Sec. 467 leases and proper structuring for deferral purposes.

• Author: Sobochan, David

The commercial real estate market boom continues to provide opportunities for tax planning, specifically in the area of lease structuring. Careful planning and documentation in the lease agreement is the key to income deferral, but practitioners need to be aware that the IRS's interpretation of Sec. 467 is stricter than once thought.

Income Recognition Under Secs. 451, 61, and 467

Regs. Sec. 1.451-1(a) requires income to be accrued when all the events have occurred that fix the right to receive the income and the amount can be determined with reasonable accuracy. Regs. Sec. 1.61-8(b) provides that gross income includes advance rentals and cancellation payments, which must be included in income in the year of receipt regardless of the period covered or the method of accounting employed by the taxpayer. This rule essentially puts income recognition for advance rentals and lease termination payments on a cash basis; however, both Secs. 451 and 61 provide an exception to the general rule when a Sec. 467 rental agreement is present.

Sec. 467 Rental Agreements

A Sec. 467 rental agreement is an agreement for the use of tangible property where the aggregate amount of payments received as consideration for use of the property and the aggregate value of any other consideration to be received for the use of the property exceeds $250,000, and that has increasing, decreasing, prepaid, or deferred rents.

A rental agreement has increasing or decreasing rent if the annualized fixed rent allocated to a rental period exceeds the annualized fixed rent allocated to any other rental period. A rental agreement has deferred rent if the cumulative amount of rent allocated as of the close of a calendar year exceeds the cumulative amount of rent payable as of the close of the succeeding calendar year. A rental agreement has prepaid rent if the cumulative amount of rent payable during the year exceeds the cumulative amount of rent allocated as of the close of the succeeding calendar year.

Allocating Fixed Rent

Regs. Sec. 1.467-1(c)(2)(ii) provides two methods for allocating fixed rent to a rental period. This is important in determining whether a rental agreement has increasing, decreasing, prepaid, or deferred rents. If a rental agreement clearly specifies for periods no longer than a year a fixed amount of rent for which the lessee becomes liable, then the amount of fixed rent allocated to the rental period is the amount of rent indicated in the agreement. If there...