Economic benefit from below-market financing can be amortizable asset.

• Author: Levy, Marc

In Federal Home Loan Mortgage Corp., 121 TC No. 13 (2003), the Tax Court held, as a matter of law, that the economic benefit from below-market financing can be an amortizable intangible asset, if the taxpayer can establish a fair market value (FMV) and limited useful life.

Facts

Under the Deficit Reduction Act of 1984 (DRA), Congress revoked the Federal Home Loan Mortgage Corp.'s (Freddie Mac's) tax-exempt status, effective Jan. 1, 1985. Freddie Mac held a number of financing arrangements (favorable financing) on Jan. 1, 1985, with interest rates payable lower than that date's prevailing market rate. The financing arrangements consisted essentially of issuances of (1) notes and bonds payable; (2) subordinated debt (capital debentures and zero-coupon bonds); (3) collateralized mortgage obligations; and (4) guaranteed mortgage certificates. The favorable financing asset, according to Freddie Mac, is the difference between the net present value of future cashflows computed at market rates as of Jan. 1, 1985, and the net present value of future cashflows for each respective instrument at its contract rate.

The DRA contained a specific adjusted basis for determining gain on the sale or other disposition of property Freddie Mac held on Jan. 1, 1985. Under DRA Section 177(d)(2)(A)(ii), the adjusted basis of any asset shall "for purposes of determining any gain, be equal to the higher of the adjusted basis of such asset or the fair market value of such asset as of such date." In a previous opinion, Federal Home Loan Mortgage Corp., 121 TC No. 8 (2003), the Tax Court held that under DRA Section 177(d)(2)(A)(ii), Freddie Mac's adjusted basis for purposes of determining Sec. 167 amortization of intangible assets held on Jan 1, 1985, was their respective FMVs on that date.

In the opinion discussed below, the Tax Court considered Freddie Mac's position that the FMV of the below-market financing in place on Jan. 1, 1985, was an intangible asset amortizable under Sec. 167. The asset's FMV is the difference between the market cost of using the borrowed money and its below-market cost. The IRS argued that the favorable financing arose from fortuitous interest rate fluctuations, is not an asset and is not amortizable as a matter of law.

Law and Analysis

Sec. 167(a) allows a depreciation deduction for property used in a trade or business or held for the production of income. For an intangible asset to be amortizable under Sec. 167(a), the taxpayer must prove...