Rent Holidays No Picnic for Lessors

By Fiore, Nicholas J. | Journal of Accountancy, July 1992 | Go to article overview

Rent Holidays No Picnic for Lessors


Fiore, Nicholas J., Journal of Accountancy


Given the state of today's real estate market, lessors have to resort to various strategies to get people to lease property. However, some inducements, such as rent holidays or stepped rent (in which the rents paid increase in succeeding years), will cause rental agreements to fall within the purview of section 467.

Section 467 was part of the Tax Reform Act of 1984 and was designed to keep taxpayers from exploiting rental arrangements in which most (or all) of the payments are due in later years. Previously, a cash basis lessor could defer income until payment was received, while an accrual basis lessee could deduct an amount for rent properly allocable to each year of the lease (even though the amount was not payable until a later year). Not only was the lessor allowed to defer income, but he or she also could convert ordinary income into capital gain, if the property (or lease) was sold at a price reflecting the higher rents due in the later years. To do away with this perceived abuse, Congress enacted rules requiring rent charged in a deferred arrangement to be "leveled" over the length of the agreement.

SECTION 467 AGREEMENT DEFINED

A section 467 agreement is any rental agreement for the use of tangible property (real or personal) in which either

* Rent is deferred for more than one year and is stated as being allocable to a specific calendar year.

* There is increasing (or decreasing) rent.

These provisions apply only to rental agreements with total payments (cash plus the fair market value of property) that exceed $250,000.

TAX TREATMENT

Generally, if a lease comes under section 467, the lessor and the lessee must account for the rental income and deductions in accordance with the lease terms. If any rental payments are due after the end of a rental period, interest must be attributed to these payments on a present value basis; as such, a portion of the lease payments may be recharacterized as interest over the lease term. (Regulations will provide different methods for determining this amount, depending on the type of lease involved. ) The total amount of rent and interest recognized for the entire lease term should equal the total amount of payments under the lease.

This rent accrual is treated as any other debt owed by an accrual basis taxpayer. Thus, both lessors and lessees will be subject to the rules governing bad debt deductions, discharge of indebtedness and the tax benefit rule. …

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