Lease termination term defeats rent allocation schedule

Plain-English summary

Chief Counsel considered whether a rental agreement made a specific allocation of fixed rent under IRC § 467. The lease stated that any termination would reduce the section 467 loan balance to zero and fully discharge it. Chief Counsel concluded that this term showed the allocation schedule did not represent the rent for which the lessee actually became liable for using the property. Because the schedule failed the requirements of Treas. Reg. § 1.467-1(c)(2)(ii)(A)(2), the taxpayer should account for rent using the payment schedule instead.

Ruling snapshot

• Question: Does a lease specifically allocate fixed rent when termination discharges the entire section 467 loan balance?
• Outcome: Advice given
• Key authorities: IRC § 467; Treas. Reg. §§ 1.467-1(c)(2)(ii)(A)(2), 1.467-4

Full text (IRS public release)

ID: CCA_2015101912193322 [Third Party Communication: None

UILC: 467.01-00 Date of Communication: ------------------------

Number: 201549027
Release Date: 12/4/2015
From:
Sent: Monday, October 19, 2015 12:19:33 PM
To:
Cc:
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Subject: Section 467 analysis

This addresses the question of whether a rental agreement contains a specific
allocation of rent for purposes of § 467.

Issue:

Does a taxpayer’s § 467 rental agreement provide a specific allocation of fixed rent if it
includes a provision stating that the § 467 loan balance is reduced to zero upon any
termination of the lease?

Discussion:

Taxpayers subject to § 467 of the Internal Revenue Code must account for fixed rent
using one of the methods prescribed in the regulations under § 467. Unless a taxpayer
is required to use constant rental accrual or proportional rental accrual, the taxpayer
must take fixed rent into account in accordance with the manner in which rent is
allocated in the rental agreement. If a taxpayer has a specific allocation of fixed rent in
its rental agreement that meets the requirements of § 1.467-1(c)(2)(ii)(A)(2), the
taxpayer’s rent allocation schedule is used to determine the rent allocated under the
rental agreement (i.e., the rent the taxpayer takes into account for a taxable year). If
there is no specific allocation of rent, the taxpayer uses the payment schedule to
account for rent.

Section 1.467-1(c)(2)(ii)(A)(2) provides as follows:

     [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. A rental agreement stating only
     when rent is payable does not specifically allocate rent.
                                         2

Thus, under §1.467-1(c)(2)(ii)(A)(2), the rent allocation must be meaningful – it must
actually represent the amount of rent for which the lessee is liable for using the
property. The allocation does not meet the requirements of § 1.467-1(c)(2)(ii)(A)(2) if its
sole purpose is to dictate the tax consequences to the lessee and lessor. If the rental
agreement provides that the rent allocation exists only for tax purposes, it does not
meet the requirements of § 1.467-1(c)(2)(ii)(A)(2) because it does not represent
amounts for which the lessee becomes liable on account of the use of the property
during that period.

A rental agreement provides the following term: Upon any termination of this lease, the
balance of the section 467 Loan is reduced to zero and is fully discharged for all
purposes. In our view, this provision means that the allocation schedule fails to
represent the amount of rent for which the lessee becomes liable on account of the use
of the property. Thus the allocation schedule does not meet the requirements of §
1.467-1(c)(2)(ii)(A)(2).

Under § 1.467-4, a taxpayer has a § 467 loan under certain circumstances. The
taxpayer’s § 467 loan is equal to the difference between the payments under the rental
agreement and the allocations under the agreement. If the payments are more than the
allocations, the lessee is considered to have made a loan to the lessor. If the
allocations exceed the payments, the lessor has made a loan to the lessee. If the loan
balance is reduced to zero and fully discharged upon termination of the lease, the
payment schedule and not the allocation schedule represents the amount of rent for
which the lessee becomes liable on account of the use of the property. Consequently, if
a rental agreement includes a provision stating that the balance of the loan is reduced
to zero and fully discharged for all purposes upon any termination of the lease, the
allocation schedule does not meet the requirements of § 1.467-1(c)(2)(ii)(A)(2). In that
case, the taxpayer should be accounting for its rents in accordance with the rent
payment schedule in the rental agreement.