In most big-ticket lease financings of equipment, the lessee has a right to cause the lessor to refinance the debt if interest rates fall. Rents are then recalculated to pass through the benefit of the lower financing costs. The lessee pays the cost of the refinancing as “supplemental rent.”

The owner of a power plant got into a dispute with the IRS about such a provision recently on audit. The parties amended the participation agreement for an existing power plant lease to give the lessee the right to ask for a refinancing. The lessee then exercised this right. At the same time, the parties agreed to extend the term of the lease. The lessee deducted the cost of the refinancing as additional rent. The IRS said it had to be amortized over the remaining term of the extended lease.

The lessee argued that spending to reduce future costs can be deducted immediately. The IRS said the spending in this case served two purposes — not only to reduce rents but also to extend the lease. The IRS explained its position in a “technical advice memorandum” in November. The number is TAM 200145003.