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loan is recharacterized as an arm's-length transaction in which
the lender made a loan to the borrower in exchange for a note
requiring the payment of interest at the applicable Federal rate.
The amount by which the interest which would have been payable on
the loan at the applicable Federal rate exceeds the interest
payable pursuant to the loan agreement is called "forgone
interest". Sec. 7872(e)(2). The forgone interest is treated as:
(1) Transferred from the lender to the borrower; and (2)
retransferred from the borrower to the lender as interest paid on
the loan. Sec. 7872(a)(1)(A) and (B). The first transfer is
treated as a gift, dividend, payment of compensation, or other
payment to the borrower, depending on the relationship between
the lender and the borrower. KTA-Tator, Inc. v. Commissioner,
supra at 102. The second transfer is treated as a payment of
interest by the borrower to the lender which is includable in the
lender's income and deductible by the borrower to the extent
allowable under section 163. Id.
Petitioners agree that the advances made by KHTC fall within
the section 7872(e)(1) definition of a below-market loan. They
contend, however, that respondent erred in determining the
amounts of the outstanding loans which were subject to section
7872 during the taxable years in issue. They argue that some of
the older loans were "unenforceable" during the taxable years in
issue by reason of Oregon's statute of limitation for commencing
actions upon a liability, effectively exempting such loans from
section 7872. Petitioners calculate that the correct amounts of
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