26 U.S.C. § 1274 — Determination of issue price in the case of certain debt instruments issued for property

(a) For a debt instrument covered by this section, the issue price is (1) the stated principal amount if it has adequate stated interest, or (2) otherwise, its imputed principal amount. (b)(1) Unless paragraph (3) applies, imputed principal amount equals the sum of the present values of all payments due under the instrument. (2) Regulations prescribed by the Secretary determine each payment's present value as of the sale or exchange date, using the applicable Federal rate compounded twice a year. (3)(A) In a potentially abusive situation, the imputed principal amount of an instrument received for property is the property's fair market value, adjusted for other consideration in the transaction. (B) “Potentially abusive situation” means (i) a tax shelter as defined in section 6662(d)(2)(C)(ii), or (ii) another situation that, because of recent sales, nonrecourse financing, financing lasting longer than the property's economic life, or other circumstances, regulations identify as having potential for tax avoidance. (c)(1) Except as otherwise provided here, this section applies to a debt instrument given for a property sale or exchange if (A) its stated redemption price at maturity is greater than the stated principal amount when interest is adequate, or greater than the imputed principal amount otherwise, and (B) some or all payments are due more than six months after the sale or exchange. (2) Interest is adequate when the stated principal amount is no more than the imputed principal amount. (3) This section does not apply to: (A) a debt instrument from an individual, estate, testamentary trust, qualifying small business corporation, or similarly qualifying partnership selling or exchanging a farm, if the sale price cannot exceed $1,000,000; related sales are combined; (B) an individual's sale or exchange of a principal residence as defined in section 121; (C) a sale or exchange when the total of payments under all debt instruments plus other consideration does not exceed $250,000, with non-debt consideration counted at fair market value and related transactions combined; (D) an instrument covered by section 1273(b)(3); (E) in a section 1235(a) patent transfer, any amount contingent on the property's productivity, use, or disposition; or (F) an instrument to the extent section 483(e) applies. (4) Assuming an instrument, or acquiring property subject to it, is ignored in deciding whether this section or section 483 applies unless the instrument's terms or the transaction's nature changes in connection with that assumption or acquisition. (d)(1)(A) For an instrument term of not over three years, the applicable Federal rate is the Federal short-term rate; over three but not over nine years, it is the Federal mid-term rate; and over nine years, it is the Federal long-term rate. (B) Each calendar month the Secretary sets those rates for the following month. (C) The short-term rate is based on the average market yield during a one-month period selected by the Secretary and ending in the determination month on outstanding marketable United States obligations maturing in three years or less. The mid-term and long-term rates use the same principles. (D) Regulations may allow a lower rate if the taxpayer proves to the Secretary that it uses the same principles and fits the instrument's term. (2)(A) For a sale or exchange, use the lowest applicable Federal rate for the relevant three-month period. (B) “Lowest 3-month rate” means the lowest rate in effect in any month of the three-calendar-month period ending with the first month in which a written binding contract exists. (3) Regulations must count renewal and extension options when determining the instrument's term. (e)(1) For an instrument covered by this subsection, the discount rate under subsection (b)(2)(B) or section 483(b) is 110 percent of the applicable Federal rate, compounded twice a year. (2) Section 1274A does not apply. (3) This subsection applies when the instrument is given for a property sale or exchange and, under a plan, the transferor or a related person leases part of the property after the sale or exchange.