[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: 26CFR1.467-5] [Page 318-320] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) PART 1_INCOME TAXES--Table of Contents Sec. 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 rent and interest in the case of section 467 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 Sec. 1.1275-5(a)(3)(i)(A) or (B) and (a)(4). If a section 467 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 rental agreements that provide adequate interest under Sec. 1.467-2(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) do not apply to rental agreements subject to constant rental accrual under Sec. 1.467-3. (b) Variable rate treated as fixed--(1) In general. If a section 467 rental agreement provides variable interest-- (i) The 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 on deferred or prepaid fixed rent provided by the rental agreement must be used in computing the proportional rental amount under Sec. 1.467-2(c), the constant rental amount under Sec. 1.467-3(d), the principal balance of a section 467 loan under Sec. 1.467-4(b), and the yield of a section 467 loan under Sec. 1.467-4(c); and (ii) The interest on fixed rent for any rental period is equal to the amount that would be determined under Sec. 1.467-1(e)(2) if the section 467 rental agreement did not provide variable interest, using the fixed rate substitutes determined under paragraph (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) 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, would have accrued during the rental period under the terms of the section 467 rental agreement; and (B) The amount of interest that, without regard to section 467, would have accrued during the rental period under the terms of the section 467 rental agreement using the fixed rate substitutes determined under paragraph (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) of this section is greater than the amount determined under paragraph (b)(2)(i)(B) of this section, the variable interest adjustment amount is positive. If the amount determined under paragraph (b)(2)(i)(A) of this section is less than the amount determined under paragraph (b)(2)(i)(B) of this section, the variable interest adjustment amount is negative. [[Page 319]] (3) Section 467 loan balance. The variable interest adjustment amount is not taken into account in determining the principal balance of a section 467 loan under Sec. 1.467-4(b). Instead, the section 467 loan balance is computed as if all amounts payable under the section 467 rental agreement were based on the fixed rate substitutes determined under paragraph (b)(1)(i) of this section. (c) Examples. The following examples illustrate the application of this section: Example 1. (i) X and Y enter into a section 467 rental agreement for the lease of personal property beginning on January 1, 2000, and ending on December 31, 2002. The rental agreement allocates $100,000 of rent to 2000, $200,000 to 2001, and $100,000 to 2002, and requires the lessee to pay all $400,000 of rent on December 31, 2002. The rental agreement requires the accrual of interest on unpaid accrued rent at two different qualified floating rates (as defined in Sec. 1.1275-5(b)), one for 2001 and the other for 2002, such interest to be paid on December 31 of the year it accrues. The rental agreement provides that the qualified floating rate is set at a current value within the meaning of Sec. 1.1275-5(a)(4). Assume that on the agreement date, 110 percent of the applicable Federal rate is 10 percent, compounded annually. Assume also that the agreement is not a leaseback or long-term agreement and, therefore, is not subject to constant rental accrual. (ii) To determine if the section 467 rental agreement provides for adequate interest under Sec. 1.467-2(b), Sec. 1.467-2(b)(2) requires the use of fixed rate substitutes (in this example determined in the same manner as under Sec. 1.1275-5(e)(3)(i) treating the agreement date as the issue date) in place of the variable rates called for by the rental agreement. Assume that on the agreement date the qualified floating rates, and therefore the fixed rate substitutes, relating to 2001 and 2002 are 10 and 15 percent compounded annually. Taking into account the fixed rate substitutes, the sum of the present values of all amounts payable by the lessee as fixed rent and interest thereon is greater than the sum of the present values of the fixed rent allocated to each rental period. Accordingly, the rental agreement provides adequate interest under Sec. 1.467-2(b)(1)(iii) and the fixed rent accruing in each calendar year during the rental agreement is the fixed rent allocated under the rental agreement. (iii) Because the section 467 rental agreement provides for variable interest on unpaid accrued fixed rent at qualified floating rates and the qualified floating rates are set at a current value, the requirements of Sec. 1.1275-5(a)(3)(i)(A) and (4) are met and the rental agreement provides for variable interest within the meaning of paragraph (a)(1) of this section. Therefore, under paragraph (b)(1)(i) of this section, the yield of the section 467 loan is computed based on the fixed rate substitutes. Under Sec. 1.467-4(c), the constant yield (rounded to two decimal places) equals 13.63 percent compounded annually. Based on the fixed rate substitutes, the fixed rent, interest on fixed rent, and the principal balance of the section 467 loan, for each calendar year during the lease term, are as follows: ---------------------------------------------------------------------------------------------------------------- Accrued Projected Cumulative Accrued rent interest payment loan ---------------------------------------------------------------------------------------------------------------- 2000........................................... $100,000 $0 $0 $100,000 2001........................................... 200,000 13,630 (10,000) 303,630 2002........................................... 100,000 41,370 (445,000) 0 ---------------------------------------------------------------------------------------------------------------- (iv) To compute the actual reported interest on fixed rent for each calendar year, the variable interest adjustment amount, as described in paragraph (b)(2) of this section, must be added to the accrued interest determined in paragraph (iii) of this Example 1. Assume that the variable rates for 2001 and 2002 are actually 11 and 14 percent, respectively. Without regard to section 467, the interest that would have accrued during each calendar year under the terms of the section 467 rental agreement, and the interest that would have accrued under the terms of the rental agreement using the fixed rate substitutes determined under paragraph (b)(1)(i) of this section are as follows: ------------------------------------------------------------------------ Accrued Accrued interest under interest using rental fixed rate agreement substitutes ------------------------------------------------------------------------ 2000.................................. $0 $0 2001.................................. 11,000 10,000 2002.................................. 42,000 45,000 ------------------------------------------------------------------------ (v) Under paragraph (b)(2) of this section, the variable interest adjustment amount is $1,000 ($11,000-$10,000) for 2001 and is -$3,000 ($42,000-$45,000) for 2002. Thus, under paragraph (b)(1)(ii) of this section, the actual interest on fixed rent for 2001 is $14,630 ($13,630 + $1,000) and for 2002 is $38,370 ($41,370-$3,000). [[Page 320]] Example 2. (i) The facts are the same as in Example 1 except that 110 percent of the applicable Federal rate is 15 percent compounded annually and the section 467 rental agreement does not provide adequate interest under Sec. 1.467-2(b). Consequently, the fixed rent for each calendar year during the lease is the proportional rental amount. (ii) The sum of the present values of the fixed rent provided for each calendar year during the lease term, discounted at 15 percent compounded annually, equals $303,936.87. (iii)(A) Paragraph (b)(1)(i) of this section requires the proportional rental amount to be computed based on the assumption that interest will accrue and be paid based on the fixed rate substitutes. Thus, the sum of the present values of the projected payments under the section 467 rental agreement equals $300,156.16, computed as follows: [GRAPHIC] [TIFF OMITTED] TR18MY99.005 (B) The fraction for computing the proportional rental amount equals .9875609 ($300,156.16/$303,936.87). (iv) Based on the fixed rate substitutes, the fixed rent, interest on fixed rent, and the balance of the section 467 loan for each calendar year during the lease term are as follows: ---------------------------------------------------------------------------------------------------------------- Proportional Accrued Projected Cumulative rent interest payment loan ---------------------------------------------------------------------------------------------------------------- 2000........................................... $98,756.09 $0.00 $0 $98,756.09 2001........................................... 197,512.18 14,813.41 (10,000) 301,081.68 2002........................................... 98,756.09 45,162.23 (445,000) 0.00 ---------------------------------------------------------------------------------------------------------------- (v) The variable interest adjustment amount in this example is the same as in Example 1. Under paragraph (b)(1)(ii) of this section, the actual interest on fixed rent for 2001 is $15,813.41 ($14,813.41 + $1,000) and for 2002 is $42,162.23 ($45,162.23-$3,000). [T.D. 8820, 64 FR 26865, May 18, 1999]