Code of Federal Regulations · Section
§ 1.1274-4 — -4 Test Rate
26 C.F.R. § 1.1274-4
(a) Determination of test rate of interest—(1) In general—(i) Test rate is the 3-month rate. Except as provided in paragraph (a)(2) of this section, the test rate of interest for a debt instrument issued in consideration for the sale or exchange of property is the 3-month rate.
(ii) The 3-month rate. Except as provided in paragraph (a)(1)(iii) of this section, the 3-month rate is the lower of—
(A) The lowest applicable Federal rate (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially sets forth the terms under which the sale or exchange is ultimately consummated; or
(B) The lowest applicable Federal rate (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs.
(iii) Special rule if there is no binding written contract. If there is no binding written contract that substantially sets forth the terms under which the sale or exchange is ultimately consummated, the 3-month rate is the lowest applicable Federal rate (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs.
(2) Test rate for certain debt instruments—(i) Sale-leaseback transactions. Under section 1274(e) (relating to certain sale-leaseback transactions), the test rate is 110 percent of the 3-month rate determined under paragraph (a)(1) of this section. For purposes of section 1274(e)(3), related party means a person related to the transferor within the meaning of section 267(b) or 707(b)(1).
(ii) Qualified debt instrument. Under section 1274A(a), the test rate for a qualified debt instrument is no greater than 9 percent, compounded semiannually, or an equivalent rate based on an appropriate compounding period.
(iii) Alternative test rate for short-term obligations—(A) Requirements. This paragraph (a)(2)(iii)(A) provides an alternative test rate under section 1274(d)(1)(D) for a debt instrument with a maturity of 1 year or less. This alternative test rate applies, however, only if the debt instrument provides for adequate stated interest using the alternative test rate, the issuer provides on the face of the debt instrument that the instrument qualifies as having adequate stated interest under section 1274(d)(1)(D), and the issuer and holder treat or agree to treat the instrument as having adequate stated interest.
(B) Alternative test rate. For purposes of paragraph (a)(2)(iii)(A), the alternative test rate is the market yield on U.S. Treasury bills with the same maturity date as the debt instrument. If the same maturity date is not available, the market yield on U.S. Treasury bills that mature in the same week or month as the debt instrument is used. The alternative test rate is determined as of the date on which there is a binding written contract that substantially sets forth the terms under which the sale or exchange is ultimately consummated or as of the date of the sale or exchange, whichever date results in a lower rate. If there is no binding written contract, however, the alternative test rate is determined as of the date of the sale or exchange.
(b) Applicable Federal rate. Except as otherwise provided in this section, the applicable Federal rate for a debt instrument is based on the term of the instrument (i.e., short-term, mid-term, or long-term). See section 1274(d)(1). The Internal Revenue Service publishes the applicable Federal rates for each month in the Internal Revenue Bulletin (see § 601.601(d)(2)(ii) of this chapter). The applicable Federal rates are based on the yield to maturity of outstanding marketable obligations of the United States of similar maturities during the one month period ending on the 14th day of the month preceding the month for which the rates are applicable.
(c) Special rules to determine the term of a debt instrument for purposes of determining the applicable Federal rate—(1) Installment obligation. If a debt instrument is an installment obligation (as defined in § 1.1273-1(e)(1)), the term of the instrument is the instrument's weighted average maturity (as defined in § 1.1273-1(e)(3)).
(2) Certain variable rate debt instruments—(i) In general. Except as otherwise provided in paragraph (c)(2)(ii) of this section, if a variable rate debt instrument (as defined in § 1.1275-5(a)) provides for stated interest at a qualified floating rate (or rates), the term of the instrument is determined by reference to the longest interval between interest adjustment dates, or, if the variable rate debt instrument provides for a fixed rate, the interval between the issue date and the last day on which the fixed rate applies, if this interval is longer.
(ii) Restrictions on adjustments. If, due to significant restrictions on variations in a qualified floating rate or the use of certain formulae pursuant to § 1.1275-5(b)(2) (e.g., 15 percent of 1-year LIBOR, plus 800 basis points), the rate in substance resembles a fixed rate, the applicable Federal rate is determined by reference to the term of the debt instrument.
(3) Counting of either the issue date or the maturity date. The term of a debt instrument includes either the issue date or the maturity date, but not both dates.
(4) Certain debt instruments that provide for principal payments uncertain as to time. If a debt instrument provides for principal payments that are fixed in total amount but uncertain as to time, the term of the instrument is determined by reference to the latest possible date on which a principal payment can be made or, in the case of an installment obligation, by reference to the longest weighted average maturity under any possible payment schedule.
(d) Foreign currency loans. If all of the payments of a debt instrument are denominated in, or determined by reference to, a currency other than the U.S. dollar, the applicable Federal rate for the debt instrument is a foreign currency rate of interest that is analogous to the applicable Federal rate described in this section. For this purpose, an analogous rate of interest is a rate based on yields (with the appropriate compounding period) of the highest grade of outstanding marketable obligations denominated in such currency (excluding any obligations that benefit from special tax exemptions or preferential tax rates not available to debt instruments generally) with due consideration given to the maturities of the obligations.
(e) Examples. The following examples illustrate the rules of this section.
(i) Facts. On July 1, 1996, A sells nonpublicly traded property to B in return for a 5-year debt instrument that provides for interest to be paid on July 1 of each year, beginning on July 1, 1997, based on the prime rate of a local bank on that date. However, the interest rate cannot increase or decrease from one year to the next by more than .25 percentage points (25 basis points).
(ii) Significant restriction. The debt instrument is a variable rate debt instrument (as defined in § 1.1275-5) that provides for stated interest at a qualified floating rate. Assume that based on all the facts and circumstances, the restriction is a significant restriction on the variations in the rate of interest. Under paragraph (c)(2)(ii) of this section, the applicable Federal rate is determined by reference to the term of the debt instrument, and the applicable Federal rate is the Federal mid-term rate.
(i) Facts. On January 1, 1996, A sells nonpublicly traded property to B in exchange for a debt instrument that calls for a payment of $500,000 on January 1, 2001, and a payment of $1,000,000 on January 1, 2006. The debt instrument does not provide for any stated interest.
(ii) Determination of term. The debt instrument is an installment obligation. Under paragraph (c)(1) of this section, the term of the debt instrument is its weighted average maturity (as defined in § 1.1273-1(e)(3)). The debt instrument's weighted average maturity is 8.33 years, which is the sum of (A) the ratio of the first payment to total payments (500,000/1,500,000), multiplied by the number of complete years from the issue date until the payment is due (5 years), and (B) the ratio of the second payment to total payments (1,000,000/1,500,000), multiplied by the number of complete years from the issue date until the second payment is due (10 years).
(iii) Applicable Federal rate. Based on the calculation in paragraph (ii) of this example, the term of the debt instrument is treated as 8.33 years. Consequently, the applicable Federal rate is the Federal mid-term rate.
Authorizing Statute
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Rules and regulations26 U.S.C. § 7805
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Advanced manufacturing production credit26 U.S.C. § 45X
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Alcohol, etc., used as fuel26 U.S.C. § 40
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Gross income defined26 U.S.C. § 61
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Transfers of excess pension assets to retiree health accounts26 U.S.C. § 420
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Partial exclusion for gain from certain small business stock26 U.S.C. § 1202
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Tax treatment of stripped bonds26 U.S.C. § 1286
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Current taxation of income from qualified electing funds26 U.S.C. § 1293
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Imposition of tax on certain foreign procurement26 U.S.C. § 5000C
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Returns regarding payments of interest26 U.S.C. § 6049
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Signing of returns and other documents26 U.S.C. § 6061
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General requirement of return, statement, or list26 U.S.C. § 6011
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Income from discharge of indebtedness26 U.S.C. § 108
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Indian general welfare benefits26 U.S.C. § 139E
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Bonds must be registered to be tax exempt; other requirements26 U.S.C. § 149
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Trade or business expenses26 U.S.C. § 162
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Accelerated cost recovery system26 U.S.C. § 168
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Amortizable bond premium26 U.S.C. § 171
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Golden parachute payments26 U.S.C. § 280G
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Distributions of stock and stock rights26 U.S.C. § 305
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Transfer to corporation controlled by transferor26 U.S.C. § 351
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Special rules for long-term contracts26 U.S.C. § 460
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Determination of basis of partner’s interest26 U.S.C. § 705
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Taxes of foreign countries and of possessions of United States26 U.S.C. § 901
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Controlled foreign corporations; United States persons26 U.S.C. § 957
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New energy efficient home credit26 U.S.C. § 45L
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2-percent floor on miscellaneous itemized deductions26 U.S.C. § 67
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Certain death benefits26 U.S.C. § 101
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Qualified business income26 U.S.C. § 199A
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Installment method26 U.S.C. § 453
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Certain payments for the use of property or services26 U.S.C. § 467
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Partners, not partnership, subject to tax26 U.S.C. § 701
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Extent of recognition of gain or loss on distribution26 U.S.C. § 731
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Capitalization of certain policy acquisition expenses26 U.S.C. § 848
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Special rules for determining source26 U.S.C. § 863
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Income of foreign governments and of international organizations26 U.S.C. § 892
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Definitions and special rules26 U.S.C. § 6241
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Computation and payment of tax26 U.S.C. § 1503
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Adjusted gross income defined26 U.S.C. § 62
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Treatment of loans with below-market interest rates26 U.S.C. § 7872
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Basis to distributees26 U.S.C. § 358
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Minimum participation standards26 U.S.C. § 410
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Other definitions and special rules26 U.S.C. § 860G
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Adjustments required by changes in method of accounting26 U.S.C. § 481
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Definitions26 U.S.C. § 7701
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Insurance income26 U.S.C. § 953
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Returns relating to actions affecting basis of specified securities26 U.S.C. § 6045B
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Information relating to certain trusts and annuity plans26 U.S.C. § 6047
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Enhanced oil recovery credit26 U.S.C. § 43
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Energy efficient commercial buildings deduction26 U.S.C. § 179D
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Redemption through use of related corporations26 U.S.C. § 304
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Certain stock purchases treated as asset acquisitions26 U.S.C. § 338
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Special limitations on certain excess credits, etc.26 U.S.C. § 383
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Optional treatment of elective deferrals as Roth contributions26 U.S.C. § 402A
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General rule for taxable year of inclusion26 U.S.C. § 451
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Qualified ABLE programs26 U.S.C. § 529A
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Charitable remainder trusts26 U.S.C. § 664
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Nonrecognition of gain or loss on contribution26 U.S.C. § 721
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Investment of earnings in United States property26 U.S.C. § 956
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Definitions and special rule26 U.S.C. § 1377
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Relief from joint and several liability on joint return26 U.S.C. § 6015
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Return of S corporation26 U.S.C. § 6037
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Notice of certain transfers to foreign persons26 U.S.C. § 6038B
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Information at source26 U.S.C. § 6041
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Imposition of accuracy-related penalty on underpayments26 U.S.C. § 6662
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Tax imposed26 U.S.C. § 1
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Railroad track maintenance credit26 U.S.C. § 45G
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Zero-emission nuclear power production credit26 U.S.C. § 45U
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Rehabilitation credit26 U.S.C. § 47
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Clean electricity investment credit26 U.S.C. § 48E
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Special rules26 U.S.C. § 52
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Election to expense certain depreciable business assets26 U.S.C. § 179
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Individual retirement accounts26 U.S.C. § 408
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Special rules for nondealers26 U.S.C. § 453A
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Deductions limited to amount at risk26 U.S.C. § 465
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Exemption from tax on corporations, certain trusts, etc.26 U.S.C. § 501
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Definition of regulated investment company26 U.S.C. § 851
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Source rules for personal property sales26 U.S.C. § 865
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Tax on nonresident alien individuals26 U.S.C. § 871
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Foreign base company income26 U.S.C. § 954
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S corporation defined26 U.S.C. § 1361
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Definitions26 U.S.C. § 1402
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Distributions of property26 U.S.C. § 301
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Life insurance contract defined26 U.S.C. § 7702
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Previously-owned clean vehicles26 U.S.C. § 25E
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Electricity produced from certain renewable resources, etc.26 U.S.C. § 45
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Clean fuel production credit26 U.S.C. § 45Z
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Taxation of employee annuities26 U.S.C. § 403
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Last-in, first-out inventories26 U.S.C. § 472
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Allocation of income and deductions among taxpayers26 U.S.C. § 482
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Definitions applicable to subparts A, B, C, and D26 U.S.C. § 643
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Taxable years of partner and partnership26 U.S.C. § 706
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Disposition of investment in United States real property26 U.S.C. § 897
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Administrative adjustment request by partnership26 U.S.C. § 6227
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Citizens or residents of the United States living abroad26 U.S.C. § 911
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Residence and source rules involving possessions26 U.S.C. § 937
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Rules relating to expatriated entities and their foreign parents26 U.S.C. § 7874
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Regulations26 U.S.C. § 1502
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Capitalization and inclusion in inventory costs of certain expenses26 U.S.C. § 263A
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Foreign corporations26 U.S.C. § 367
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Roth IRAs26 U.S.C. § 408A
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Minimum vesting standards26 U.S.C. § 411
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Partner’s distributive share26 U.S.C. § 704
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Unrealized receivables and inventory items26 U.S.C. § 751
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Taxation of residual interests26 U.S.C. § 860C
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Exclusions from gross income26 U.S.C. § 883
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Income affected by treaty26 U.S.C. § 894
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Other definitions and special rules26 U.S.C. § 989
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Special rules26 U.S.C. § 1474
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Returns of brokers26 U.S.C. § 6045
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Information returns of tax return preparers26 U.S.C. § 6060
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Authority to make credits or refunds26 U.S.C. § 6402
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Failure by individual to pay estimated income tax26 U.S.C. § 6654
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Interest on certain home mortgages26 U.S.C. § 25
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Credit for qualified commercial clean vehicles26 U.S.C. § 45W
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Interest on State and local bonds26 U.S.C. § 103
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Qualified lessee construction allowances for short-term leases26 U.S.C. § 110
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Losses26 U.S.C. § 165
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Charitable, etc., contributions and gifts26 U.S.C. § 170
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Incentive stock options26 U.S.C. § 422
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Deemed paid credit for subpart F inclusions26 U.S.C. § 960
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Election of mark to market for marketable stock26 U.S.C. § 1296
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Returns relating to certain life insurance contract transactions26 U.S.C. § 6050Y
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Clean vehicle credit26 U.S.C. § 30D
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Credit for carbon oxide sequestration26 U.S.C. § 45Q
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Amount of credit26 U.S.C. § 46
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Advanced manufacturing investment credit26 U.S.C. § 48D
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Arbitrage26 U.S.C. § 148
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Amortization of goodwill and certain other intangibles26 U.S.C. § 197
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Interest on education loans26 U.S.C. § 221
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Disallowance of certain entertainment, etc., expenses26 U.S.C. § 274
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Qualifications for tax credit employee stock ownership plans26 U.S.C. § 409
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Unrelated debt-financed income26 U.S.C. § 514
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Rules for allocation of basis26 U.S.C. § 755
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Rules for certain reserves26 U.S.C. § 807
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Special rules in case of foreign oil and gas income26 U.S.C. § 907
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Basis of property acquired from a decedent26 U.S.C. § 1014
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Special rules26 U.S.C. § 1298
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Definitions26 U.S.C. § 3401
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Extension of time for filing returns26 U.S.C. § 6081
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Renumbered § 45C]26 U.S.C. § 28
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Credit for production of clean hydrogen26 U.S.C. § 45V
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Energy credit26 U.S.C. § 48
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Limitation on credit26 U.S.C. § 904
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Qualified pension, profit-sharing, and stock bonus plans26 U.S.C. § 401
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Dependent care assistance programs26 U.S.C. § 129
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Special rules for nuclear decommissioning costs26 U.S.C. § 468A
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Mark to market accounting method for dealers in securities26 U.S.C. § 475
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Basis of distributed property other than money26 U.S.C. § 732
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Straddles26 U.S.C. § 1092
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Qualified electing fund26 U.S.C. § 1295
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Averaging of farm income26 U.S.C. § 1301
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Withholdable payments to foreign financial institutions26 U.S.C. § 1471
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Definitions26 U.S.C. § 1504
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Basis information to persons acquiring property from decedent26 U.S.C. § 6035
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Information with respect to certain foreign-owned corporations26 U.S.C. § 6038A
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Returns relating to cash received in trade or business, etc.26 U.S.C. § 6050I
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Credit for increasing research activities26 U.S.C. § 41
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Definitions and special rules26 U.S.C. § 150
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Passive activity losses and credits limited26 U.S.C. § 469
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Certain expenses for which credits are allowable26 U.S.C. § 280C
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Assumption of liability26 U.S.C. § 357
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Complete liquidations of subsidiaries26 U.S.C. § 332
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Distribution of stock and securities of a controlled corporation26 U.S.C. § 355
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Period for computation of taxable income26 U.S.C. § 441
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General rule for taxable year of deduction26 U.S.C. § 461
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Special rules for modified guaranteed contracts26 U.S.C. § 817A
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Treatment of variable contracts26 U.S.C. § 817
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Certain reinsurance agreements26 U.S.C. § 845
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Failure to file notice of redetermination of foreign tax26 U.S.C. § 6689
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Branch transactions26 U.S.C. § 987
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Qualified zone property defined26 U.S.C. § 1397D
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Withholdable payments to other foreign entities26 U.S.C. § 1472
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Liquidating, etc., transactions26 U.S.C. § 6043
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Verification of returns26 U.S.C. § 6065
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Mode or time of collection26 U.S.C. § 6302
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Transfer of certain credits26 U.S.C. § 6418
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American Opportunity and Lifetime Learning credits26 U.S.C. § 25A
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Refundable credit for coverage under a qualified health plan26 U.S.C. § 36B
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Clean electricity production credit26 U.S.C. § 45Y
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Other special rules26 U.S.C. § 50
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Treatment of community income26 U.S.C. § 66
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Basis to corporations26 U.S.C. § 362
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Election of taxable year other than required taxable year26 U.S.C. § 444
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Transactions between partner and partnership26 U.S.C. § 707
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Special allocation rules for certain asset acquisitions26 U.S.C. § 1060
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Discounted unpaid losses defined26 U.S.C. § 846
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Definitions and special rules26 U.S.C. § 864
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Capital asset defined26 U.S.C. § 1221
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Interest on tax deferral26 U.S.C. § 1291
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Passive foreign investment company26 U.S.C. § 1297
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Withholding of tax on nonresident aliens26 U.S.C. § 1441
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Returns as to interests in foreign partnerships26 U.S.C. § 6046A
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State and local income tax refunds26 U.S.C. § 6050E
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Returns relating to exchanges of certain partnership interests26 U.S.C. § 6050K
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Returns relating to higher education tuition and related expenses26 U.S.C. § 6050S
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Reporting of health insurance coverage26 U.S.C. § 6055
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Low-income housing credit26 U.S.C. § 42
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New markets tax credit26 U.S.C. § 45D
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Definitions and special rules26 U.S.C. § 414
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Qualified asset account; limitation on additions to account26 U.S.C. § 419A
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General rule for methods of accounting26 U.S.C. § 446
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Interest on certain deferred payments26 U.S.C. § 483
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Reserves for losses on loans of banks26 U.S.C. § 585
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Certain revocable trusts treated as part of estate26 U.S.C. § 645
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Insurance company taxable income26 U.S.C. § 832
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Income from sources within the United States26 U.S.C. § 861
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Treatment of certain foreign currency transactions26 U.S.C. § 988
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Functional currency26 U.S.C. § 985
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Other definitions and special rules26 U.S.C. § 1275
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Election to extend time for payment of tax on undistributed earnings26 U.S.C. § 1294
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Requirement to maintain minimum essential coverage26 U.S.C. § 5000A
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Returns by exempt organizations26 U.S.C. § 6033
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Information with respect to foreign financial assets26 U.S.C. § 6038D
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Returns relating to the cancellation of indebtedness by certain entities26 U.S.C. § 6050P
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Identifying numbers26 U.S.C. § 6109
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Elective payment of applicable credits26 U.S.C. § 6417
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Certain fringe benefits26 U.S.C. § 132
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Dependent defined26 U.S.C. § 152
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Interest26 U.S.C. § 163
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Bad debts26 U.S.C. § 166
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Special rules for credits and deductions26 U.S.C. § 642
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General rule for inventories26 U.S.C. § 471
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Political organizations26 U.S.C. § 527
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Special rules applicable to sections 661 and 66226 U.S.C. § 663
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Allowance of deductions and credits26 U.S.C. § 874
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Branch profits tax26 U.S.C. § 884
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Tax imposed on certain built-in gains26 U.S.C. § 1374
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Foreign tax-exempt organizations26 U.S.C. § 1443
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Valuation tables26 U.S.C. § 7520
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Losses on small business stock26 U.S.C. § 1244
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Distributions26 U.S.C. § 1368
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Definitions26 U.S.C. § 1473
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Information with respect to certain fines, penalties, and other amounts26 U.S.C. § 6050X
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Failure by corporation to pay estimated income tax26 U.S.C. § 6655