## Facts

- A domestic corporation using the accrual method made first mortgage construction and development loans with terms of 18 to 36 months.
- Borrowers generally repaid the loans in a single lump-sum upon project completion when permanent financing was obtained.
- In addition to stated interest, the lender charged “points,” calculated as a percentage of the loan’s face amount, as compensation for making the loan.
- No rebate of points was provided if a loan was repaid before its stated due date.
- In most cases, the lender withheld the points from the initial disbursement of loan proceeds; in other cases, the borrower paid the points by check at origination or at repayment.
- The points were not paid for specific services; they were treated as an interest adjustment reflecting the cost of borrowing.

## Issues

1. For an accrual-basis lender, when must points treated as interest on short-term construction loans be included in gross income: entirely at loan origination when withheld/paid, or over the loan term as interest accrues (or earlier as payments become due or are received)?

## Decision

- The points were characterized as interest (compensation for the use or forbearance of money), not as fees for specific services.
- The lender must include the points in gross income over the term of the loan as the interest accrues, rather than entirely at the time the loan is made.
- Up-front withholding or receipt of the points does not, by itself, require immediate inclusion of the full amount.

## Legal Principles

- Under the accrual method, income is includible when all events have occurred that fix the right to receive the income and the amount is reasonably determinable; the test is met at the earliest of performance, due date, or payment.
- For interest, the relevant “performance” occurs as the borrower is allowed to use the funds over the agreed period.
- Points computed as a percentage of principal and not tied to specific services are treated as discounted interest, includible over the loan term as payments become due, or earlier if actually received.

## Conclusion

An accrual-basis construction lender must recognize loan points that function as interest as the borrower’s use of funds occurs over the loan period, with inclusion aligned to interest accrual (or earlier when due or received), even if the points are withheld or paid at origination.


Rev. Rul. 74-607, 1974-2 C.B. 149 (1974)