467 clause in a zero-cash-flow

The “467 clause” in a zero-cash-flow (zero-coupon) deal refers to Section 467 of the Internal Revenue Code, which governs how rent is recognized for tax purposes when lease payments are uneven or deferred over time.

Here’s what it means in plain English 👇

🏢 What’s a Zero-Cash-Flow (Zero Coupon) Deal?

• These are long-term, fully leased NNN properties (often 20–25 years) where the tenant’s rent exactly matches the debt service.

• Because of this, the owner receives no net cash flow — all rent goes directly to pay the loan.

• Investors buy them mainly for tax deferral or 1031-exchange stability, not for income.

💡 What the 467 Clause Does

• Section 467 says: if rent payments are uneven, deferred, or prepaid, the IRS may “level” the rent for tax reporting.

• So even if you don’t physically receive rent now, you might still have to report some rental income each year.

• It prevents investors from pushing all income to later years just to defer taxes.

⚖️ In Practice

In zero-cash-flow deals:

• The rent is usually structured to match the loan payments, which are often interest-heavy early and principal-heavy later.

• Because of that unevenness, the 467 clause kicks in and the IRS spreads (“accrues”) rent evenly over the life of the lease.

• You might show phantom income on your taxes — income you haven’t actually received in cash yet.

📘 Simple Example

Imagine a 20-year NNN lease where the tenant’s payments increase each year.
Even though you don’t get extra cash at the beginning, the IRS says:

“We’ll treat part of that future rent as earned today.”

So you might owe tax this year on rent you won’t receive until later.

🧭 Why It Matters

• Important for 1031 exchange buyers and institutional investors in zero-cash-flow properties.

• Affects how you report income, not how much rent you actually receive.

• Usually handled in the lease language and tax opinion provided by the sponsor or issuer.

🏢 Example: Buying a $3 Million Zero-Cash-Flow Property

Property: Walgreens (25-year NNN lease)
Purchase Price: $3,000,000
Loan: $3,000,000 (100% financed, 25-year amortization)
Interest Rate: 6.0%
Tenant Rent: Starts at $180,000/year and increases 1.5% annually
You (the investor) receive no actual cash flow — all rent goes directly to the lender.

💰 What Happens in a Normal Year

• Tenant pays: $180,000 rent

• Lender receives: $180,000 loan payment

• You receive: $0 actual cash

• So, it feels like you made no money, right?

But here’s where Section 467 steps in.

⚖️ What the 467 Clause Does

The IRS looks at that rent schedule and says:

“Rent increases every year — so it’s not level. You can’t just pay tax later when the rent gets higher.”

They then require you to “accrue” rent evenly over the lease term.

So instead of reporting rent based on actual payments, you must report level rent each year — for example:

• IRS says: total rent over 25 years = $5,000,000

• Divide evenly: $200,000 per year

• Even though you only receive (or technically pay to the lender) $180,000 in early years, you must still report $200,000 of rent income.

That extra $20,000 difference becomes “phantom income” — taxable income with no actual cash in hand.

early, even though you never receive rent — then you get small deductions later.

🧭 Why Investors Still Buy These

Even with the phantom income issue:

• They’re 100% passive, no landlord duties.

• Ideal for 1031 exchange buyers who want stability, not cash flow.

• At the end of the loan term, you own the property free and clear.

🧾 Summary

467 Clause = Leveling rent for tax fairness

• IRS spreads rent evenly → causes phantom income

• Applies when rent escalates or is deferred

• Affects tax reporting, not cash flow

• Built into almost every zero-coupon / zero-cash-flow lease

Example: $3,000,000 Zero-Cash-Flow Walgreens Lease

Purchase Price: $3,000,000
Loan: $3,000,000 (100% financed, 25-year amortization)
Interest Rate: 6.0%
Lease Term: 25 years absolute NNN
Rent: $180,000 per year (flat for 22 years)
Rent Holidays: No rent for the final 3 years (years 23–25)
All rent paid directly to lender — zero cash flow to investor

💡 How This Looks Without Section 467

If the IRS didn’t step in, the rent pattern would be:

Total rent over 25 years: $3,960,000

You’d receive $0 cash (it all goes to the bank) and report rent income only when received — meaning no income for the last 3 years.

⚖️ What Section 467 Requires

IRS Section 467 says:

“You can’t front-load deductions or back-load income by having rent holidays. We’ll smooth (‘level’) the rent over the entire term.”

So instead of showing $180,000 for 22 years and $0 for 3 years, you must report the same ‘level rent’ every year:

Total rent ÷ 25 years = $3,960,000 ÷ 25 = $158,400 per year

That means you must accrue $158,400 of rental income every year, even in the final 3 years when the tenant pays nothing.

📘 Year-by-Year Example (Simplified)

🧮 What It Means Financially

• Years 1–22: You over-pay debt vs. tax income → small timing deduction.

• Years 23–25: No rent collected but still taxed on “accrued” income → phantom income.

• Over 25 years it balances, but taxes shift forward.

🧭 Why Investors Accept This

• Ideal for 1031 exchange buyers wanting a fully passive, predictable asset.

• Property is often owned by a credit-rated tenant (Walgreens, FedEx, etc.).

• Tax timing issue only — not a real cash loss.

• At loan maturity, you own the building free and clear.

🧾 Summary Table