LEASE-STRIPPING

Lease strips are transactions in which one participant claims to realize rental or other income from property while another participant claims the deductions related to that income (e.g., depreciation or rental expenses). Lease strips may come in a variety of forms, including, but not limited to, the following three types (as specifically referenced in the IRS’ Notice 2003-55):

Effected by a Single Participant:

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Effected Through a Transferred Basis Transaction:

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Effected Through a Transfer of a Partnership Interest:

In this IRS Notice, the IRS concludes that lease strips (also called obligation shifting transactions) improperly separate income from related deductions. The IRS believes that the transactions do not produce the tax consequences desired by the participants. Depending on the facts, the IRS may apply one or more Code sections or theories to challenge any lease strip transaction, including: (1) Section 165 (rules governing disallowance of losses); (2) Section 269 (disallowing deductions/credits where control of a corporation or assets in a carryover basis transaction are acquired for the principal purpose of obtaining the tax benefit); (3) Section 382 (limiting the use of NOL carryforwards and built-in losses following certain corporate ownership changes); (4) Section 446(b) (allowing IRS to impose a method of accounting on a taxpayer when the taxpayer’s method does not clearly reflect income); (5) Section 701 (relating to the taxation of partnerships and partners, including anti-abuse provisions when transactions are pursued that are not consistent with the intent of Subchapter K); (6) Section 704 (allowing the IRS to reallocate partnership items of income, deductions, etc. where the partnership allocation does not have substantial economic effect); (7) assignment of income doctrine (that purported assignment of income is really a financing); (8) business purpose doctrine; (9) substance-over-form doctrine; (10) step-transaction doctrine; and/or (11) sham transaction doctrine. The IRS notes further that the IRS’ approach also applies to lease strips involving licenses of intangible property, service contracts, leaseholds or other non-fee interests in property, and the prepayment, front-loading, or retention of rights to receive future payments.

If you believe that you may have engaged in a transaction that is the same or substantially similar to the transaction described above, Federal law may require you to disclose your and other parties’ participation in any such “listed transaction” on IRS Form 8886. For more information about Federal law requirements, please contact us.