Attack on tax-exempt leasing structure.

Prop. Regs. Sec. 1.168(i)-2 targets gets a commonly used tax-exempt leasing structure known as an "accelerator" or "replacement lease." Under the 1984 Pickle-Dole legislation, property leased to a tax-exempt entity (including foreign entities) must be depreciated over a recovery period not less than 125% of the lease term. To create the effect of shortening (or accelerating) the recovery period, transactions economically based on a longer period (e.g., 20 years) were structured with a shorter base term (e.g., 10 years), coupled with a financial obligation of the lessee at the expiration of the lease term to (1) purchase the asset at a predetermined price estimated to equal or exceed its then fair market value; (2) make a termination payment (or provide a limited residual loss guarantee); or (3) arrange for another party with acceptable credit to enter into a "replacement lease" containing certain specified minimum economic terms.

Under the proposed regulations, the term of the lease for purposes of determining the applicable recovery period includes any period of time with respect to which a lessee (or a party related to the lessee) retains a financial obligation to make a payment of rent or a payment in the nature of rent (including a payment intended to substitute for rent or to fund or supplement the rental payment of another). Accordingly, the proposed regulation would include the term of any potential replacement lease for purposes of determining the applicable recovery period. Comments have been submitted to Treasury to exclude from the scope of the final regulations transactions using a replacement lease structure when the nature of the economic investment and risks differ from a full payout lease over the longer term.

Pursuant to the proposed regulations, the effective date would be April 20, 1995 (for all leases entered into on or after that date).

From Jay H. Zukerman, Esq., Washington, D.C.