Proposed regulations on "sec. 467 rental agreements."

• Author: Corrick, Stephen R.

Proposed regulations under Sec. 467 would require both parties (lessor and lessee) to a "Sec. 467 rental agreement" to accrue rental income and expense, regardless of either party's regular accounting method. The proposed regulations apply to rental agreements with total payments in excess of $250,000, when the agreement does not specify equal amounts of rent throughout the term or the rent payments are deferred or prepaid. Rent adjustments based on a reasonable price index, or on the lessee's obligation to pay taxes, insurance and maintenance on the property, may be disregarded in determining total payments.

For rental agreements with total payments of $2 million or less (determined on the same basis discussed above), when all payments are due in the year to which the rent relates, or in the preceding or subsequent year, the only effect of Sec. 467 is to require that the rent be taken into account in the tax year to which it relates. If the rent has a greater prepayment or deferral, the regulations require interest to be imputed, but generally do not require rent to be leveled. For disqualified leasebacks or long-term agreements that have a principal purpose of tax avoidance, the Service may impose rent-leveling. Taxpayers may not apply the rent-leveling rules to themselves.

Sec. 467 Rental Agreement

Defined

Sec. 467 defines a Sec. 467 rental agreement as any rental agreement for the use of tangible property with total payments aggregating more than $250,000, in which there are increases in the amount to be paid under the agreement or there is deferred rent. The proposed regulations expand Sec. 467 to agreements calling for prepaid rent or decreases in the amounts to be paid under the agreement, thus broadening the universe of rental agreements subject to the mandatory accrual method of accounting.

The proposed regulations would provide limited relief from the definition of a Sec. 467 rental agreement by permitting rent holidays of three months or less to be ignored in determining whether there is increasing or decreasing rent.

A rental agreement characterized as a Sec. 467 rental agreement affects how and when the parties take into account the rental payments anticipated by the lease. The characterization may also affect the nature of any gain if the lessor disposes of the leased property before the lease terminates. There are three possible rent-recognition methods that may apply to a Sec. 467 rental agreement: 1. "According to the...