
From the U.S. Code Online via GPO Access
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[Laws in effect as of January 2, 2001]
[Document affected by Public Law 106-554 Section 1(a)(7)]
[CITE: 26USC7872]

 
                     TITLE 26--INTERNAL REVENUE CODE
 
                Subtitle F--Procedure and Administration
 
                        CHAPTER 80--GENERAL RULES
 
        Subchapter C--Provisions Affecting More Than One Subtitle
 
Sec. 7872. Treatment of loans with below-market interest rates


(a) Treatment of gift loans and demand loans

                           (1) In general

        For purposes of this title, in the case of any below-market loan 
    to which this section applies and which is a gift loan or a demand 
    loan, the forgone interest shall be treated as--
            (A) transferred from the lender to the borrower, and
            (B) retransferred by the borrower to the lender as interest.

                    (2) Time when transfers made

        Except as otherwise provided in regulations prescribed by the 
    Secretary, any forgone interest attributable to periods during any 
    calendar year shall be treated as transferred (and retransferred) 
    under paragraph (1) on the last day of such calendar year.

(b) Treatment of other below-market loans

                           (1) In general

        For purposes of this title, in the case of any below-market loan 
    to which this section applies and to which subsection (a)(1) does 
    not apply, the lender shall be treated as having transferred on the 
    date the loan was made (or, if later, on the first day on which this 
    section applies to such loan), and the borrower shall be treated as 
    having received on such date, cash in an amount equal to the excess 
    of--
            (A) the amount loaned, over
            (B) the present value of all payments which are required to 
        be made under the terms of the loan.

      (2) Obligation treated as having original issue discount

        For purposes of this title--

        (A) In general

            Any below-market loan to which paragraph (1) applies shall 
        be treated as having original issue discount in an amount equal 
        to the excess described in paragraph (1).

        (B) Amount in addition to other original issue discount

            Any original issue discount which a loan is treated as 
        having by reason of subparagraph (A) shall be in addition to any 
        other original issue discount on such loan (determined without 
        regard to subparagraph (A)).

(c) Below-market loans to which section applies

                           (1) In general

        Except as otherwise provided in this subsection and subsection 
    (g), this section shall apply to--

        (A) Gifts

            Any below-market loan which is a gift loan.

        (B) Compensation-related loans

            Any below-market loan directly or indirectly between--
                (i) an employer and an employee, or
                (ii) an independent contractor and a person for whom 
            such independent contractor provides services.

        (C) Corporation-shareholder loans

            Any below-market loan directly or indirectly between a 
        corporation and any shareholder of such corporation.

        (D) Tax avoidance loans

            Any below-market loan 1 of the principal purposes of the 
        interest arrangements of which is the avoidance of any Federal 
        tax.

        (E) Other below-market loans

            To the extent provided in regulations, any below-market loan 
        which is not described in subparagraph (A), (B), (C), or (F) if 
        the interest arrangements of such loan have a significant effect 
        on any Federal tax liability of the lender or the borrower.

        (F) Loans to qualified continuing care facilities

            Any loan to any qualified continuing care facility pursuant 
        to a continuing care contract.

      (2) $10,000 de minimis exception for gift loans between 
                                 individuals

        (A) In general

            In the case of any gift loan directly between individuals, 
        this section shall not apply to any day on which the aggregate 
        outstanding amount of loans between such individuals does not 
        exceed $10,000.

        (B) De minimis exception not to apply to loans attributable to 
                acquisition of income-producing assets

            Subparagraph (A) shall not apply to any gift loan directly 
        attributable to the purchase or carrying of income-producing 
        assets.

        (C) Cross reference

            For limitation on amount treated as interest where loans do 
        not exceed $100,000, see subsection (d)(1).

     (3) $10,000 de minimis exception for compensation-related 
                       and corporate-shareholder loans

        (A) In general

            In the case of any loan described in subparagraph (B) or (C) 
        of paragraph (1), this section shall not apply to any day on 
        which the aggregate outstanding amount of loans between the 
        borrower and lender does not exceed $10,000.

        (B) Exception not to apply where 1 of principal purposes is tax 
                avoidance

            Subparagraph (A) shall not apply to any loan the interest 
        arrangements of which have as 1 of their principal purposes the 
        avoidance of any Federal tax.

(d) Special rules for gift loans

     (1) Limitation on interest accrual for purposes of income 
                  taxes where loans do not exceed $100,000

        (A) In general

            For purposes of subtitle A, in the case of a gift loan 
        directly between individuals, the amount treated as 
        retransferred by the borrower to the lender as of the close of 
        any year shall not exceed the borrower's net investment income 
        for such year.

        (B) Limitation not to apply where 1 of principal purposes is tax 
                avoidance

            Subparagraph (A) shall not apply to any loan the interest 
        arrangements of which have as 1 of their principal purposes the 
        avoidance of any Federal tax.

        (C) Special rule where more than 1 gift loan outstanding

            For purposes of subparagraph (A), in any case in which a 
        borrower has outstanding more than 1 gift loan, the net 
        investment income of such borrower shall be allocated among such 
        loans in proportion to the respective amounts which would be 
        treated as retransferred by the borrower without regard to this 
        paragraph.

        (D) Limitation not to apply where aggregate amount of loans 
                exceed $100,000

            This paragraph shall not apply to any loan made by a lender 
        to a borrower for any day on which the aggregate outstanding 
        amount of loans between the borrower and lender exceeds 
        $100,000.

        (E) Net investment income

            For purposes of this paragraph--
            (i) In general

                The term ``net investment income'' has the meaning given 
            such term by section 163(d)(4).
            (ii) De minimis rule

                If the net investment income of any borrower for any 
            year does not exceed $1,000, the net investment income of 
            such borrower for such year shall be treated as zero.
            (iii) Additional amounts treated as interest

                In determining the net investment income of a person for 
            any year, any amount which would be included in the gross 
            income of such person for such year by reason of section 
            1272 if such section applied to all deferred payment 
            obligations shall be treated as interest received by such 
            person for such year.
            (iv) Deferred payment obligations

                The term ``deferred payment obligation'' includes any 
            market discount bond, short-term obligation, United States 
            savings bond, annuity, or similar obligation.

                    (2) Special rule for gift tax

        In the case of any gift loan which is a term loan, subsection 
    (b)(1) (and not subsection (a)) shall apply for purposes of chapter 
    12.

(e) Definitions of below-market loan and forgone interest

    For purposes of this section--

                        (1) Below-market loan

        The term ``below-market loan'' means any loan if--
            (A) in the case of a demand loan, interest is payable on the 
        loan at a rate less than the applicable Federal rate, or
            (B) in the case of a term loan, the amount loaned exceeds 
        the present value of all payments due under the loan.

                        (2) Forgone interest

        The term ``forgone interest'' means, with respect to any period 
    during which the loan is outstanding, the excess of--
            (A) the amount of interest which would have been payable on 
        the loan for the period if interest accrued on the loan at the 
        applicable Federal rate and were payable annually on the day 
        referred to in subsection (a)(2), over
            (B) any interest payable on the loan properly allocable to 
        such period.

(f) Other definitions and special rules

    For purposes of this section--

                          (1) Present value

        The present value of any payment shall be determined in the 
    manner provided by regulations prescribed by the Secretary--
            (A) as of the date of the loan, and
            (B) by using a discount rate equal to the applicable Federal 
        rate.

                     (2) Applicable Federal rate

        (A) Term loans

            In the case of any term loan, the applicable Federal rate 
        shall be the applicable Federal rate in effect under section 
        1274(d) (as of the day on which the loan was made), compounded 
        semiannually.

        (B) Demand loans

            In the case of a demand loan, the applicable Federal rate 
        shall be the Federal short-term rate in effect under section 
        1274(d) for the period for which the amount of forgone interest 
        is being determined, compounded semiannually.

                            (3) Gift loan

        The term ``gift loan'' means any below-market loan where the 
    forgoing of interest is in the nature of a gift.

                          (4) Amount loaned

        The term ``amount loaned'' means the amount received by the 
    borrower.

                           (5) Demand loan

        The term ``demand loan'' means any loan which is payable in full 
    at any time on the demand of the lender. Such term also includes 
    (for purposes other than determining the applicable Federal rate 
    under paragraph (2)) any loan if the benefits of the interest 
    arrangements of such loan are not transferable and are conditioned 
    on the future performance of substantial services by an individual. 
    To the extent provided in regulations, such term also includes any 
    loan with an indefinite maturity.

                            (6) Term loan

        The term ``term loan'' means any loan which is not a demand 
    loan.

              (7) Husband and wife treated as 1 person

        A husband and wife shall be treated as 1 person.

       (8) Loans to which section 483, 643(i), or 1274 applies

        This section shall not apply to any loan to which section 483, 
    643(i), or 1274 applies.

                         (9) No withholding

        No amount shall be withheld under chapter 24 with respect to--
            (A) any amount treated as transferred or retransferred under 
        subsection (a), and
            (B) any amount treated as received under subsection (b).

                  (10) Special rule for term loans

        If this section applies to any term loan on any day, this 
    section shall continue to apply to such loan notwithstanding 
    paragraphs (2) and (3) of subsection (c). In the case of a gift 
    loan, the preceding sentence shall only apply for purposes of 
    chapter 12.

       (11) Time for determining rate applicable to employee 
                              relocation loans

        (A) In general

            In the case of any term loan made by an employer to an 
        employee the proceeds of which are used by the employee to 
        purchase a principal residence (within the meaning of section 
        121), the determination of the applicable Federal rate shall be 
        made as of the date the written contract to purchase such 
        residence was entered into.

        (B) Paragraph only to apply to cases to which section 217 
                applies

            Subparagraph (A) shall only apply to the purchase of a 
        principal residence in connection with the commencement of work 
        by an employee or a change in the principal place of work of an 
        employee to which section 217 applies.

(g) Exception for certain loans to qualified continuing care facilities

                           (1) In general

        This section shall not apply for any calendar year to any below-
    market loan made by a lender to a qualified continuing care facility 
    pursuant to a continuing care contract if the lender (or the 
    lender's spouse) attains age 65 before the close of such year.

                          (2) $90,000 limit

        Paragraph (1) shall apply only to the extent that the aggregate 
    outstanding amount of any loan to which such paragraph applies 
    (determined without regard to this paragraph), when added to the 
    aggregate outstanding amount of all other previous loans between the 
    lender (or the lender's spouse) and any qualified continuing care 
    facility to which paragraph (1) applies, does not exceed $90,000.

                    (3) Continuing care contract

        For purposes of this section, the term ``continuing care 
    contract'' means a written contract between an individual and a 
    qualified continuing care facility under which--
            (A) the individual or individual's spouse may use a 
        qualified continuing care facility for their life or lives,
            (B) the individual or individual's spouse--
                (i) will first--
                    (I) reside in a separate, independent living unit 
                with additional facilities outside such unit for the 
                providing of meals and other personal care, and
                    (II) not require long-term nursing care, and

                (ii) then will be provided long-term and skilled nursing 
            care as the health of such individual or individual's spouse 
            requires, and

            (C) no additional substantial payment is required if such 
        individual or individual's spouse requires increased personal 
        care services or long-term and skilled nursing care.

               (4) Qualified continuing care facility

        (A) In general

            For purposes of this section, the term ``qualified 
        continuing care facility'' means 1 or more facilities--
                (i) which are designed to provide services under 
            continuing care contracts, and
                (ii) substantially all of the residents of which are 
            covered by continuing care contracts.

        (B) Substantially all facilities must be owned or operated by 
                borrower

            A facility shall not be treated as a qualified continuing 
        care facility unless substantially all facilities which are used 
        to provide services which are required to be provided under a 
        continuing care contract are owned or operated by the borrower.

        (C) Nursing homes excluded

            The term ``qualified continuing care facility'' shall not 
        include any facility which is of a type which is traditionally 
        considered a nursing home.

                (5) Adjustment of limit for inflation

        (A) In general

            In the case of any loan made during any calendar year after 
        1986 to which paragraph (1) applies, the dollar amount in 
        paragraph (2) shall be increased by the inflation adjustment for 
        such calendar year. Any increase under the preceding sentence 
        shall be rounded to the nearest multiple of $100 (or, if such 
        increase is a multiple of $50, such increase shall be increased 
        to the nearest multiple of $100).

        (B) Inflation adjustment

            For purposes of subparagraph (A), the inflation adjustment 
        for any calendar year is the percentage (if any) by which--
                (i) the CPI for the preceding calendar year exceeds
                (ii) the CPI for calendar year 1985.

        For purposes of the preceding sentence, the CPI for any calendar 
        year is the average of the Consumer Price Index as of the close 
        of the 12-month period ending on September 30 of such calendar 
        year.

(h) Regulations

                           (1) In general

        The Secretary shall prescribe such regulations as may be 
    necessary or appropriate to carry out the purposes of this section, 
    including--
            (A) regulations providing that where, by reason of varying 
        rates of interest, conditional interest payments, waivers of 
        interest, disposition of the lender's or borrower's interest in 
        the loan, or other circumstances, the provisions of this section 
        do not carry out the purposes of this section, adjustments to 
        the provisions of this section will be made to the extent 
        necessary to carry out the purposes of this section,
            (B) regulations for the purpose of assuring that the 
        positions of the borrower and lender are consistent as to the 
        application (or nonapplication) of this section, and
            (C) regulations exempting from the application of this 
        section any class of transactions the interest arrangements of 
        which have no significant effect on any Federal tax liability of 
        the lender or the borrower.

                     (2) Estate tax coordination

        Under regulations prescribed by the Secretary, any loan which is 
    made with donative intent and which is a term loan shall be taken 
    into account for purposes of chapter 11 in a manner consistent with 
    the provisions of subsection (b).

(Added Pub. L. 98-369, div. A, title I, Sec. 172(a), July 18, 1984, 98 
Stat. 699; amended Pub. L. 99-121, title II, Secs. 201, 202, Oct. 11, 
1985, 99 Stat. 511-513; Pub. L. 99-514, title V, Sec. 511(d)(1), title 
XVIII, Secs. 1812(b)(2)-(4), 1854(c)(2)(B), Oct. 22, 1986, 100 Stat. 
2248, 2834, 2879; Pub. L. 100-647, title I, Secs. 1005(c)(15), 
1018(u)(48), Nov. 10, 1988, 102 Stat. 3393, 3593; Pub. L. 104-188, title 
I, Secs. 1602(b)(7), 1704(t)(58), 1906(c)(2), Aug. 20, 1996, 110 Stat. 
1834, 1890, 1916; Pub. L. 105-34, title III, Sec. 312(d)(1), Aug. 5, 
1997, 111 Stat. 839; Pub. L. 105-206, title VI, Sec. 6023(30), July 22, 
1998, 112 Stat. 826; Pub. L. 106-554, Sec. 1(a)(7) [title III, 
Sec. 319(30)], Dec. 21, 2000, 114 Stat. 2763, 2763A-648.)


                               Amendments

    2000--Subsec. (f)(3). Pub. L. 106-554 substituted ``forgoing'' for 
``foregoing''.
    1998--Subsec. (f)(2)(B). Pub. L. 105-206 substituted ``forgone'' for 
``foregone''.
    1997--Subsec. (f)(11)(A). Pub. L. 105-34 substituted ``section 121'' 
for ``section 1034''.
    1996--Subsec. (a)(1), (2). Pub. L. 104-188, Sec. 1704(t)(58)(A), 
substituted ``forgone'' for ``foregone''.
    Subsec. (e). Pub. L. 104-188, Sec. 1704(t)(58)(B), substituted 
``forgone'' for ``foregone'' in heading.
    Subsec. (e)(2). Pub. L. 104-188, Sec. 1704(t)(58), substituted 
``Forgone'' for ``Foregone'' in heading and ``forgone'' for ``foregone'' 
in introductory provisions of text.
    Subsec. (f)(8). Pub. L. 104-188, Sec. 1906(c)(2), inserted ``, 
643(i),'' before ``or 1274'' in heading and text.
    Subsec. (f)(12). Pub. L. 104-188, Sec. 1602(b)(7), struck out par. 
(12) which read as follows: ``Special rule for certain employer security 
loans.--This section shall not apply to any loan between a corporation 
(or any member of the controlled group of corporations which includes 
such corporation) and an employee stock ownership plan described in 
section 4975(e)(7) to the extent that the interest rate on such loan is 
equal to the interest rate paid on a related securities acquisition loan 
(as described in section 133(b)) to such corporation.''
    1988--Subsec. (d)(1)(E)(i). Pub. L. 100-647, Sec. 1005(c)(15), 
directed substitution of ``section 163(d)(4)'' for ``section 
163(d)(3)'', which substitution had been previously made by Pub. L. 99-
514, Sec. 511(d)(1).
    Subsec. (f)(11), (12). Pub. L. 100-647, Sec. 1018(u)(48), 
redesignated former par. (11), Pub. L. 99-514, relating to special rule 
for certain employer security loans, as (12).
    1986--Subsec. (d)(1)(E)(i). Pub. L. 99-514, Sec. 511(d)(1), 
substituted ``section 163(d)(4)'' for ``section 163(d)(3)''.
    Subsec. (f)(2)(B). Pub. L. 99-514, Sec. 1812(b)(4), inserted ``, 
compounded semiannually'' before the period at end.
    Subsec. (f)(5). Pub. L. 99-514, Sec. 1812(b)(3), amended par. (5) 
generally. Prior to amendment, par. (5) read as follows: ``The term 
`demand loan' means any loan which is payable in full at any time on the 
demand of the lender. Such term also includes (for purposes other than 
determining the applicable Federal rate under paragraph (2)) any loan 
which is not transferable and the benefits of the interest arrangements 
of which is conditioned on the future performance of substantial 
services by an individual.''
    Subsec. (f)(9). Pub. L. 99-514, Sec. 1812(b)(2), amended par. (9) 
generally, inserting the subpar. (A) designation and adding subpar. (B).
    Subsec. (f)(11). Pub. L. 99-514, Sec. 1854(c)(2)(B), added par. (11) 
relating to special rule for certain employer security loans.
    1985--Subsec. (c)(1). Pub. L. 99-121, Sec. 201(c)(1), inserted ``and 
subsection (g)'' after ``this subsection'' in provisions preceding 
subpar. (A).
    Subsec. (c)(1)(E). Pub. L. 99-121, Sec. 201(c)(2), substituted 
``(C), or (F)'' for ``or (C)''.
    Subsec. (c)(1)(F). Pub. L. 99-121, Sec. 201(b), added subpar. (f).
    Subsec. (f)(11). Pub. L. 99-121, Sec. 202, added par. (11) relating 
to time for determining rate applicable to employee relocation loans.
    Subsecs. (g), (h). Pub. L. 99-121, Sec. 201(a), added subsec. (g) 
and redesignated former subsec. (g) as (h).


                    Effective Date of 1997 Amendment

    Amendment by Pub. L. 105-34 applicable to sales and exchanges after 
May 6, 1997, with certain exceptions, see section 312(d) of Pub. L. 105-
34, set out as a note under section 121 of this title.


                    Effective Date of 1996 Amendment

    Amendment by section 1602(b)(7) of Pub. L. 104-188 applicable to 
loans made after Aug. 20, 1996, with exception and provisions relating 
to certain refinancings, see section 1602(c) of Pub. L. 104-188, set out 
as an Effective Date of Repeal note under former section 133 of this 
title.
    Amendment by section 1906(c)(2) of Pub. L. 104-188 applicable to 
loans of cash or marketable securities made after Sept. 19, 1995, see 
section 1906(d)(3) of Pub. L. 104-188, set out as a note under section 
643 of this title.


                    Effective Date of 1988 Amendment

    Amendment by Pub. L. 100-647 effective, except as otherwise 
provided, as if included in the provision of the Tax Reform Act of 1986, 
Pub. L. 99-514, to which such amendment relates, see section 1019(a) of 
Pub. L. 100-647, set out as a note under section 1 of this title.


                    Effective Date of 1986 Amendment

    Amendment by section 511(d)(1) of Pub. L. 99-514 applicable to 
taxable years beginning after Dec. 31, 1986, see section 511(e) of Pub. 
L. 99-514, set out as a note under section 163 of this title.
    Amendment by sections 1812(b)(2)-(4) and 1854(c)(2)(B) of Pub. L. 
99-514 effective, except as otherwise provided, as if included in the 
provisions of the Tax Reform Act of 1984, Pub. L. 98-369, div. A, to 
which such amendment relates, see section 1881 of Pub. L. 99-514, set 
out as a note under section 48 of this title.


                    Effective Date of 1985 Amendment

    Section 204(a), (b) of Pub. L. 99-121, as amended by Pub. L. 99-514, 
Sec. 2, Oct. 22, 1986, 100 Stat. 2095, provided that:
    ``(a) Section 201.--
        ``(1) In general.--The amendments made by section 201 [amending 
    this section] shall apply with respect to loans made after the date 
    of enactment of this Act [Oct. 11, 1985].
        ``(2) Section 7872 not to apply to certain loans.--Section 7872 
    of the Internal Revenue Code of 1986 [formerly I.R.C. 1954] shall 
    not apply to loans made on or before the date of the enactment of 
    this Act [Oct. 11, 1985] to any qualified continuing care facility 
    pursuant to a continuing care contract. For purposes of this 
    paragraph, the terms `qualified continuing care facility' and 
    `continuing care contract' have the meanings given such terms by 
    section 7872(g) of such Code (as added by section 201).
    ``(b) Section 202.--The amendment made by section 202 [amending this 
section] shall apply to contracts entered into after June 30, 1985, in 
taxable years ending after such date.''


                             Effective Date

    Section 172(c) of Pub. L. 98-369, as amended by Pub. L. 99-514, 
Sec. 2, Oct. 22, 1986, 100 Stat. 2095, provided that:
    ``(1) In general.--Except as provided in paragraph (2), the 
amendments made by this section [enacting this section] shall apply to--
        ``(A) term loans made after June 6, 1984, and
        ``(B) demand loans outstanding after June 6, 1984.
    ``(2) Exception for demand loans outstanding on june 6, 1984, and 
repaid within 60 days after date of enactment.--The amendments made by 
this section shall not apply to any demand loan which--
        ``(A) was outstanding on June 6, 1984, and
        ``(B) was repaid before the date 60 days after the date of the 
    enactment of this Act [July 18, 1984].
    ``(3) Exception for certain existing loans to continuing care 
facilities.--Nothing in this subsection shall be construed to apply the 
amendments made by this section to any loan made before June 6, 1984, to 
a continuing care facility by a resident of such facility which is 
contingent on continued residence at such facility.
    ``(4) Applicable federal rate for periods before january 1, 1985.--
For periods before January 1, 1985, the applicable Federal rate under 
paragraph (2) of section 7872(f) of the Internal Revenue Code of 1986 
[formerly I.R.C. 1954], as added by this section, shall be 10 percent, 
compounded semiannually.
    ``(5) Treatment of renegotiations, etc.--For purposes of this 
subsection, any loan renegotiated, extended, or revised after June 6, 
1984, shall be treated as a loan made after such date.
    ``(6) Definition of term and demand loans.--For purposes of this 
subsection, the terms `demand loan' and `term loan' have the respective 
meanings given such terms by paragraphs (5) and (6) of section 7872(f) 
of the Internal Revenue Code of 1986, as added by this section, but the 
second sentence of such paragraph (5) shall not apply.''


           Plan Amendments Not Required Until January 1, 1989

    For provisions directing that if any amendments made by subtitle A 
or subtitle C of title XI [Secs. 1101-1147 and 1171-1177] or title XVIII 
[Secs. 1800-1899A] of Pub. L. 99-514 require an amendment to any plan, 
such plan amendment shall not be required to be made before the first 
plan year beginning on or after Jan. 1, 1989, see section 1140 of Pub. 
L. 99-514, as amended, set out as a note under section 401 of this 
title.


 Certain Israel or Polish Bonds Not Subject to Rules Relating to Below-
                              Market Loans

    Section 1812(b)(5) of Pub. L. 99-514, as amended by Pub. L. 101-179, 
title III, Sec. 307(a), Nov. 28, 1989, 103 Stat. 1314, provided that: 
``Section 7872 of the Internal Revenue Code of 1954 [now 1986] (relating 
to treatment of loans with below-market interest rates) shall not apply 
to any obligation issued by Israel or Poland if--
        ``(A) the obligation is payable in United States dollars, and
        ``(B) the obligation bears interest at an annual rate of not 
    less than 4 percent.''
    [Section 307(b) of Pub. L. 101-179 provided that: ``The amendments 
made by this section [amending section 1812(b)(5) of Pub. L. 99-514, set 
out above] shall apply to obligations issued after the date of the 
enactment of this Act [Nov. 28, 1989].'']

                  Section Referred to in Other Sections

    This section is referred to in sections 142, 856, 4941 of this 
title.
