IRS Section 467 loan structuring techniques are commonly used today as powerful leveraged lease structuring approaches that can greatly improve a transaction’s economics. Ivory Consulting founder Chris Ivory provides insight into the use of a 467 loan.
One of the best ways to conceptualize a 467 loan is with an example of a new solar facility. Solar facilities have highly accelerated rent because they produce more revenue early in their lives. When we structure a lease that reflects the highly accelerated nature of a solar facility, it fails the IRS Uneven Rent Test.
IRS Section 467 loan structuring techniques are commonly used today as powerful leveraged lease structuring approaches that can greatly improve a transaction’s economics.
Let’s consider a hypothetical lease over a seven year period with a funding date of August 21, 2015, equipment cost of $1 million and a residual value of 12.5%. There is a 2% fee expense and the Federal tax depreciation basis is 85%. There is a 30% federal tax credit. The lessee has the following locked quarterly payments: two payments of $110,000, four payments of $60,000, six payments of $20,000, eight payments of $10,000, and eight payments of $5,000.
Let’s take a look at the IRS uneven rent test.
These parameters fail the uneven rent test badly. Note the highly accelerated rent structure of this example.
What is the Lessor Supposed to Do?
Thank goodness for the IRS 1999 tax ruling with its Section 467 that allows cash rent to be taken into Federal income any time in a three year window: the prior year, the current year or the following year. This ruling provides some relief to the lessor, but it is not enough.
The 467 Loan Structure Saves the Day
The “467 loan” allows lessors to create a structure to pass the uneven rent test.
This structure introduces rent payments referred to as 467 loan rent payments. These payments are exactly matched by 467 loan debt service payment.
Negative “467 loan” rent payments are from the lessor to the lessee.
Positive “467 Loan” rent payments are from the lessee to the lessor.
Positive “467 Loan” debt service payments are from the lessor to the lessee.
Negative “467 Loan” debt service payments are the lessee lending money to the lessor.
Negative “467 Loan” debt service payments increase the loan balance.
Positive “467 Loan” debt service payments reduce the loan balance.
It may appear counter-intuitive for the lessor to pay rent to the lessee and for the lessee to lend money to the lessor.
The cash flow report helps us to understand how this works:
Applying a 467 Loan Gives Favorable Results
Without the 467 loan this lease failed the IRS uneven rent test and had a yield with taxes of 7.0326%. With the 467 loan structure, this lease passes the uneven rent test and shows a yield with taxes of 9.6650%, an increase of 2.6324%.
The yield is enhanced solely through the timing of the lessor’s tax payments.
The 467 Loan Structure
The original rent payments are highly accelerated.
The addition of the 467 loan rent payments: They are negative in the first three years, and positive in the last five years.
The addition of the 467 loan debt service payments: They are positive in the first three years, and negative in the last five years.
The uneven rent test now passes at the limit in most years.
The lease now passes the prepaid deferred test at the limit in most years:
Some investors are not comfortable with the three-year window. To address this, the 467 loan can be structured such that the cash rents match the allocated rents each year. In this case the yield drops .0703%, from 9.6650% to 9.5947%, still a large yield enhancement above the 7.0326% original yield, and the lease still passes the uneven rent test.
467 Loan Structuring Enhances the Yield – Why Not Apply it to Every Lease?
In this hypothetical lease the 467 loan structure not only allows the lease to pass the IRS uneven rent test, but it also increases the yield. We then ask ourselves if we can apply it to other leases and increase their yields as well. Unfortunately, if an original lease is already structured at the 90% limit in the early years, then the 467 loan will likely have little benefit. However, it may help if the original lease is not bound by the 90% test in the early years. For example, in a 10-year lease with level locked rents, the lessor’s yield can be increased from 6.0% to 6.1325% by using a 3-year window, and to 6.1506% with a 467 loan.
The 467 loan structure is an excellent tool to allow leases to pass the Uneven Rent Test while enhancing the yield. Leases already passing the uneven rent test at the 90/110 limits cannot receive a yield enhancement from a 467 loan structuring. The best way to enhance yield for leases already at the 90/110 limit is the 3-year window. Perhaps this technique can prove useful in your lease structuring.
Chris Ivory founded Ivory in 1983 with the idea of building lease analysis software on PCs. His programming skills and knowledge of leasing resulted in the software application known in the equipment finance industry as “SuperTRUMP.” His days are spent deep within the software code making sure SuperTRUMP standard and custom versions give the right numbers every time. When he takes a breather from programming, he is always open for a quick 10-minute chess match using the chess set right outside his office door. Chris earned an M.B.A. from the University of Rhode Island and a B.S. in Mathematics from Brigham Young University.
Some sales tax concepts for the leasing industry are simple; others are more complicated. Brian Greer, Partner and CRO at TaxConnex, gives some context to the more complex terms and offers advice on managing tax obligations.
Vice President of Technology and Data Analytics ,
Corcentric Fleet Solutions
Frank Bussone, vice president of technology and date analytics at Corecentric Fleet Solutions talks shop on employing customized structures when setting up a lease agreement. Learn how to avoid overpaying with this insider look at utilizing analytics to their maximum potential.