the modification.** The [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for periods after the effective date of the modification are determined under the terms of the entire agreement (as modified).
    - (iv) **Applicable Federal rate.** The applicable Federal rate for the agreement does not change as a result of the modification.
    - (v) **Modification effective within a rental period.** If the effective date of a modification does not coincide with the beginning or end of a rental period under the agreement in effect before the modification, the [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for the portion of the rental period ending immediately prior to the effective date of the modification are a pro rata portion of the [section 467](/cfr/26/467.md) rent and the [section 467](/cfr/26/467.md) interest, respectively, for the rental period. Such amounts are also taken into account in determining the [section 467](/cfr/26/467.md) loan balance, prior to any adjustment thereof that may be required under [paragraph (h)](#h) of this section, immediately before the effective date of the modification. Similar rules apply with respect to the [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest determined under the terms of the entire agreement (as modified) for purposes of computing the amount of the [section 467](/cfr/26/467.md) loan under [paragraph (g)(2)(i)](#g-2-i) of this section and the [section 467](/cfr/26/467.md) rent and [section 467](/cfr/26/467.md) interest for a partial rental period beginning on the effective date of the modification.
    - (vi) **Other adjustments.** The lessor and lessee must take into account, in the taxable year in which a retroactive modification occurs, any amount necessary to prevent the duplication or omission of rent or interest for the period before the beginning of the taxable year in which the modification occurs.
    - (vii) **Coordination with rules relating to dispositions and assignments.** If the modification involves a sale, exchange, or other disposition of the property subject to the rental agreement, an assignment of the lessee's interest in the rental agreement to a substitute lessee or a substitute lessee having use of the property during a period otherwise included in the lease term, adjustments required under this [paragraph (g)](#g) are taken into account before applying paragraphs [(a)](#a), [(b)](#b), [(c)](#c), [(e)](#e), and [(f)](#f) of this section.
    - (viii) **Exception for agreements entered into prior to effective date of section 467.** This [paragraph (g)(2)](#g-2) does not apply to a modification of a rental agreement that is not subject to [section 467](/cfr/26/467.md) because of the effective date provisions of section 92(c) of the Tax Reform Act of 1984 (Public Law 98-369 (98 Stat. 612)).
  - (3) **Adjustment by Commissioner.** If the entire agreement (as modified) is treated as a single agreement under [§ 1.467-1(f)(4)(vi)](/cfr/26/1.467-1.md?p=f-4-vi), the Commissioner may require adjustments to taxable income to reflect the effect of the modification, including adjustments that are similar to those required under [paragraph (g)(2)](#g-2) of this section.
  - (4) **Effective date of modification.** The effective date of a modification of a rental agreement occurs at the earliest of—
    - (i) The date on which the modification occurs;
    - (ii) The beginning of the first period for which the amount of rent or interest provided under the entire agreement (as modified) differs from the amount of rent or interest provided under the agreement in effect before the modification;
    - (iii) The due date of the first payment, under either the entire agreement (as modified) or the agreement in effect before the modification, that is not identical, in due date and amount, under both such agreements;
    - (iv) The date, in the case of a modification involving the substitution of a new lessor, on which the property subject to the rental agreement is transferred; or
    - (v) The date, in the case of a modification involving the substitution of a new lessee, on which the substitute lessee first has use of the property subject to the rental agreement.
  - (5) **Examples.** The following examples illustrate the application of this [paragraph (g)](#g):
- (h) **Omissions or duplications—**
  - (1) **In general.** In applying the rules of this section in conjunction with the rules of [§§ 1.467-1 through 1.467-5](/cfr/26/1.467-1..1.467-5.md), adjustments must be made to the extent necessary to prevent the omission or duplication of items of income, deduction, gain, or loss. For example, if a transferee lessor acquires property subject to a [section 467](/cfr/26/467.md) rental agreement at other than the beginning or end of a rental period, and the transferee lessor's beginning [section 467](/cfr/26/467.md) loan balance differs from the transferor lessor's [section 467](/cfr/26/467.md) loan balance immediately prior to the transfer, it will be necessary to treat the rental period that includes the day of transfer as consisting of two rental periods, one beginning at the beginning of the rental period that includes the day of transfer and ending with or immediately prior to the transfer and one beginning with or immediately after the transfer and ending immediately prior to the beginning of the succeeding rental period. Because the substitution of two rental periods for one rental period may change the proportional rental amount or constant rental amount, the change in rental periods should be treated as a modification of the rental agreement that occurs immediately prior to the transfer. The change in rental periods, by itself, is not treated as a substantial modification of the rental agreement although the substitution of a new lessor may constitute a substantial modification of the rental agreement. Likewise, [§ 1.467-1(j)(2)](/cfr/26/1.467-1.md?p=j-2), which provides rules regarding when amounts are treated as payable, is designed to simplify calculations of present values, [section 467](/cfr/26/467.md) loan balances, and proportional and constant rental amounts. These simplifying conventions assume that there will be no change in the lessor or lessee under a [section 467](/cfr/26/467.md) rental agreement and that the terms of the [section 467](/cfr/26/467.md) rental agreement will not be modified. Therefore, as illustrated in the example in [paragraph (h)(2)](#h-2) of this section, when actual events do not reflect these assumptions, it may be necessary to alter the application of these rules to properly reflect taxable income.
  - (2) **Example.** The following example illustrates an application of this [paragraph (h)](#h):

# §1.467-8. Automatic consent to change to constant rental accrual for certain rental agreements.

- (a) **General rule.** For the first taxable year ending after May 18, 1999, a taxpayer may change to the constant rental accrual method, as described in [§ 1.467-3](/cfr/26/1.467-3.md), for all of its [section 467](/cfr/26/467.md) rental agreements described in [paragraph (b)](#b) of this section. A change to the constant rental accrual method is a change in method of accounting to which the provisions of sections [446](/cfr/26/446.md) and [481](/cfr/26/481.md) and the regulations thereunder apply. A taxpayer changing its method of accounting in accordance with this section must follow the automatic change in accounting method provisions of Rev. Proc. 98-60 (see [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter) except, for purposes of this [paragraph (a)](#a), the scope limitations in [section 4.02](/cfr/26/4.02.md) of Rev. Proc. 98-60 are not applicable. Taxpayers changing their method of accounting in accordance with this section must do so for all of their [section 467](/cfr/26/467.md) rental agreements described in [paragraph (b)](#b) of this section.
- (b) **Agreements to which automatic consent applies.** A [section 467](/cfr/26/467.md) rental agreement is described in this [paragraph (b)](#b) if—
  - (1) The property subject to the [section 467](/cfr/26/467.md) rental agreement is financed with an “exempt facility bond” within the meaning of [section 142](/cfr/26/142.md);
  - (2) The facility subject to the [section 467](/cfr/26/467.md) rental agreement is described in section [142(a)(1)](/cfr/26/142.md?p=a-1), [(2)](/cfr/26/142.md?p=a-2), [(3)](/cfr/26/142.md?p=a-3), or [(12)](/cfr/26/142.md?p=a-12);
  - (3) The [section 467](/cfr/26/467.md) rental agreement does not include a specific allocation of fixed rent within the meaning of [§ 1.467-1(c)(2)(ii)(A)(2)](/cfr/26/1.467-1.md?p=c-2-ii-A-2); and
  - (4) **The section 467 rental agreement was entered into on or before May 18, 1999.**