Rev. Proc. 75-21

Section 1. Purpose.

The purpose of this Revenue Procedure is to set forth guidelines that the Internal Revenue Service will use for advance ruling purposes in determining whether certain transactions purporting to be leases of property are, in fact, leases for Federal income tax purposes. The type of transaction covered by this Revenue Procedure is commonly called a "leveraged lease". Such a lease transaction generally involves three parties: a lessor, a lessee and a lender to the lessor. In general, these leases are net leases, the lease term covers a substantial part of the useful life of the leased property, and the lessee's payments to the lessor are sufficient to discharge the lessor's payments to the lender.

Sec. 2. Background

Section 4.01 of Rev. Rul. 55-540, 1955-2 C.B. 39, sets forth certain conditions that, in the absence of compelling factors of contrary implication, would warrant treatment of a transaction for Federal income tax purposes as a conditional sales contract rather than a lease of equipment. See Rev. Rul. 55-541, 1955-2 C.B. 19; Rev. Rul. 55-542, 1955-2 C.B. 59; and Rev. Rul. 57-371, 1957-2 C.B. 214, for examples of transactions determined to be sales rather than leases. See Rev. Rul. 60-122, 1960-1 C.B. 56, for two transactions, one considered a lease and the other considered a sale. See also Rev. Rul. 72-408, 1972-2 C.B. 86, concerning the Federal income tax consequences of a transaction cast in the form of a lease subsequently determined to be a sale.

Sec. 3. Nature of the Problem

Rev. Rul. 55-540, cited in section 2, provides guidelines for determining the existence of a conditional sales contract but does not contain guidelines for determining the existence of a lease. The guidelines set forth in section 4 of this Revenue Procedure are being published to clarify the circumstances in which an advance ruling recognizing the existence of a lease ordinarily will be issued and thus to provide assistance to taxpayers in preparing ruling requests and to assist the Service in issuing advance ruling letters as promptly as practicable. These guidelines do not define, as a matter of law, whether a transaction is or is not a lease for Federal income tax purposes and are not intended to be used for audit purposes. If these guidelines are not satisfied, the Service nevertheless will consider ruling in appropriate cases on the basis of all the facts and circumstances.

Sec. 4. Guidelines

Unless other facts and circumstances indicate a contrary intent, for advance ruling purposes only, the Service will consider the lessor in a leveraged lease transaction to be the owner of the property and the transaction a valid lease if all the following conditions are met:

(1) Minimum Unconditional "At Risk" Investment.

The lessor must have made a minimum unconditional "at risk" investment in the property (the "Minimum Investment") when the lease begins, must maintain such Minimum Investment throughout the entire lease term, and such Minimum Investment must remain at the end of the lease term. The Minimum Investment must be an equity investment (the "Equity Investment") which, for purposes of this Revenue Procedure, includes only consideration paid and personal liability incurred by the lessor to purchase the property. The net worth of the lessor must be sufficient to satisfy any such personal liability. In determining the lessor's Minimum Investment, the following rules will be applied:

(A) Initial Minimum Investment. When the property is first placed in service or use by the lessee, the Minimum Investment must be equal to at least 20 percent of the cost of the property. The Minimum Investment must be unconditional. That is, after the property is first placed in service or use by the lessee, the lessor must not be entitled to a return of any portion of the Minimum Investment through any arrangement, directly or indirectly, with the lessee, a shareholder of the lessee, or any party related to the lessee (within the meaning of section 318 of the Internal Revenue Code of 1954) (the "Lessee Group"). The lease transaction may include an arrangement with someone other than the foregoing parties that provides for such a return to the lessor if the property fails to satisfy written specifications for the supply, construction, or manufacture of the property.

(B) Maintenance of Minimum Investment. The Minimum Investment must remain equal to at least 20 percent of the cost of the property at all times throughout the entire lease term. That is, the excess of the cumulative payments required to have been paid by the lessee to or for the lessor over the cumulative disbursements required to have been paid by or for the lessor in connection with the ownership of the property must never exceed the sum of (i) any excess of the lessor's initial Equity Investment over 20 percent of the cost of the property plus (ii) the cumulative pro rata portion of the projected profit from the transaction (exclusive of tax benefits).

(C) Residual Investment. The lessor must represent and demonstrate that an amount equal to at least 20 percent of the original cost of the property is a reasonable estimate of what the fair market value of the property will be at the end of the lease term. For this purpose, fair market value must be determined (i) without including in such value any increase or decrease for inflation or deflation during the lease term, and (ii) after subtracting from such value any cost to the lessor for removal and delivery of possession of the property to the lessor at the end of the lease term. In addition, the lessor must represent and demonstrate that a remaining useful life of the longer of one year or 20 percent of the originally estimated useful life of the property is a reasonable estimate of what the remaining useful life of the property will be at the end of the lease term.

(2) Lease Term and Renewal Options.

For purposes of this Revenue Procedure, the lease term includes all renewal or extension periods except renewals or extensions at the option of the lessee at fair rental value at the time of such renewal or extension.

(3) Purchase and Sale Rights.

No member of the Lessee Group may have a contractual right to purchase the property from the lessor at a price less than its fair market value at the time the right is exercised. When the property is first placed in service or use by the lessee, the lessor may not have a contractual right (except as provided in section 4(1)(A) above) to cause any party to purchase the property. The lessor must also represent that it does not have any present intention to acquire such a contractual right. The effect of any such right acquired at a subsequent time will be determined at that time based on all the facts and circumstances. A provision that permits the lessor to abandon the property to any party will be treated as a contractual right of the lessor to cause such party to purchase the property.

(4) No Investment by Lessee.

No part of the cost of the property may be furnished by any member of the Lessee Group. Nor may any such party furnish any part of the cost of improvements or additions to the property, except for improvements or additions that are owned by any member of the Lessee Group and are readily removable without causing material damage to the property. Any item that is so readily removable must not be subject to a contract or option for purchase or sale between the lessor and any member of the Lessee Group at a price other than its fair market value at the time of such purchase or sale. However:

(A) Cost Overruns and Modifications. If the cost of property exceeds the estimate on which the lease was based, the lease may provide for adjustment of the rents to compensate the lessor for such additional cost (but see section 5.01 concerning uneven rent payments).

(B) Maintenance and Repair. If the lease requires the lessee to maintain and keep the property in good repair during the term of the lease, ordinary maintenance and repairs performed by the lessee will not constitute an improvement or addition to the property.

(5) No Lessee Loans or Guarantees.

No member of the Lessee Group may lend to the lessor any of the funds necessary to acquire the property, or guarantee any indebtedness created in connection with the acquisition of the property by the lessor. A guarantee by any member of the Lessee Group of the lessee's obligation to pay rent, properly maintain the property, or pay insurance premiums or other similar conventional obligations of a net lease does not constitute the guarantee of the indebtedness of the lessor.

(6) Profit Requirement.

The lessor must represent and demonstrate that it expects to receive a profit from the transaction, apart from the value of or benefits obtained from the tax deductions, allowances, credits and other tax attributes arising from such transaction. This requirement is met if:

the aggregate amount required to be paid by the lessee to or for the lessor over the lease term plus the value of the residual investment referred to in section 4(1)(C) above exceed an amount equal to the sum of the aggregate disbursements required to be paid by or for the lessor in connection with the ownership of the property and the lessor's Equity Investment in the property, including any direct costs to finance the Equity Investment, and the aggregate amount required to be paid to or for the lessor over the lease term exceeds by a reasonable amount the aggregate disbursements required to be paid by or for the lessor in connection with the ownership of the property.

Sec. 5. Other Considerations

.01 Leveraged lease transactions that satisfy the guidelines set forth in section 4 hereof nevertheless may contain uneven rent payments that result in prepaid or deferred rent. The Service ordinarily will not raise any question about prepaid or deferred rent if the annual rent for any year (i) is not more than 10 percent above or below the amount calculated by dividing the total rent payable over the lease term by the number of years in such term, or (ii) during at least the first two-thirds of the lease term is not more than 10 percent above or below the amount calculated by dividing the total rent payable over such initial portion of the lease term by the number of years in such initial portion of the lease term, and if the annual rent for any year during the remainder of the lease term is no greater than the highest annual rent for any year during the initial portion of the lease term and no less than one-half of the average annual rent during such initial portion of the lease term. Any ruling request involving uneven rent payments that do not satisfy the above exceptions must contain a request for a ruling as to whether any portion of the uneven rent payments is prepaid or deferred rent. Any ruling issued by the Service as to the existence of a lease may contain an appropriate ruling or caveat as to such prepaid or deferred rent.

.02 The Service has not decided whether rulings will be issued with respect to property that is expected not to be useful or usable by the lessor at the end of the lease term except for purposes of continued leasing or transfer to any member of the Lessee Group. Prior to the final decision, consideration will be given to any comments pertaining thereto that are submitted in writing (preferably six copies) to the Commissioner of Internal Revenue at the address in Section 7 below by May 30, 1975. Designations of material as confidential or not to be disclosed, contained in such comments will not be accepted. Thus, a person submitting written comments should not include therein material that is considered to be confidential or inappropriate for disclosure to the public. It will be presumed by the Internal Revenue Service that every written comment submitted to it in response to this request is intended by the person submitting it to be subject in its entirety to public inspection and copying in accordance with the same procedures as are prescribed in 26 CFR 601.702(d)(9) for public inspection and copying of written comments received in response to a notice of proposed rule making.

Sec. 6. Effective Date

The provisions of this Revenue Procedure are effective with respect to those requests received after May 5, 1975.

Sec. 7. Inquiries

Inquiries regarding this Revenue Procedure should refer to its number and be addressed to the Commissioner of Internal Revenue, 1111 Constitution Avenue, N. W., Washington, D. C. 20224, Attention: T:C:C.

¹ Also released as TIR-1362, dated April 11, 1975.