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IRS attacks leasing transactions.

The IRS recently announced it will use all the tools at its disposal to allocate gross income, deductions, credits or allowances between parties as appropriate in certain "lease strips" or "stripping transactions." These transactions are ones that separate the income from property or service contracts from the deductions related to that income.

The Service has stated that it will issue regulations to implement this position and that the regulations will apply to stripping transactions undertaken on or after Oct. 13, 1995.


The IRS will challenge transactions intended to allow one party to realize income from property or service contracts and another to report deductions related to that income. Transactions such as this are referred to as "lease strips" or "stripping transactions." These stripping transactions often provide for the transfer of tax benefits from exempt entities to taxpayers in a position to exploit them.

Notice 95-53 covers a variety of stripping transactions, including:

* Stripping transactions effected through a transferred basis transaction.

* Stripping transactions effected through a transfer of an interest in a partnership (or other passthrough entity).

* Other variations of stripping transactions that could involve licenses of intangible property; service contracts; leaseholds; or prepayment, front-loading, or retention of rights to receive future payments.

The Service intends to exercise its authority under Sec. 482 to reallocate gross income, deductions, credits or allowances between parties controlled directly or indirectly by the same interests, if necessary to clearly reflect income or to prevent the evasion of taxes. According to Notice 95-53, the parties to a stripping transaction would be considered to be controlled by the same interests because they, among other factors, act in concert with the common goal of arbitrarily shifting income or deductions between the transferor and the transferee.

The IRS may also determine that one or more of the following authorities applies to a stripping transaction:

*Sec. 269, 382, 446(b), 701 or 704, and the regulations thereunder.

* Authorities that recharacterize assignments or accelerations of future payments as financings.

* Assignment-of-income principles.

* The business purpose doctrine.

* The substance-over-form doctrine (including the step-transaction and sham doctrines).

Notice 95-53 states that regulations will be issued recharacterizing stripping transactions pursuant to Sec. 7701(1), and will be effective with respect to stripping transactions any significant element of which is undertaken on or after Oct. 13, 1995. As an example, the regulations would apply to a stripping transaction when the property is transferred to the transferee on or after Oct. 13, 1995, even if the rights were assigned prior to that date.

When deciding whether to enter into a leasing agreement, especially one marketed as a tax lease, taxpayers should consider the potential for IRS challenge to any purported tax benefits.
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Article Details
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Author:Ziegelbauer, John R.
Publication:The Tax Adviser
Date:Feb 1, 1996
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