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

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8917] RIN 1545-AW75

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

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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

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

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

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to 26 CFR Part 1 under section 467
of the Internal Revenue Code (Code). Section 467 was added to the
Code by section 92(a) of the Tax Reform Act of 1984 (Public Law
98-369; 98 Stat. 609).

On May 18, 1999, a notice of proposed rulemaking (REG-103694-99,
1999-24, I.R.B. 49) under section 467 was published in the Federal
Register (64 FR 26924). The notice proposed to amend the section 467
regulations relating to constant rental accrual by treating section
467 rental agreements involving payments of $2,000,000 or less in
the same manner as agreements involving payments of more than
$2,000,000. Although comments and requests for a public hearing were
solicited, no comments were received and no public hearing was
requested or held. Accordingly, the amendment to the constant rental
accrual rules called for by the proposed regulations is adopted
without revision.

In addition, the IRS and Treasury Department have identified three
provisions in the section 467 regulations (TD 8820), published on
May 18, 1999, at 64 FR 26845, that require clarification.
Accordingly, these final regulations also provide clarifying
amendments to the section 467 regulations.

Explanation of Provisions

A. Removal of the $2,000,000 Constant Rental Accrual Exception
Section 467 includes an anti-abuse rule applicable to certain
section 467 rental agreements. Under this rule, a constant rental
amount must be taken into account by a lessor and lessee for each
rental period during the lease term. The constant rental amount is
the amount that, if paid at the end of each rental period, would
result in a present value equal to the present value of all amounts
payable under the agreement. Constant rental accrual applies only
with respect to leasebacks and long-term agreements that provide for
increasing or decreasing rent and only if the Commissioner
determines that the agreement is disqualified because tax avoidance
is a principal purpose for providing increasing or decreasing rent.
In addition, however, the regulations provide that a rental
agreement will not be disqualified and, consequently, will not be
subject to constant rental accrual unless it requires more than
$2,000,000 in rental payments and other consideration.

These final regulations remove the $2,000,000 exception from
constant rental accrual for section 467 rental agreements entered
into on or after July 19, 1999. Consequently, for section 467 rental
agreements entered into on or after July 19, 1999, the Commissioner
may determine that the agreement is a disqualified leaseback or
long-term agreement subject to constant rental accrual, even if the
agreement requires $2,000,000 or less in rental payments and other
consideration.

B. Definition of Lease Term

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

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

C. When an Amount is Considered Payable

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

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

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

E. Effective Dates

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

Special Analyses

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

Drafting Information

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

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regu ations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

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

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

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

§1.467-0 Table of contents.

* * * * *

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

(b) * * *

(3) Agreements with both deferred and prepaid rent.

* * * * *

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

* * * * *

(h) * * *

(6) Lease term means the period during which the lessee has use of
the property subject to the rental agreement, including any option
of the lessor to renew or extend the term of the agreement. An
option of the lessee to renew or extend the term of the agreement is
included in the lease term only if it is expected, as of the
agreement date, that the option will be exercised. For this purpose,
a lessee is generally expected to exercise an option if, for
example, as of the agreement date the rent for the option period is
less than the expected fair market value rental for such period. The
lessor's or lessee's determination that an option period is either
included in or excluded from the lease term is not binding on the
Commissioner. If the lessee (or a related person) agrees that one or
both of them will or could be obligated to make payments in the
nature of rent (within the meaning of §1.168(i)-2(b)(2)) for a
period when another lessee (the substitute lessee) or the lessor
will have use of the property subject to the rental agreement, the
Commissioner may, in appropriate cases, treat the period when the
substitute lessee or lessor will have use of the property as part of
the lease term. See §1.467-7(f) for special rules applicable to
the lessee, substitute lessee, and lessor. This paragraph (h)(6)
applies to section 467 rental agreements entered into after March 6,
2001. However, taxpayers may choose to apply this paragraph (h)(6)
to any rental agreement that is described in §1.467-9(a) and is
entered into on or before March 6, 2001.

* * * * *

(j) * * *

(2) * * *

(ii) Time amount is payable. For purposes of this section and
§§1.467-2 through 1.467-9, an amount is payable on the
last day for timely payment (that is, the last day such amount may
be paid without incurring interest, computed at an arm's-length
rate, a substantial penalty, or other substantial detriment (such as
giving the lessor the right to terminate the agreement, bring an
action to enforce payment, or exercise other similar remedies under
the terms of the agreement or applicable law)). This paragraph (j)
(2)(ii) applies to section 467 rental agreements entered into after
March 6, 2001. However, taxpayers may choose to apply this paragraph
(j)(2)(ii) to any rental agreement that is described in
§1.467-9(a) and is entered into on or before March 6, 2001.

* * * * *

Par 4. In §1.467-2, paragraph (b)(3) is added to read as
follows: §1.467-2 Rent accrual for section 467 rental
agreements without adequate interest.

* * * * *

(b) * * *

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

* * * * *

Par 5. In §1.467-3, paragraph (b)(1)(iii) is revised to read as
follows: §1.467-3 Disqualified leasebacks and long-term
agreements.

* * * * *

(b) * * * (1) * * *

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

* * * * *

Robert E. Wenzel
Deputy Commissioner of Internal Revenue.

Approved: 

Jonathan Talisman
Assistant Secretary of the Treasury.

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