Rev. Rul. 81-160

ISSUE AND FACTS

The Internal Revenue Service has received inquiries as to the current applicability of Rev. Rul. 56-136, 1956-1 C.B. 92.

Rev. Rul. 56-136 holds that commitment fees incurred pursuant to a bond sale agreement under which funds for construction are made available in stated amounts over a specified period are deductible under section 162 of the Internal Revenue Code for the year paid or incurred, depending upon the taxpayer's method of accounting, or may, at the election of the taxpayer, be capitalized as part of the construction cost. The commitment fees or standby charges discussed in Rev. Rul. 56-136 are amounts paid by the taxpayer under a bond sale agreement entered into in connection with the construction whereby the total amount of bonds to be issued to the purchaser is delivered to the purchaser in agreed amounts over a specified period. A separate commitment fee is paid, calculated at x percent per annum on the principal amount of the unissued bonds. Delivery of the bonds to the purchaser and the "draw down" of funds are related to the cash requirements of the taxpayer as construction progresses. The commitment fees or standby charges are paid or incurred by the taxpayer for the purpose of having money made available when needed and preserving a firm price and interest rate for the total bond issue, without incurring the heavy interest expense that would result if the bonds were sold in advance of full need of the funds for construction.

LAW AND ANALYSIS

Section 162 of the Code provides for a deduction of all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business.

Section 461(a) of the Code provides that the amount of any deduction or credit shall be taken for the taxable year that is the proper taxable year under the method of accounting used in computing taxable income.

Section 1.461-1(a)(1) of the Income Tax Regulations provides that if an expenditure results in the creation of an asset having a useful life that extends beyond the close of the taxable year, such an expenditure may not be deductible, or may be deductible only in part, for the taxable year in which made.

A loan commitment fee in the nature of a standby charge is an expenditure that results in the acquisition of a property right, that is, the right to the use of money. Such a loan commitment fee is similar to the cost of an option, which becomes part of the cost of the property acquired upon exercise of the option. Therefore, if the right is exercised, the commitment fee becomes a cost of acquiring the loan and is to be deducted ratably over the term of the loan. See Rev. Rul. 75-172, 1975-1 C.B. 145, and Francis v. Commissioner, T.C.M. 1977-170. If the right is not exercised, the taxpayer may be entitled to a loss deduction under section 165 of the Code when the right expires. See Rev. Rul. 71-191, 1971-1 C.B. 77.

HOLDING

Rev. Rul. 56-136 is no longer applicable with respect to the deductibility of loan commitment fees in the nature of standby charges, that is, such fees must be deducted ratably over the term of the loan to which they relate.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 56-136 is revoked.

PROSPECTIVE APPLICATION

Pursuant to the authority of section 7805(b) of the Code this revenue ruling will not be applied adversely to taxpayers who either (1) consummated transactions prior to the date of publication of this revenue ruling, or (2) consummated transactions after that date pursuant to the terms of a binding written contract entered into before that date.