[Code of Federal Regulations]
[Title 26, Volume 6]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.467-1]

[Page 296-306]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.467-1  Treatment of lessors and lessees generally.

    (a) Overview--(1) In general. When applicable, section 467 requires 
a lessor and lessee of tangible property to treat rents consistently and 
to use the accrual method of accounting (and time value of money 
principles) regardless of their overall method of accounting. In 
addition, in certain cases involving tax avoidance, the lessor and 
lessee must take rent and stated or imputed interest into account under 
a constant rental accrual method, pursuant to which the rent is treated 
as accruing ratably over the entire lease term.
    (2) Cases in which rules are inapplicable. Section 467 applies only 
to leases (or other similar arrangements) that constitute section 467 
rental agreements as defined in paragraph (c) of this section. For 
example, a rental agreement is not a section 467 rental agreement, and, 
therefore, is not subject to the provisions of this section and 
Sec. Sec. 1.467-2 through 1.467-9 (the section 467 regulations), if it 
specifies equal amounts of rent for each month throughout the lease term 
and all payments of rent are due in the calendar year to which the rent 
relates (or in the preceding or succeeding calendar year). In addition, 
the section 467 regulations do not apply to a rental agreement that 
requires total rents of $250,000 or less. For purposes of determining 
whether the agreement has total rents of $250,000 or less, certain 
specified contingent rent is disregarded.
    (3) Summary of rules--(i) Basic rules. Paragraph (c) of this section 
provides rules for determining whether a rental agreement is a section 
467 rental agreement. Paragraphs (d) and (e) of this section provide 
rules for determining the amount of rent and interest, respectively, 
required to be taken into account by a lessor and lessee under a section 
467 rental agreement. Paragraphs (f) through (h) and (j) of this section 
provide various definitions and special rules relating to the 
application of the section 467 regulations. Paragraph (i) of this 
section is reserved.
    (ii) Special rules. Section 1.467-2 provides rules for section 467 
rental agreements that have deferred or prepaid rents without providing 
for adequate interest. Section 1.467-3 provides rules for application of 
the constant rental accrual method, including criteria for determining 
whether an agreement is subject to this method. Section 1.467-4 provides 
rules for establishing and adjusting a section 467 loan (the amount that 
a lessor is deemed to have loaned to the lessee, or vice versa, pursuant 
to the application of the section 467 regulations). Section 1.467-5 
provides rules for applying the section 467 regulations where a rental 
agreement requires payments of interest at a variable rate. Section 
1.467-6, relating to the treatment of certain section 467 rental 
agreements with contingent payments, is reserved. Section 1.467-7 
provides rules for the treatment of dispositions by a lessor of property 
subject to a section 467 rental agreement and the treatment of 
assignments by lessees and certain lessee-financed renewals of a section 
467 rental agreement. Section 1.467-7 also provides rules for the 
treatment of modified rental agreements. Section 1.467-8 provides 
special transitional rules relating to the method of

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accounting for certain rental agreements entered into on or before May 
18, 1999. Finally, Sec. 1.467-9 provides the effective date rules for 
the section 467 regulations.
    (4) Scope of rules. No inference should be drawn from any provision 
of this section or Sec. Sec. 1.467-2 through 1.467-9 concerning 
whether--
    (i) For Federal tax purposes, an arrangement constitutes a lease; or
    (ii) For Federal tax purposes, any obligation of the lessee under a 
rental agreement is treated as rent.
    (5) Application of other authorities. Notwithstanding section 467 
and the regulations thereunder, other authorities such as section 446(b) 
clear-reflection-of-income principles, section 482, and the substance-
over-form doctrine, may be applied by the Commissioner to determine the 
income and expense from a rental agreement (including the proper 
allocation of fixed rent under a rental agreement).
    (b) Method of accounting for section 467 rental agreements. If a 
rental agreement is a section 467 rental agreement, as described in 
paragraph (c) of this section, the lessor and lessee must each take into 
account for any taxable year the sum of--
    (1) The section 467 rent for the taxable year (as defined in 
paragraph (d) of this section); and
    (2) The section 467 interest for the taxable year (as defined in 
paragraph (e) of this section).
    (c) Section 467 rental agreements--(1) In general. Except as 
otherwise provided in paragraph (c)(4) of this section, the term section 
467 rental agreement means a rental agreement, as defined in paragraph 
(h)(12) of this section, that has increasing or decreasing rents (as 
described in paragraph (c)(2) of this section), or deferred or prepaid 
rents (as described in paragraph (c)(3) of this section).
    (2) Increasing or decreasing rent--(i) Fixed rent--(A) In general. A 
rental agreement has increasing or decreasing rent if the annualized 
fixed rent, as described in paragraph (j)(3) of this section, allocated 
to any rental period exceeds the annualized fixed rent allocated to any 
other rental period in the lease term.
    (B) Certain rent holidays disregarded. Notwithstanding the 
provisions of paragraph (c)(2)(i)(A) of this section, a rental agreement 
does not have increasing or decreasing rent if the increasing or 
decreasing rent is solely attributable to a rent holiday provision 
allowing reduced rent (or no rent) for a period of three months or less 
at the beginning of the lease term.
    (ii) Fixed rent allocated to a rental period--(A) Specific 
allocation--(1) In general. If a rental agreement provides a specific 
allocation of fixed rent, as described in paragraph (c)(2)(ii)(A)(2) of 
this section, the amount of fixed rent allocated to each rental period 
during the lease term is the amount of fixed rent allocated to that 
period by the rental agreement.
    (2) Rental agreements specifically allocating fixed rent. A rental 
agreement specifically allocates fixed rent if the rental agreement 
unambiguously specifies, for periods no longer than a year, a fixed 
amount of rent for which the lessee becomes liable on account of the use 
of the property during that period, and the total amount of fixed rent 
specified is equal to the total amount of fixed rent payable under the 
lease. For example, a rental agreement providing that rent is $100,000 
per calendar year, and providing for total payments of fixed rent equal 
to the total amount specified, specifically allocates rent. A rental 
agreement stating only when rent is payable does not specifically 
allocate rent.
    (B) No specific allocation. If a rental agreement does not provide a 
specific allocation of fixed rent (for example, because the total amount 
of fixed rent specified is not equal to the total amount of fixed rent 
payable under the lease), the amount of fixed rent allocated to a rental 
period is the amount of fixed rent payable during that rental period. If 
an amount of fixed rent is payable before the beginning of the lease 
term, it is allocated to the first rental period in the lease term. If 
an amount of fixed rent is payable after the end of the lease term, it 
is allocated to the last rental period in the lease term.

[[Page 298]]

    (iii) Contingent rent--(A) In general. A rental agreement has 
increasing or decreasing rent if it requires (or may require) the 
payment of contingent rent (as defined in paragraph (h)(2) of this 
section), other than contingent rent described in paragraph 
(c)(2)(iii)(B) of this section.
    (B) Certain contingent rent disregarded. For purposes of this 
paragraph (c)(2)(iii), rent is disregarded to the extent it is 
contingent as the result of one or more of the following provisions--
    (1) A qualified percentage rents provision, as defined in paragraph 
(h)(8) of this section;
    (2) An adjustment based on a reasonable price index, as defined in 
paragraph (h)(10) of this section;
    (3) A provision requiring the lessee to pay third-party costs, as 
defined in paragraph (h)(15) of this section;
    (4) A provision requiring the payment of late payment charges, as 
defined in paragraph (h)(4) of this section;
    (5) A loss payment provision, as defined in paragraph (h)(7) of this 
section;
    (6) A qualified TRAC provision, as defined in paragraph (h)(9) of 
this section;
    (7) A residual condition provision, as defined in paragraph (h)(13) 
of this section;
    (8) A tax indemnity provision, as defined in paragraph (h)(14) of 
this section;
    (9) A variable interest rate provision, as defined in paragraph 
(h)(16) of this section; or
    (10) Any other provision provided in regulations or other published 
guidance issued by the Commissioner, but only if the provision is 
designated as contingent rent to be disregarded for purposes of this 
paragraph (c)(2)(iii).
    (3) Deferred or prepaid rent--(i) Deferred rent. A rental agreement 
has deferred rent under this paragraph (c)(3) if the cumulative amount 
of rent allocated as of the close of a calendar year (determined under 
paragraph (c)(3)(iii) of this section) exceeds the cumulative amount of 
rent payable as of the close of the succeeding calendar year.
    (ii) Prepaid rent. A rental agreement has prepaid rent under this 
paragraph (c)(3) if the cumulative amount of rent payable as of the 
close of a calendar year exceeds the cumulative amount of rent allocated 
as of the close of the succeeding calendar year (determined under 
paragraph (c)(3)(iii) of this section).
    (iii) Rent allocated to a calendar year. For purposes of this 
paragraph (c)(3), the rent allocated to a calendar year is the sum of--
    (A) The fixed rent allocated to any rental period (determined under 
paragraph (c)(2)(ii) of this section) that begins and ends in the 
calendar year;
    (B) A ratable portion of the fixed rent allocated to any other 
rental period that begins or ends in the calendar year; and (C) Any 
contingent rent that accrues during the calendar year.
    (iv) Examples. The following examples illustrate the application of 
this paragraph (c)(3):

    Example 1. (i) A and B enter into a rental agreement that provides 
for the lease of property to begin on January 1, 2000, and end on 
December 31, 2003. The rental agreement provides that rent of $100,000 
accrues during each year of the lease term. Under the rental agreement, 
no rent is payable during calendar year 2000, a payment of $100,000 is 
to be made on December 31, 2001, and December 31, 2002, and a payment of 
$200,000 is to be made on December 31, 2003. A and B both select the 
calendar year as their rental period. Thus, the amount of rent allocated 
to each rental period under paragraph (c)(2)(ii) of this section is 
$100,000. Therefore, the rental agreement does not have increasing or 
decreasing rent as described in paragraph (c)(2)(i) of this section.
    (ii) Under paragraph (c)(3)(i) of this section, a rental agreement 
has deferred rent if, at the close of a calendar year, the cumulative 
amount of rent allocated under paragraph (c)(3)(iii) of this section 
exceeds the cumulative amount of rent payable as of the close of the 
succeeding year. In this example, there is no deferred rent: the rent 
allocated to 2000 ($100,000) does not exceed the cumulative rent payable 
as of December 31, 2001 ($100,000); the rent allocated to 2001 and 
preceding years ($200,000) does not exceed the cumulative rent payable 
as of December 31, 2002 ($200,000); the rent allocated to 2002 and 
preceding years ($300,000) does not exceed the cumulative rent payable 
as of December 31, 2003 ($400,000); and the rent allocated to 2003 and 
preceding years ($400,000) does not exceed the cumulative rent payable 
as of December 31, 2004 ($400,000). Therefore, because the rental 
agreement does not have increasing or decreasing rent and does not have 
deferred or prepaid rent, the rental agreement is not a section 467 
rental agreement.
    Example 2. (i) A and B enter into a rental agreement that provides 
for a 10-year lease

[[Page 299]]

of personal property, beginning on January 1, 2000, and ending on 
December 31, 2009. The rental agreement provides for accruals of rent of 
$10,000 during each month of the lease term. Under paragraph (c)(3)(iii) 
of this section, $120,000 is allocated to each calendar year. The rental 
agreement provides for a $1,200,000 payment on December 31, 2000.
    (ii) The rental agreement does not have increasing or decreasing 
rent as described in paragraph (c)(2)(i) of this section. The rental 
agreement, however, provides prepaid rent under paragraph (c)(3)(ii) of 
this section because the cumulative amount of rent payable as of the 
close of a calendar year exceeds the cumulative amount of rent allocated 
as of the close of the succeeding calendar year. For example, the 
cumulative amount of rent payable as of the close of 2000 ($1,200,000 is 
payable on December 31, 2000) exceeds the cumulative amount of rent 
allocated as of the close of 2001, the succeeding calendar year 
($240,000). Accordingly, the rental agreement is a section 467 rental 
agreement.

    (4) Rental agreements involving total payments of $250,000 or less--
(i) In general. A rental agreement is not a section 467 rental agreement 
if, as of the agreement date (as defined in paragraph (h)(1) of this 
section), it is not reasonably expected that the sum of the aggregate 
amount of rental payments under the rental agreement and the aggregate 
value of all other consideration to be received for the use of property 
(taking into account any payments of contingent rent, and any other 
contingent consideration) will exceed $250,000.
    (ii) Special rules in computing amount described in paragraph 
(c)(4)(i) of this section of this section. The following rules apply in 
determining the amount described in paragraph (c)(4)(i) of this section:
    (A) Stated interest on deferred rent is not taken into account. 
However, the Commissioner may recharacterize a portion of stated 
interest as additional rent if a rental agreement provides for interest 
on deferred rent at a rate that, in light of all of the facts and 
circumstances, is clearly greater than the arm's-length rate of interest 
that would have been charged in a lending transaction between the lessor 
and lessee.
    (B) Consideration that does not involve a cash payment is taken into 
account at its fair market value. A liability that is either assumed or 
secured by property acquired subject to the liability is taken into 
account at the sum of its remaining principal amount and accrued 
interest (if any) thereon or, in the case of an obligation originally 
issued at a discount, at the sum of its adjusted issue price and accrued 
qualified stated interest (if any), within the meaning of Sec. 1.1273-
1(c)(1).
    (C) All rental agreements that are part of the same transaction or a 
series of related transactions involving the same lessee (or any related 
person) and the same lessor (or any related person) are treated as a 
single rental agreement. Whether two or more rental agreements are part 
of the same transaction or a series of related transactions depends on 
all the facts and circumstances.
    (D) If an agreement includes a provision increasing or decreasing 
rent payable solely as a result of an adjustment based on a reasonable 
price index, the amount described in paragraph (c)(4)(i) of this section 
must be determined as if the applicable price index did not change 
during the lease term.
    (E) If an agreement includes a variable interest rate provision (as 
defined in paragraph (h)(16) of this section), the amount described in 
paragraph (c)(4)(i) of this section must be determined by using fixed 
rate substitutes (determined in the same manner as under Sec. 1.1275-
5(e), treating the agreement date as the issue date) for the variable 
rates of interest applicable to the lessor's indebtedness.
    (F) Contingent rent described in paragraphs (c)(2)(iii)(B)(3) 
through (8) of this section is not taken into account.
    (d) Section 467 rent--(1) In general. The section 467 rent for a 
taxable year is the sum of--
    (i) The fixed rent for any rental period (determined under paragraph 
(d)(2) of this section) that begins and ends in the taxable year;
    (ii) A ratable portion of the fixed rent for any other rental period 
beginning or ending in the taxable year; and
    (iii) In the case of a section 467 rental agreement that provides 
for contingent rent, the contingent rent that accrues during the taxable 
year.
    (2) Fixed rent for a rental period--(i) Constant rental accrual. In 
the case of a

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section 467 rental agreement that is a disqualified leaseback or long-
term agreement (as described in Sec. 1.467-3(b)), the fixed rent for a 
rental period is the constant rental amount (as determined under Sec. 
1.467-3(d)).
    (ii) Proportional rental accrual. In the case of a section 467 
rental agreement that is not described in paragraph (d)(2)(i) of this 
section, and does not provide adequate interest on fixed rent (as 
determined under Sec. 1.467-2(b)), the fixed rent for a rental period 
is the proportional rental amount (as determined under Sec. 1.467-
2(c)).
    (iii) Section 467 rental agreement accrual. In the case of a section 
467 rental agreement that is not described in either paragraph (d)(2)(i) 
or (ii) of this section, the fixed rent for a rental period is the 
amount of fixed rent allocated to the rental period under the rental 
agreement, as determined under paragraph (c)(2)(ii) of this section.
    (e) Section 467 interest--(1) In general. The section 467 interest 
for a taxable year is the sum of--
    (i) The interest on fixed rent for any rental period that begins and 
ends in the taxable year;
    (ii) A ratable portion of the interest on fixed rent for any other 
rental period beginning or ending in the taxable year; and
    (iii) In the case of a section 467 rental agreement that provides 
for contingent rent, any interest that accrues on the contingent rent 
during the taxable year.
    (2) Interest on fixed rent for a rental period--(i) In general. 
Except as provided in paragraph (e)(2)(ii) of this section and Sec. 
1.467-5(b)(1)(ii), the interest on fixed rent for a rental period is 
equal to the product of--
    (A) The principal balance of the section 467 loan (as described in 
Sec. 1.467-4(b)) at the beginning of the rental period; and
    (B) The yield of the section 467 loan (as described in Sec. 1.467-
4(c)).
    (ii) Section 467 rental agreements with adequate interest. Except in 
the case of a section 467 rental agreement that is a disqualified 
leaseback or long-term agreement, if a section 467 rental agreement 
provides adequate interest under Sec. 1.467-2(b)(1)(i) (agreements with 
no deferred or prepaid rent) or Sec. 1.467-2(b)(1)(ii) (agreements with 
adequate interest stated at a single fixed rate), the interest on fixed 
rent for a rental period is the amount of interest provided in the 
rental agreement for the period.
    (3) Treatment of interest. If the section 467 interest for a rental 
period is a positive amount, the lessor has interest income and the 
lessee has an interest expense. If the section 467 interest for a rental 
period is a negative amount, the lessee has interest income and the 
lessor has an interest expense. Section 467 interest is treated as 
interest for all purposes of the Internal Revenue Code.
    (f) Substantial modification of a rental agreement--(1) Treatment as 
new agreement--(i) In general. If a substantial modification of a rental 
agreement occurs after June 3, 1996, the post-modification agreement is 
treated as a new agreement and the date on which the modification occurs 
is treated as the agreement date in applying section 467 and the 
regulations thereunder to the post-modification agreement. Thus, for 
example, the post-modification agreement is treated as a new agreement 
entered into on the date the modification occurs for purposes of 
determining whether it is a section 467 rental agreement under this 
section, whether it is a disqualified leaseback or long-term agreement 
under Sec. 1.467-3, and whether it is entered into after the applicable 
effective date in Sec. 1.467-9.
    (ii) Limitation. In the case of a substantial modification of a 
rental agreement occurring on or before May 18, 1999, this paragraph (f) 
applies only if--
    (A) The rental agreement was a disqualified leaseback or long-term 
agreement before the modification and the agreement date, determined 
without regard to the modification, is after June 3, 1996; or
    (B) The post-modification agreement would, after application of the 
rules in this paragraph (f) (other than the special rule for 
disqualified agreements in paragraph (f)(4)(iii) of this section), be a 
disqualified leaseback or long-term agreement.
    (2) Post-modification agreement; in general. For purposes of 
determining whether a post-modification agreement is a section 467 
rental agreement or a

[[Page 301]]

disqualified leaseback or long-term agreement under paragraph (f)(1) of 
this section, the terms of the post-modification agreement are, except 
as provided in paragraph (f)(4) of this section, only those terms that 
provide for rights and obligations relating to post-modification items 
(within the meaning of paragraph (f)(5)(iv) of this section).
    (3) Other effects of a modification. For rules relating to amounts 
that must be taken into account following certain modifications, see 
Sec. 1.467-7(g).
    (4) Special rules--(i) Carryover of character; leasebacks. If an 
agreement is a leaseback prior to its modification and the lessee prior 
to the modification (or a related person) is the lessee after the 
modification, the post-modification agreement is a leaseback even if the 
post-modification lessee did not have an interest in the property at any 
time during the two-year period ending on the date on which the 
modification occurs.
    (ii) Carryover of character; long-term agreements. If an agreement 
is a long-term agreement prior to its modification and the entire 
agreement (as modified) would be a long-term agreement, the post-
modification agreement is a long-term agreement.
    (iii) Carryover of character; disqualified agreements. If an 
agreement (as in effect before its modification) is a disqualified 
leaseback or long-term agreement as the result of a determination 
(whether occurring before or after the modification) under Sec. 1.467-
3(b)(1)(ii) and the post-modification agreement is a section 467 rental 
agreement (or the entire agreement (as modified) would be a section 467 
rental agreement), the post-modification agreement will, notwithstanding 
its treatment as a new agreement under paragraph (f)(1)(i) of this 
section, be subject to constant rental accrual unless the Commissioner 
determines that, because of the absence of tax avoidance potential, the 
post-modification agreement should not be treated as a disqualified 
leaseback or long-term agreement.
    (iv) Allocation of rent. If the entire agreement (as modified) 
provides a specific allocation of fixed rent, as described in paragraph 
(c)(2)(ii)(A)(2) of this section, the post-modification agreement is 
treated as an agreement that provides a specific allocation of fixed 
rent. If the entire agreement (as modified) does not provide a specific 
allocation of fixed rent, the fixed rent allocated to rental periods 
during the lease term of the post-modification agreement is determined 
by applying the rules of paragraph (c)(2)(ii)(B) of this section to the 
entire agreement (as modified).
    (v) Difference between aggregate rent and interest and aggregate 
payments--(A) In general. Except as provided in paragraph (f)(4)(v)(B) 
of this section, a post-modification agreement described in paragraph 
(f)(4)(v)(C) of this section is treated as a section 467 rental 
agreement subject to proportional rental accrual (determined under Sec. 
1.467-2(c)).
    (B) Constant rental accrual prior to the modification. A post-
modification agreement described in paragraph (f)(4)(v)(C) of this 
section is treated as a section 467 rental agreement subject to constant 
rental accrual if--
    (1) Constant rental accrual is required under paragraph (f)(4)(iii) 
of this section; or
    (2) The post-modification agreement involves total payments of more 
than $250,000 (as described in paragraph (c)(4) of this section), and 
the Commissioner determines that the post-modification agreement is a 
disqualified leaseback or long-term agreement.
    (C) Agreements described in this paragraph (f)(4)(v)(C). A post-
modification agreement is described in this paragraph (f)(4)(v)(C) if 
the aggregate amount of fixed rent and stated interest treated as post-
modification items does not equal the aggregate amount of payments 
treated as post-modification items.
    (vi) Principal purpose of tax avoidance. If a principal purpose of a 
substantial modification is to avoid the purpose or intent of section 
467 or the regulations thereunder, the Commissioner may treat the entire 
agreement (as modified) as a single agreement for purposes of section 
467 and the regulations thereunder.
    (5) Definitions. The following definitions apply for purposes of 
this paragraph (f) and Sec. 1.467-7(g):
    (i) A modification of a rental agreement is any alteration, 
including any

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deletion or addition, in whole or in part, of a legal right or 
obligation of the lessor or lessee thereunder, whether the alteration is 
evidenced by an express agreement (oral or written), conduct of the 
parties, or otherwise.
    (ii) A modification is substantial only if, based on all of the 
facts and circumstances, the legal rights or obligations that are 
altered and the degree to which they are altered are economically 
substantial. A modification of a rental agreement will not be treated as 
substantial solely because it is not described in paragraph (f)(6) of 
this section.
    (iii) A modification occurs on the earlier of the first date on 
which there is a binding contract that substantially sets forth the 
terms of the modification or the date on which agreement to such terms 
is otherwise evidenced.
    (iv) Post-modification items with respect to any modification of a 
rental agreement are all items (other than pre-modification items) 
provided under the terms of the entire agreement (as modified).
    (v) Pre-modification items with respect to any modification of a 
rental agreement are pre-modification rent, interest thereon, and 
payments allocable thereto (whether payable before or after the 
modification.) For this purpose--
    (A) Pre-modification rent is rent allocable to periods before the 
effective date of the modification, but only to the extent such rent is 
payable under the entire agreement (as modified) at the time such rent 
was due under the agreement in effect before the modification; and
    (B) Pre-modification items are identified by applying payments, in 
the order payable under the entire agreement (as modified) unless the 
agreement specifies otherwise, to rent and interest thereon in the order 
in which amounts accrue.
    (vi) The entire agreement (as modified) with respect to any 
modification is the agreement consisting of pre-modification terms 
providing for rights and obligations that are not affected by the 
modification and post-modification terms providing for rights and 
obligations that differ from the rights and obligations under the 
agreement in effect before the modification. For example, if a 10-year 
rental agreement that provides for rent of $25,000 per year is modified 
at the end of the 5th year to provide for rent of $30,000 per year in 
subsequent years, the entire agreement (as modified) provides for a 10-
year lease term and provides for rent of $25,000 per year in years 1 
through 5 and rent of $30,000 per year in years 6 through 10. The result 
would be the same if the modification provided for both the increase in 
rent and the substitution of a new lessee.
    (6) Safe harbors. Notwithstanding the provisions of paragraph (f)(5) 
of this section, a modification of a rental agreement is not a 
substantial modification if the modification occurs solely as the result 
of one or more of the following--
    (i) The refinancing of any indebtedness incurred by the lessor to 
acquire the property subject to the rental agreement and secured by such 
property (or any refinancing thereof) but only if all of the following 
conditions are met--
    (A) Neither the amount, nor the time for payment, of the principal 
amount of the new indebtedness differs from the amount and time for 
payment of the remaining principal amount of the refinanced 
indebtedness, except for de minimis changes;
    (B) For each of the remaining rental periods, the rent allocation 
schedule, the payments of rent and interest, and the amount accrued 
under section 467 are changed only to the extent necessary to take into 
account the change in financing costs, and such changes are made 
pursuant to the terms of the rental agreement in effect before the 
modification;
    (C) The lessor and the lessee are not related persons to each other 
or to any lender to the lessor with respect to the property (whether 
under the refinanced indebtedness or the new indebtedness); and
    (D) With respect to the indebtedness being refinanced, the lessor 
was granted a unilateral option (within the meaning of Sec. 1.1001-
3(c)(3)) by the creditor to repay the refinanced indebtedness, 
exercisable with or without the lessee's consent;

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    (ii) A change in the obligation of the lessee to make any of the 
contingent payments described in paragraphs (c)(2)(iii)(B)(3) through 
(8) of this section; or
    (iii) A change in the amount of fixed rent allocated to a rental 
period that, when combined with all previous changes in the amount of 
fixed rent allocated to the rental period, does not exceed one percent 
of the fixed rent allocated to that rental period prior to the 
modification.
    (7) Special rules for certain transfers--(i) In general. For 
purposes of this paragraph (f), a substitution of a new lessee or a 
sale, exchange, or other disposition by a lessor of property subject to 
a rental agreement will not, by itself, be treated as a substantial 
modification unless a principal purpose of the transaction giving rise 
to the modification is the avoidance of Federal income tax. In 
determining whether a principal purpose of the transaction giving rise 
to the modification is the avoidance of Federal income tax--
    (A) The safe harbors and other principles of Sec. 1.467-3(c) are 
taken into account; and
    (B) The Commissioner may treat the post-modification agreement as a 
new agreement or treat the entire agreement (as modified) as a single 
agreement.
    (ii) Exception. Notwithstanding the provisions of paragraph 
(f)(7)(i) of this section, the continuing lessor and the new lessee (in 
the case of a substitution of a new lessee) or the new lessor and the 
continuing lessee (in the case of a sale, exchange, or other disposition 
by a lessor of property subject to a rental agreement) may, in 
appropriate cases, request the Commissioner to treat the transaction as 
if it were a substantial modification in order to have the provisions of 
paragraph (f)(4)(iii) of this section and Sec. 1.467-7(g)(1) apply to 
the transaction.
    (g) Treatment of amounts payable by lessor to lessee--(1) Interest. 
For purposes of determining present value, any amounts payable by the 
lessor to the lessee as interest on prepaid rent are treated as negative 
amounts.
    (2) Other amounts. [Reserved]
    (h) Meaning of terms. The following meanings apply for purposes of 
this section and Sec. Sec. 1.467-2 through 1.467-9:
    (1) Agreement date means the earlier of the lease date or the first 
date on which there is a binding written contract that substantially 
sets forth the terms under which the property will be leased.
    (2) Contingent rent means any rent that is not fixed rent, including 
any amount reflecting an adjustment based on a reasonable price index 
(as defined in paragraph (h)(10) of this section) or a variable interest 
rate provision (as defined in paragraph (h)(16) of this section).
    (3) Fixed rent means any rent to the extent its amount and the time 
at which it is required to be paid are fixed and determinable under the 
terms of the rental agreement as of the lease date. The following rules 
apply for the purpose of determining the extent to which rent is fixed 
rent:
    (i) The possibility of a breach, default, or other early termination 
of the rental agreement and any adjustments based on a reasonable price 
index or a variable interest rate provision are disregarded.
    (ii) Rent will not fail to be treated as fixed rent merely because 
of the possibility of impairment by insolvency, bankruptcy, or other 
similar circumstances.
    (iii) If the lease term (as defined in paragraph (h)(6) of this 
section) includes one or more periods as to which either the lessor or 
the lessee has an option to renew or extend the term of the agreement, 
rent will not fail to be treated as fixed rent merely because the option 
has not been exercised.
    (iv) If the lease term includes one or more periods during which a 
substitute lessee or lessor may have use of the property, rent will not 
fail to be treated as fixed rent merely because the contingencies 
relating to the obligation of the lessee (or a related person) to make 
payments in the nature of rent have not occurred.
    (v) If either the lessor or the lessee has an unconditional option 
or options, exercisable on one or more dates during the lease term, 
that, if exercised, require payments of rent to be made under an 
alternative payment schedule

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or schedules, the amount of fixed rent and the dates on which such rent 
is required to be paid are determined on the basis of the payment 
schedule that, as of the agreement date, is most likely to occur. If 
payments of rent are made under an alternative payment schedule that 
differs from the payment schedule assumed in applying the preceding 
sentence, then, for purposes of paragraph (f) of this section, the 
rental agreement is treated as having been modified at the time the 
option to make payments on such alternative schedule is exercised.
    (4) Late payment charge means any amount required to be paid by the 
lessee to the lessor as additional compensation for the lessee's failure 
to make any payment of rent under a rental agreement when due.
    (5) Lease date means the date on which the lessee first has the 
right to use of the property that is the subject of the rental 
agreement.
    (6) Lease term means the period during which the lessee has use of 
the property subject to the rental agreement, including any option of 
the lessor to renew or extend the term of the agreement. An option of 
the lessee to renew or extend the term of the agreement is included in 
the lease term only if it is expected, as of the agreement date, that 
the option will be exercised. For this purpose, a lessee is generally 
expected to exercise an option if, for example, as of the agreement date 
the rent for the option period is less than the expected fair market 
value rental for such period. The lessor's or lessee's determination 
that an option period is either included in or excluded from the lease 
term is not binding on the Commissioner. If the lessee (or a related 
person) agrees that one or both of them will or could be obligated to 
make payments in the nature of rent (within the meaning of Sec. 
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 Sec. 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 Sec. 
1.467-9(a) and is entered into on or before March 6, 2001.
    (7) A loss payment provision means a provision that requires the 
lessee to pay the lessor a sum of money (which may be either a 
stipulated amount or an amount determined by reference to a formula or 
other objective measure) if the property subject to the rental agreement 
is lost, stolen, damaged or destroyed, or otherwise rendered unsuitable 
for any use (other than for scrap purposes).
    (8) A qualified percentage rents provision means a provision 
pursuant to which the rent is equal to a fixed percentage of the 
lessee's receipts or sales (whether or not receipts or sales are 
adjusted for returned merchandise or Federal, state, or local sales 
taxes), but only if the percentage does not vary throughout the lease 
term. A provision will not fail to be treated as a qualified percentage 
rents provision solely by reason of one or more of the following 
additional terms:
    (i) Differing percentages of receipts or sales apply to different 
departments or separate floors of a retail store, but only if the 
percentage applicable to a particular department or floor does not vary 
throughout the lease term.
    (ii) The percentage is applied to receipts or sales in excess of 
determinable dollar amounts, but only if the determinable dollar amounts 
are fixed and do not vary throughout the lease term.
    (9) A qualified TRAC provision means a terminal rental adjustment 
clause (as defined in section 7701(h)(3)) contained in a qualified motor 
vehicle operating agreement (as defined in section 7701(h)(2)), but only 
if the adjustment to the rental price is based on a reasonable estimate, 
determined as of any date between the agreement date and the lease date 
(or, in the event the agreement date is the same as or later than the 
lease date, determined as of the agreement date), of the fair market 
value of the motor vehicle (including any trailer) at the end of the 
lease term.

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    (10) An adjustment is based on a reasonable price index if the 
adjustment reflects inflation or deflation occurring over a period 
during the lease term and is determined consistently under a generally 
recognized index for measuring inflation or deflation (for example, the 
non-seasonally adjusted U.S. City Average All Items Consumer Price Index 
for All Urban Consumers (CPI-U), which is published by the Bureau of 
Labor Statistics of the Department of Labor). An adjustment will not 
fail to be treated as one that is based on a reasonable price index 
merely because the adjustment may be limited to a fixed percentage, but 
only if the parties reasonably expect, as of any date between the 
agreement date and the lease date (or, in the event the agreement date 
is the same as the lease date, as of such date), that the fixed 
percentage will actually limit the amount of the rent payable during 
less than 50 percent of the lease term.
    (11) For purposes of determining whether a section 467 rental 
agreement is a leaseback within the meaning of Sec. 1.467-3(b)(2), two 
persons are related persons if they are related persons within the 
meaning of section 465(b)(3)(C). In all other cases, two persons are 
related persons if they either have a relationship to each other that is 
specified in section 267(b) or section 707(b)(1) or are related entities 
within the meaning of sections 168(h)(4)(A), (B), or (C).
    (12) Rental agreement includes any agreement, whether written or 
oral, that provides for the use of tangible property and is treated as a 
lease for Federal income tax purposes.
    (13) A residual condition provision means a provision in a rental 
agreement that requires a payment to be made by either the lessor or the 
lessee to the other party based on the difference between the actual 
condition of the property subject to the agreement, determined as of the 
expiration of the lease term, and the expected condition of the property 
at the expiration of the lease term, as set forth in the rental 
agreement. The amount of any such payment may be determined by reference 
to any objective measure relating to the use or condition of the 
property, such as miles, hours or other duration of use, units of 
production, or similar measure. A provision will be treated as a 
residual condition provision only if the payment represents compensation 
for the use of, or wear and tear on, the property in excess of, or 
below, a standard set forth in the rental agreement, and the standard is 
reasonably expected, as of any date between the agreement date and the 
lease date (or, in the event the agreement date is the same as or later 
than the lease date, as of the agreement date), to be met at the 
expiration of the lease term.
    (14) A tax indemnity provision means a provision in a rental 
agreement that may require the lessee to make one or more payments to 
the lessor in the event that the Federal, foreign, state, or local 
income tax consequences actually realized by a lessor from owning the 
property subject to the rental agreement and leasing it to the lessee 
differ from the consequences reasonably expected by the lessor, but only 
if the differences in such consequences result from a misrepresentation, 
act, or failure to act on the part of the lessee, or any other factor 
not within the control of the lessor or any related person.
    (15) Third-party costs include any real estate taxes, insurance 
premiums, maintenance costs, and any other costs (excluding a debt 
service cost) that relate to the leased property and are not within the 
control of the lessor or lessee or any person related to the lessor or 
lessee.
    (16) A variable interest rate provision means a provision in a 
rental agreement that requires the rent payable by the lessee to the 
lessor to be adjusted by the dollar amount of changes in the amount of 
interest payable by the lessor on any indebtedness that was incurred to 
acquire the property subject to the rental agreement (or any refinancing 
thereof), but--
    (i) Only to the extent the changes are attributable to changes in 
the interest rate; and
    (ii) Only if the indebtedness provides for interest at one or more 
qualified floating rates (within the meaning of Sec. 1.1275-5(b)), or 
the changes are attributable to a refinancing at a fixed rate or one or 
more qualified floating rates.

[[Page 306]]

    (i) [Reserved]
    (j) Computational rules. For purposes of this section and Sec. Sec. 
1.467-2 through 1.467-9, the following rules apply--
    (1) Counting conventions. Any reasonable counting convention may be 
used (for example, 30 days per month/360 days per year) to determine the 
length of a rental period or to perform any computation. Rental periods 
of the same descriptive length, for example annual, semiannual, 
quarterly, or monthly, may be treated as being of equal length.
    (2) Conventions regarding timing of rent and payments--(i) In 
general. For purposes of determining present values and yield only, 
except as otherwise provided in this section and Sec. Sec. 1.467-2 
through 1.467-8--
    (A) The rent allocated to a rental period is taken into account on 
the last day of the rental period;
    (B) Any amount payable during the first half of the first rental 
period is treated as payable on the first day of that rental period;
    (C) Any amount payable during the first half of any other rental 
period is treated as payable on the last day of the preceding rental 
period;
    (D) Any amount payable during the second half of a rental period is 
treated as payable on the last day of the rental period; and
    (E) Any amount payable at the midpoint of a rental period is 
treated, in applying this paragraph (j)(2), as an amount payable during 
the first half of the rental period.
    (ii) Time amount is payable. For purposes of this section and 
Sec. Sec. 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 Sec. 1.467-9(a) and is entered into on 
or before March 6, 2001.
    (3) Annualized fixed rent. Annualized fixed rent is determined by 
multiplying the fixed rent allocated to the rental period under 
paragraph (c)(2)(ii) of this section by the number of periods of the 
rental period's length in a calendar year. Thus, if the fixed rent 
allocated to a rental period is $10,000 and the rental period is one 
month, the annualized fixed rent for that rental period is $120,000 
($10,000 times 12).
    (4) Allocation of fixed rent within a period. A rental agreement 
that allocates fixed rent to any period is treated as allocating fixed 
rent ratably within that period. Thus, if a rental agreement provides 
that $120,000 is allocated to each calendar year in the lease term, 
$10,000 of rent is allocated to each calendar month.
    (5) Rental period length. Except as provided in Sec. 1.467-3(d)(1) 
(relating to agreements for which constant rental accrual is required), 
rental periods may be of any length, may vary in length, and may be 
different as between the lessor and the lessee as long as--
    (i) The rental periods are one year or less, cover the entire lease 
term, and do not overlap;
    (ii) Each scheduled payment under the rental agreement (other than a 
payment scheduled to occur before or after the lease term) occurs within 
30 days of the beginning or end of a rental period; and
    (iii) In the case of a rental agreement that does not provide a 
specific allocation of fixed rent, the rental periods selected do not 
cause the agreement to be treated as a section 467 rental agreement 
unless all alternative rental period schedules would result in such 
treatment.

[T.D. 8820, 64 FR 26853, May 18, 1999, as amended by T.D. 8917, 66 FR 
1039, Jan. 5, 2001]