[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.168(i)-2]

[Page 1053-1055]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.168(i)-2  Lease term.

    (a) In general. For purposes of section 168, a lease term is 
determined under all the facts and circumstances. Paragraph (b) of this 
section and Sec. 1.168(j)-1T, Q&A 17, describe certain circumstances 
that will result in a period of time not included in the stated duration 
of an original lease (additional period) nevertheless being included in 
the lease term. These rules do not prevent the inclusion of an 
additional period in the lease term in other circumstances.
    (b) Lessee retains financial obligation--(1) In general. An 
additional period of time during which a lessee may not continue to be 
the lessee will nevertheless be included in the lease term if the lessee 
(or a related person)--
    (i) Has agreed that one or both of them will or could be obligated 
to make a payment of rent or a payment in the nature of rent with 
respect to such period; or
    (ii) Has assumed or retained any risk of loss with respect to the 
property for such period (including, for example, by holding a note 
secured by the property).

[[Page 1054]]

    (2) Payments in the nature of rent. For purposes of paragraph 
(b)(1)(i) of this section, a payment in the nature of rent includes a 
payment intended to substitute for rent or to fund or supplement the 
rental payments of another. For example, a payment in the nature of rent 
includes a payment of any kind (whether denominated as supplemental 
rent, as liquidated damages, or otherwise) that is required to be made 
in the event that--
    (i) The leased property is not leased for the additional period;
    (ii) The leased property is leased for the additional period under 
terms that do not satisfy specified terms and conditions;
    (iii) There is a failure to make a payment of rent with respect to 
such additional period; or
    (iv) Circumstances similar to those described in paragraph (b)(2) 
(i), (ii), or (iii) of this section occur.
    (3) De minimis rule. For the purposes of this paragraph (b), 
obligations to make de minimis payments will be disregarded.
    (c) Multiple leases or subleases. If property is subject to more 
than one lease (including any sublease) entered into as part of a single 
transaction (or a series of related transactions), the lease term 
includes all periods described in one or more of such leases. For 
example, if one taxable corporation leases property to another taxable 
corporation for a 20-year term and, as part of the same transaction, the 
lessee subleases the property to a tax-exempt entity for a 10-year term, 
then the lease term of the property for purposes of section 168 is 20 
years. During the period of tax-exempt use, the property must be 
depreciated under the alternative depreciation system using the straight 
line method over the greater of its class life or 25 years (125 percent 
of the 20-year lease term).
    (d) Related person. For purposes of paragraph (b) of this section, a 
person is related to the lessee if such person is described in section 
168(h)(4).
    (e) Changes in status. Section 168(i)(5) (changes in status) applies 
if an additional period is included in a lease term under this section 
and the leased property ceases to be tax-exempt use property for such 
additional period.
    (f) Example. The following example illustrates the principles of 
this section. The example does not address common law doctrines or other 
authorities that may apply to cause an additional period to be included 
in the lease term or to recharacterize a lease as a conditional sale or 
otherwise for federal income tax purposes. Unless otherwise indicated, 
parties to the transactions are not related to one another.

    Example Financial obligation with respect to an additional period--
(i) Facts.
    X, a taxable corporation, and Y, a foreign airline whose income is 
not subject to United States taxation, enter into a lease agreement 
under which X agrees to lease an aircraft to Y for a period of 10 years. 
The lease agreement provides that, at the end of the lease period, Y is 
obligated to find a subsequent lessee (replacement lessee) to enter into 
a subsequent lease (replacement lease) of the aircraft from X for an 
additional 10-year period. The provisions of the lease agreement require 
that any replacement lessee be unrelated to Y and that it not be a tax-
exempt entity as defined in section 168(h)(2). The provisions of the 
lease agreement also set forth the basic terms and conditions of the 
replacement lease, including its duration and the required rental 
payments. In the event Y fails to secure a replacement lease, the lease 
agreement requires Y to make a payment to X in an amount determined 
under the lease agreement.
    (ii) Application of this section. The lease agreement between X and 
Y obligates Y to make a payment in the event the aircraft is not leased 
for the period commencing after the initial 10-year lease period and 
ending on the date the replacement lease is scheduled to end. 
Accordingly, pursuant to paragraph (b) of this section, the term of the 
lease between X and Y includes such additional period, and the lease 
term is 20 years for purposes of section 168.
    (iii) Facts modified. Assume the same facts as in paragraph (i) of 
this Example, except that Y is required to guarantee the payment of 
rentals under the 10-year replacement lease and to make a payment to X 
equal to the present value of any excess of the replacement lease rental 
payments specified in the lease agreement between X and Y, over the 
rental payments actually agreed to be paid by the replacement lessee. 
Pursuant to paragraph (b) of this section, the term of the lease between 
X and Y includes the additional period, and the lease term is 20 years 
for purposes of section 168.
    (iv) Changes in status. If, upon the conclusion of the stated 
duration of the lease between X and Y, the aircraft either is returned 
to X or leased to a replacement lessee

[[Page 1055]]

that is not a tax-exempt entity as defined in section 168(h)(2), the 
subsequent method of depreciation will be determined pursuant to section 
168(i)(5).

    (g) Effective date--(1) In general. Except as provided in paragraph 
(g)(2) of this section, this section applies to leases entered into on 
or after April 20, 1995.
    (2) Special rules. Paragraphs (b)(1)(ii) and (c) of this section 
apply to leases entered into after April 26, 1996.

[T.D. 8667, 61 FR 18677, Apr. 29, 1996]