Limitation on Deduction for Business Interest Expense, 56686-56845 [2020-16531]
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9905]
RIN 1545–BO73; RIN 1545–BP07
Limitation on Deduction for Business
Interest Expense
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:
This document contains final
regulations providing guidance about
the limitation on the deduction for
business interest expense after
amendment of the Internal Revenue
Code (Code) by the provisions
commonly known as the Tax Cuts and
Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus
Aid, Relief, and Economic Security Act,
which was enacted on March 27, 2020.
The regulations provide guidance to
taxpayers on how to calculate the
limitation, what constitutes interest for
purposes of the limitation, which
taxpayers and trades or businesses are
subject to the limitation, and how the
limitation applies in consolidated
group, partnership, international, and
other contexts.
DATES:
Effective date: The regulations are
effective on November 13, 2020.
Sections 1.163(j)–1 through 1.163(j)–11
are generally applicable to taxable years
beginning on or after November 13,
2020.
Applicability dates: For dates of
applicability, see §§ 1.163(j)–1(c),
1.163(j)–2(k), 1.163(j)–3(d), 1.163(j)–
4(g), 1.163(j)–5(h), 1.163(j)–6(p),
1.163(j)–9(k), 1.163(j)–10(f), 1.163(j)–
11(d), 1.263A–15(a), 1.381(c)(20)–1(d),
1.382–2(b)(3), 1.382–5(f), 1.382–6(h),
1.383–1(j), 1.446–3(j)(2), 1.469–11(a)(3)
and (4), 1.1502–36(h)(2), 1.1502–99(d),
and 1.1504–4(i).
Pursuant to section 7805(b)(7),
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may apply the rules set
forth in §§ 1.163(j)–1 through 1.163(j)–
11, in their entirety, to a taxable year
beginning after December 31, 2017, and
before November 13, 2020, so long as
the taxpayers and their related parties
consistently apply these rules, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1,469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
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SUMMARY:
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1.1502–90, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–2, 1.382–5, 1.382–6,
and 1.383–1), and 1.1504–4, to that
taxable year. However, see § 1.163(j)–
1(c) for the applicability date rules
relating to notional principal contracts
and the interest anti-avoidance rule; see
also part II(E)(2) (relating to notional
principal contracts) and part II(E)(4)
(relating to the interest anti-avoidance
rule) of the Summary of Comments and
Revisions section of this preamble.
Alternatively, taxpayers and their
related parties, within the meaning of
sections 267(b) and 707(b)(1), may rely
on proposed §§ 1.163(j)–1 through
1.163(j)–11, which were issued in a
notice of proposed rulemaking (REG–
106089–18) and published on December
28, 2018, in the Federal Register (83 FR
67490), in their entirety, for a taxable
year beginning after December 31, 2017,
and before November 13, 2020, so long
as the taxpayers and their related parties
consistently apply proposed §§ 1.163(j)–
1 through –11, and, if applicable,
proposed §§ 1.263A–9, 1.381(c)(20)–1,
1.382–1, 1.382–2, 1.382–5, 1.382–6,
1.382–7, 1.383–0, 1.383–1, 1.469–9,
1.469–11, 1.882–5, 1.1502–13, 1.1502–
21, 1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, and 1.383–1), and 1.1504–4,
to that taxable year. Notwithstanding
the preceding sentence, taxpayers
applying the provisions in the notice of
proposed rulemaking may apply
§ 1.163(j)–1(b)(1)(iii) in these final
regulations for taxable years beginning
after December 31, 2017.
With respect to § 1.382–2 and, if
applicable, §§ 1.1502–91 through
1.1502–99 (to the extent they effectuate
the rules of § 1.382–2), and with respect
to § 1.382–5 and, if applicable,
§§ 1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§ 1.382–5), the regulations apply to
testing dates and ownership changes,
respectively, occurring on or after
November 13, 2020.
Taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of § 1.382–2 and, if applicable,
§§ 1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§ 1.382–2), and § 1.382–5 and, if
applicable, §§ 1.1502–91 through
1.1502–99 (to the extent they effectuate
the rules of § 1.382–5), to a testing date
or an ownership change, respectively,
that occurs in a taxable year beginning
after December 31, 2017, and before
November 13, 2020, so long as the
taxpayers and their related parties
consistently apply the rules of
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§§ 1.163(j)–1 through –11, 1.382–1,
1.382–2, 1.382–5, 1.382–6, 1.382–7,
1.383–0, and 1.383–1, and, if applicable,
§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–90, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–2, 1.382–5, 1.382–6,
and 1.383–1), and 1.1504–4, to that
taxable year.
Alternatively, taxpayers and their
related parties, within the meaning of
sections 267(b) and 707(b)(1), may rely
on the rules of proposed § 1.382–2 and,
if applicable, §§ 1.1502–91 through
1.1502–99 (to the extent they effectuate
the rules of § 1.382–2), and § 1.382–5
and, if applicable, §§ 1.1502–91 through
1.1502–99 (to the extent they effectuate
the rules of § 1.382–5), which were
issued in a notice of proposed
rulemaking (REG–106089–18) and
published on December 28, 2018, in the
Federal Register (83 FR 67490), with
respect to a testing date or an ownership
change, respectively, that occurs in a
taxable year beginning after December
31, 2017, and before November 13,
2020, so long as the taxpayers and their
related parties consistently apply the
rules of proposed §§ 1.163(j)–1 through
–11, 1.382–1, 1.382–2, 1.382–5, 1.382–6,
1.382–7, 1.383–0, and 1.383–1, and, if
applicable, proposed §§ 1.263A–9,
1.381(c)(20)–1, 1.469–9, 1.469–11,
1.882–5, 1.1502–13, 1.1502–21, 1.1502–
36, 1.1502–79, 1.1502–90, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, and 1.383–1), and 1.1504–4,
to that taxable year. As noted
previously, taxpayers relying on the
provisions in the notice of proposed
rulemaking may apply § 1.163(j)–
1(b)(1)(iii) in these final regulations for
taxable years ending after December 31,
2017.
FOR FURTHER INFORMATION CONTACT:
Concerning § 1.163(j)–1, § 1.163(j)–2,
§ 1.163(j)–3, § 1.163(j)–9, § 1.263A–9, or
§ 1.263A–15, Sophia Wang, (202) 317–
4890 or Justin Grill, (202) 317–4850;
concerning § 1.163(j)–4, § 1.163(j)–5,
§ 1.163(j)–10, § 1.163(j)–11,
§ 1.381(c)(20)–1, § 1.382–1, § 1.382–2,
§ 1.382–5, § 1.382–6, § 1.382–7, § 1.383–
0, § 1.383–1, § 1.1502–13, § 1.1502–21,
§ 1.1502–36, § 1.1502–79, § 1.1502–90,
§ 1.1502–91, § 1.1502–95, § 1.1502–98,
§ 1.1502–99, or § 1.1504–4, Russell
Jones, (202) 317–5357, John Lovelace,
(202) 317–5363, Aglaia Ovtchinnikova,
(202) 317–6975, or Marie C. MilnesVasquez, (202) 317–3181; concerning
§ 1.163(j)–6, § 1.469–9(b)(2), § 1.469–11,
§ 1.704–1, § 1.1362–3, § 1.1368–1, or
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§ 1.1377–1, William Kostak, (202) 317–
6852, Anthony McQuillen, (202) 317–
5027, or Adrienne Mikolashek, (202)
317–5050; concerning § 1.163(j)–7,
§ 1.163(j)–8, or § 1.882–5, Azeka
Abramoff, (202) 317–3800, Angela
Holland, (202) 317–5474, or Steve
Jensen, (202) 317–6938; concerning
§ 1.446–3, § 1.860C–2, RICs, REITs,
REMICs, and the definition of the term
‘‘interest’’, Michael Chin, (202) 317–
5846 (not toll-free numbers).
ADDRESSES: Submit electronic
submissions to the Federal eRulemaking
Portal at https://www.regulations.gov
(indicate IRS and REG–106089–18) by
following the online instructions for
submitting comments. Once submitted
to the Federal eRulemaking Portal,
comments cannot be edited or
withdrawn. The Department of the
Treasury (Treasury Department) and the
Internal Revenue Service (IRS) will
publish for public availability any
comment received to its public docket,
whether submitted electronically or in
hard copy. Send hard copy submissions
to CC:PA:LPD:PR (REG–106089–18),
Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
SUPPLEMENTARY INFORMATION:
Background
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Table of Contents
I. Overview
II. Comments on and Changes to Proposed
§ 1.163(j)–1: Definitions
A. Definition and Calculation of Adjusted
Taxable Income (ATI)—Proposed
§ 1.163(j)–1(b)(1)
1. Taxable Income and Tentative Taxable
Income
2. Adjustments to ATI for Amounts
Incurred as Depreciation, Amortization,
and Depletion
3. ATI and Floor Plan Financing Interest
4. Adjustments to Taxable Income in
Computing ATI Under Section
163(j)(8)(A)
5. Certain Adjustments to Tentative
Taxable Income in Computing ATI
Under Section 163(j)(8)(B)
6. Adjustments to Adjusted Taxable
Income in Respect of United States
Shareholders of CFCs
B. Definition of Business Interest
Expense—Proposed § 1.163(j)–1(b)(2)
C. Definition of Excepted Regulated Utility
Trade or Business—Proposed § 1.163(j)–
1(b)(13)
D. Definition of Floor Plan Financing
Interest Expense—Proposed § 1.163(j)–
1(b)(17)
E. Definition of Interest—Proposed
§ 1.163(j)–1(b)(20)
1. In General
2. Swaps With Significant Nonperiodic
Payments
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary
Income or Loss on Certain Debt
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Instruments, Section 1258 Gain, and
Factoring Income
ii. Substitute Interest Payments
iii. Commitment Fees
iv. Debt Issuance Costs
v. Guaranteed Payments
vi. Hedging Transactions
vii. Other Items
a. Dividends From Regulated Investment
Company (RIC) Shares
b. MMF Income
c. Negative Interest
d. Leases
4. Anti-Avoidance Rule for Amounts
Predominantly Associated With the
Time Value of Money
5. Authority Comments
F. Definition of Motor Vehicle—Proposed
§ 1.163(j)–1(b)(25)
G. Definition of Taxable Income—Proposed
§ 1.163(j)–1(b)(37)
1. Calculation of Taxable Income
2. Interaction With Section 250
3. When Disallowed Business Interest
Expense is ‘‘Paid or Accrued’’
4. Interaction With Sections 461(l), 465,
and 469—Proposed § 1.163(j)–1(b)(37)
H. Definition of Trade or Business—
Proposed § 1.163(j)–1(b)(38)
1. In General
2. Multiple Trades or Businesses Within an
Entity
3. Rental Real Estate Activities as a Trade
or Business
4. Separate Entities
I. Applicability Dates
III. Comments on and Changes to Proposed
§ 1.163(j)–2: Deduction for Business
Interest Expense Limited
A. Whether the Section 163(j) Limitation Is
a Method of Accounting
B. General Gross Receipts Test and
Aggregation
C. Small Business Exemption and Single
Employer Aggregation Rules—Proposed
§§ 1.163(j)–2(d) and 1.52–1(d)(1)(i)
D. Small Business Exemption and Tax
Shelters—Proposed § 1.163(j)–2(d)(1)
E. Gross Receipts for Partners in
Partnerships and Shareholders of S
Corporation Stock—Proposed § 1.163(j)–
2(d)(2)(iii)
IV. Comments on and Changes to Section
Proposed § 1.163(j)–3: Relationship of
Section 163(j) Limitation to Other
Provisions Affecting Interest
A. Capitalized Interest
B. Provisions That Characterize Interest
Expense as Something Other Than
Business Interest Expense
C. Section 108
D. Sections 461(l), 465, and 469
V. Comments on and Changes to Proposed
§ 1.163(j)–4: General Rules Applicable to
C Corporations (Including Real Estate
Investment Trusts (REITs), RICs, and
Members of Consolidated Groups) and
Tax-Exempt Corporations
A. Aggregating Affiliated but NonConsolidated Entities
B. Intercompany Transactions and
Intercompany Obligations
C. Repurchase Premium on Obligations
That Are Deemed Satisfied and Reissued
D. Intercompany Transfers of Partnership
Interests
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1. Overview of Proposed § 1.163(j)–4(d)(4)
2. Intercompany Transfers of Partnership
Interests Treated as Dispositions; SingleEntity Treatment; Application of
§ 1.1502–13
3. Possible Approach to Intercompany
Partnership Interest Transfers
4. Offsetting Excess Business Interest
Expense and Adjusted Taxable Income
Within the Consolidated Group
5. Intercompany Nonrecognition
Transactions
6. Basis Adjustments Under § 1.1502–32
7. Partnership Terminations
E. Application of § 1.1502–36 to Excess
Business Interest Expense
F. Calculating ATI for Cooperatives
G. Calculating ATI for a Consolidated
Group
H. Application of Section 163(j) to LifeNonlife Groups
I. Application of Section 163(j) to TaxExempt Entities
J. Partnership Investment Income and
Corporate Partners
K. Earnings and Profits of a Corporate
Partner
VI. Comments on and Changes to Proposed
§ 1.163(j)–5: General Rules Governing
Disallowed Business Interest Expense
Carryforwards for C Corporations
A. Absorption of Disallowed Business
Interest Expense Carryforwards Before
Use of NOLs in Life-Nonlife Groups
B. Carryforwards from Separate Return
Limitation Years
C. Offsetting Business Interest Expense
With Business Interest Income and Floor
Plan Financing Interest Expense at the
Member Level
VII. Comments on and Changes to Section
1.163(j)–6: Application of the Business
Interest Expense Deduction Limitations
to Partnerships and Subchapter S
Corporations
A. Partnership-Level Calculation and
Allocation of Section 163(j) Excess Items
1. Nonseparately Stated Taxable Income or
Loss of the Partnership
2. Requested Clarifications and
Modifications
3. Recommended Alternative Methods
4. Publicly Traded Partnerships
5. Pro Rata Exception
B. Basis Adjustments
1. Basis and Capital Account Adjustments
for Excess Business Interest Expense
Allocations
2. Basis Adjustments Upon Disposition of
Partnership Interests Pursuant to Section
163(j)(4)(B)(iii)(II)
3. Intercompany Transfer of a Partnership
Interest
C. Debt-Financed Distributions
D. Trading Partnerships
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
F. Partnership Mergers and Divisions
G. Applicability of Section 382 to S
Corporations Regarding Disallowed
Business Interest Expense Carryforwards
H. Separate Application of Section 163(j)
Limitation to Short Taxable Years of S
Corporation
I. Partnership or S Corporation Not Subject
to Section 163(j)
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J. Trusts
K. Qualified Expenditures
L. CARES Act Partnership Rules
VIII. Comments on and Changes to Proposed
§ 1.163(j)–7: Application of the Section
163(j) Limitation to Foreign Corporations
and United States Shareholders
IX. Comments on and Changes to Section
1.163(j)–8: Application of the Section
163(j) Limitation to Foreign Persons with
Effectively Connected Taxable Income.
X. Comments on and Changes to Proposed
§ 1.163(j)–9: Elections for Excepted
Trades or Businesses; Safe Harbor for
Certain REITs
A. Protective Elections
B. One-Time Late Election or Withdrawal
of Election Procedures
C. The Anti-Abuse Rule Under Proposed
§ 1.163(j)–9(h)
D. Residential Living Facilities and Notice
With Proposed Revenue Procedure
E. Safe Harbor for Certain REITs
F. Real Property Trade or Business
XI. Comments on and Changes to Proposed
§ 1.163(j)–10: Allocation of Interest
Expense, Interest Income, and Other
Items of Expense and Gross Income to an
Excepted Trade or Business.
A. General Method of Allocation: Asset
Basis
B. Allocation Between Trades or
Businesses and Non-Trades or
Businesses
C. Consolidated Groups
1. Overview
2. Intercompany Transactions
3. Use of Property Derives From an
Intercompany Transaction
4. Purchase of Member Stock From a
Nonmember
5. Inclusion of Income From Excepted
Trades or Businesses in Consolidated
ATI
6. Engaging in Excepted or Non-Excepted
Trades or Businesses as a ‘‘Special
Status’’
D. Quarterly Asset Testing
E. De Minimis Rules
1. Overview
2. Order in Which the De Minimis Rules
Apply
3. Mandatory Application of De Minimis
Rules
4. De Minimis Threshold for Electric
Cooperatives
5. Standardization of 90 Percent De
Minimis Tests
6. Overlapping De Minimis Tests
F. Assets Used in More Than One Trade or
Business
1. Overview
2. Consistency Requirement
3. Changing a Taxpayer’s Allocation
Methodology
4. Mandatory Use of Relative Output for
Utility Trades or Businesses
G. Exclusions From Basis Calculations
H. Look-Through Rules
1. Ownership Thresholds; Direct and
Indirect Ownership Interests
2. Application of Look-Through Rules to
Partnerships
i. In General
ii. Coordination of Look-Through Rule and
Basis Determination Rules
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iii. Applying the Look-Through Rule and
Determining Share of Partnership Basis
iv. Investment Asset Basis Reduction Rule
v. Coordination of Section 752 Basis
Reduction Rule and Investment Asset
Basis Reduction Rule
vi. Allocating Basis in a Partnership
Interest Between Excepted and NonExcepted Trades or Businesses
3. Additional Limitation on Application of
Look-Through Rules to C Corporations
4. Dispositions of Stock in NonConsolidated C Corporations
5. Application of Look-Through Rules to
Small Businesses
6. Application of the Look-Through Rules
to Foreign Utilities
I. Deemed Asset Sale
J. Carryforwards of Disallowed Disqualified
Interest
K. Anti-Abuse Rule
L. Direct Allocation
1. Overview
2. Expansion of the Direct Allocation Rule
3. Basis Reduction Requirement for
Qualified Nonrecourse Indebtedness
4. Direct Allocation Rule for Financial
Services Businesses
XII. Comments on Proposed Changes to
§ 1.382–2: General Rules for Ownership
Change
XIII. Comments on Proposed Changes to
§ 1.382–6: Allocation of Income and Loss
to Periods Before and After the Change
Date for Purposes of Section 382
XIV. Comments on and Changes to Proposed
§ 1.383–1: Special Limitations on Certain
Capital Losses and Excess Credits
XV. Other Comments about Section 382
A. Application of Section 382(l)(5)
B. Application of Section 382(e)(3)
C. Application of Section 382(h)(6)
XVI. Definition of Real Property Trade or
Business
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 163(j) of the Code.
The final regulations reflect
amendments to section 163(j) made by
Public Law 115–97, 131 Stat. 2054
(December 22, 2017), commonly
referred to as the Tax Cuts and Jobs Act
(the TCJA) and the Coronavirus Aid,
Relief, and Economic Security Act,
Public Law 116–136 (2020) (the CARES
Act). Section 13301(a) of the TCJA
amended section 163(j) by removing
prior section 163(j)(1) through (9) and
adding section 163(j)(1) through (10)
and significantly changed the limitation
for deducting interest on certain
indebtedness. The provisions of section
163(j) as amended by section 13301 of
the TCJA are effective for tax years
beginning after December 31, 2017. The
CARES Act further amended section
163(j) by redesignating section
163(j)(10), as amended by the TCJA, as
new section 163(j)(11), and adding a
new section 163(j)(10) providing special
rules for applying section 163(j) to
taxable years beginning in 2019 or 2020.
All references to ‘‘old section 163(j)’’ in
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this document are references to section
163(j) prior to amendment by the TCJA
and the CARES Act, and all references
to ‘‘section 163(j)’’ are references to
section 163(j) as amended by the TCJA
and the CARES Act.
Old section 163(j) generally
disallowed a deduction for ‘‘disqualified
interest’’ paid or accrued by a
corporation in a taxable year if the
payor’s debt-to-equity ratio exceeded 1.5
to 1.0, and if the payor’s net interest
expense exceeded 50 percent of its
adjusted taxable income. Disqualified
interest included interest paid or
accrued to (1) related parties when no
Federal income tax was imposed with
respect to such interest; (2) unrelated
parties in certain instances in which a
related party guaranteed the debt; or (3)
certain real estate investment trusts
(REIT). Interest amounts disallowed for
any taxable year under old section 163(j)
were treated as interest paid or accrued
in the succeeding taxable year and
could be carried forward indefinitely. In
addition, any excess limitation, the
excess of the taxpayer’s net interest
expense over 50 percent of its adjusted
taxable income, could be carried
forward three years. The interest
limitation under old section 163(j) was
designed to prevent a taxpayer from
deducting interest from its U.S. taxable
income without a corresponding
inclusion in U.S. taxable income by the
recipient, or to prevent the stripping of
earnings from the U.S. tax system.
In contrast, section 163(j) now applies
broadly to all business interest expense
regardless of whether the related
indebtedness is between related parties
or incurred by a corporation, and
regardless of the taxpayer’s debt-toequity ratio. Section 163(j) provides an
entirely new limitation on the
deduction for ‘‘business interest
expense’’ of all taxpayers, including, for
example, individuals, corporations,
partnerships, S corporations, unless a
specific exclusion applies under section
163(j). Although certain terms are used
in both old section 163(j) and section
163(j), such as ‘‘adjusted taxable
income,’’ such terms have been updated
in the final regulations to reflect the
new limitation under section 163(j).
Section 163(j) generally limits the
amount of business interest expense that
can be deducted in the current taxable
year (also referred to in this preamble as
the current year). Under section
163(j)(1), the amount allowed as a
deduction for business interest expense
is limited to the sum of (1) the
taxpayer’s business interest income for
the taxable year; (2) 30 percent of the
taxpayer’s adjusted taxable income
(ATI) for the taxable year (30 percent
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ATI limitation); and (3) the taxpayer’s
floor plan financing interest expense for
the taxable year. As further described
later in this Background section, section
163(j)(10), as amended by the CARES
Act, provides special rules relating to
the 30 percent ATI limitation for taxable
years beginning in 2019 or 2020. The
section 163(j) limitation applies to all
taxpayers, except for certain small
businesses that meet the gross receipts
test in section 448(c) and certain trades
or businesses listed in section 163(j)(7).
Section 163(j)(2) provides that the
amount of any business interest not
allowed as a deduction for any taxable
year as a result of the section 163(j)
limitation is carried forward and treated
as business interest paid or accrued in
the next taxable year. In contrast to old
section 163(j), section 163(j) does not
allow the carryforward of any excess
limitation.
Section 163(j)(3) provides that the
section 163(j) limitation does not apply
to a taxpayer, other than a tax shelter as
described in section 448(a)(3), with
average annual gross receipts of $25
million or less, determined under
section 448(c) (including any
adjustment for inflation under section
448(c)(4)). For taxpayers other than
corporations or partnerships, section
163(j)(3) provides that the gross receipts
test is determined for purposes of
section 163(j) as if the taxpayer were a
corporation or partnership.
Section 163(j)(4) provides special
rules for applying section 163(j) in the
case of partnerships and S corporations.
Section 163(j)(4)(A) requires that the
limitation on the deduction for business
interest expense be applied at the
partnership level, and that a partner’s
ATI be increased by the partner’s share
of the partnership’s excess taxable
income, as defined in section
163(j)(4)(C), but not by the partner’s
distributive share of the partnership’s
income, gain, deduction, or loss. Section
163(j)(4)(B)(i) provides that the amount
of partnership business interest expense
limited by section 163(j)(1) is carried
forward at the partner level. Section
163(j)(4)(B)(ii) provides that excess
business interest expense allocated to a
partner and carried forward is available
to be deducted in a subsequent year
only if, and to the extent, the
partnership allocates excess taxable
income to the partner. As further
described later in this Background
section, section 163(j)(10)(A)(ii)(II), as
amended by the CARES Act, provides a
special rule for excess business interest
expense allocated to a partner in a
taxable year beginning in 2019. Section
163(j)(4)(B)(iii) provides basis
adjustment rules for a partner that is
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allocated excess business interest
expense. Section 163(j)(4)(D) provides
that rules similar to the rules of section
163(j)(4)(A) and (C) apply to S
corporations and S corporation
shareholders.
Section 163(j)(5) and (6) defines
‘‘business interest’’ and ‘‘business
interest income,’’ respectively, for
purposes of section 163(j). Generally,
these terms include interest expense
and interest includible in gross income
that is properly allocable to a trade or
business (as defined in section 163(j)(7))
and do not include investment income
or investment expense within the
meaning of section 163(d). The
legislative history states that ‘‘a
corporation has neither investment
interest nor investment income within
the meaning of section 163(d). Thus,
interest income and interest expense of
a corporation is properly allocable to a
trade or business, unless such trade or
business is otherwise explicitly
excluded from the application of the
provision.’’ H. Rept. 115–466, at 386, fn.
688 (2017).
Under section 163(j)(7), the limitation
on the deduction for business interest
expense in section 163(j)(1) does not
apply to certain trades or businesses
(excepted trades or businesses). The
excepted trades or businesses are the
trade or business of providing services
as an employee, electing real property
businesses, electing farming businesses,
and certain regulated utility businesses.
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer without
regard to the following: Items not
properly allocable to a trade or business;
business interest and business interest
income; net operating loss (NOL)
deductions; and deductions for
qualified business income under section
199A. ATI also generally excludes
deductions for depreciation,
amortization, and depletion with
respect to taxable years beginning before
January 1, 2022, and it includes other
adjustments provided by the Secretary
of the Treasury.
Section 163(j)(9) defines ‘‘floor plan
financing interest’’ as interest paid or
accrued on ‘‘floor plan financing
indebtedness.’’ These provisions allow
taxpayers incurring interest expense for
the purpose of securing an inventory of
motor vehicles held for sale or lease to
deduct the full expense without regard
to the section 163(j) limitation.
Under section 163(j)(10)(A)(i), the
amount of business interest that is
deductible under section 163(j)(1) for
taxable years beginning in 2019 or 2020
is computed using 50 percent, rather
than 30 percent, of the taxpayer’s ATI
for the taxable year (50 percent ATI
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limitation). A taxpayer may elect not to
apply the 50 percent ATI limitation to
any taxable year beginning in 2019 or
2020, and instead apply the 30 percent
ATI limitation. The election must be
made separately for each taxable year.
Once the taxpayer makes the election,
the election may not be revoked without
the consent of the Secretary of the
Treasury or his delegate. See section
163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and
163(j)(10)(A)(iii) provide that, in the
case of a partnership, the 50 percent ATI
limitation does not apply to
partnerships for taxable years beginning
in 2019, and the election to not apply
the 50 percent ATI limitation may be
made only for taxable years beginning in
2020. This election may be made only
by the partnership and may not be
revoked without the consent of the
Secretary of the Treasury or his
delegate. Under section
163(j)(10)(A)(ii)(II), however, a partner
treats 50 percent of its allocable share of
a partnership’s excess business interest
expense for 2019 as a business interest
expense in the partner’s first taxable
year beginning in 2020 that is not
subject to the section 163(j) limitation
(50 percent EBIE rule). The remaining
50 percent of the partner’s allocable
share of the partnership’s excess
business interest expense remains
subject to the section 163(j) limitation
applicable to excess business interest
expense carried forward at the partner
level. A partner may elect out of the 50
percent EBIE rule.
Section 163(j)(10)(B)(i) allows a
taxpayer to elect to use its ATI for the
last taxable year beginning in 2019 for
the taxpayer’s ATI in determining the
taxpayer’s section 163(j) limitation for
any taxable year beginning in 2020.
Section 163(j)(11) provides crossreferences to provisions requiring that
electing farming businesses and electing
real property businesses excepted from
the section 163(j) limitation use the
alternative depreciation system (ADS),
rather than the general depreciation
system for certain types of property. The
required use of ADS results in the
inability of these electing trades or
businesses to use the additional firstyear depreciation deduction under
section 168(k) for those types of
property.
On December 28, 2018, the Treasury
Department and the IRS (1) published
proposed regulations under section
163(j) in a notice of proposed
rulemaking (REG–106089–18) (proposed
regulations) in the Federal Register (83
FR 67490), and (2) withdrew the notice
of proposed rulemaking (1991–2 C.B.
1040) published in the Federal Register
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on June 18, 1991 (56 FR 27907) (as
corrected by 56 FR 40285 (August 14,
1991)) to implement rules under old
section 163(j) (1991 Proposed
Regulations). The proposed regulations
were issued following guidance
announcing and describing regulations
intended to be issued under section
163(j). See Notice 2018–28, 2018–16
I.R.B. 492.
A public hearing was held on
February 27, 2019. The Treasury
Department and the IRS received
written comments responding to the
notice of proposed rulemaking.
Comments received before the final
regulations were substantially
developed, including all comments
received on or before the deadline for
comments on February 26, 2019, were
carefully considered in developing the
final regulations.
Copies of the comments received are
available for public inspection at https://
www.regulations.gov or upon request.
After consideration of the comments
received and the testimony at the public
hearing, this Treasury decision adopts
the proposed regulations as revised in
response to such comments and
testimony as described in the Summary
of Comments and Explanation of
Revisions section. The revisions are
discussed in this preamble.
Concurrently with the publication of the
final regulations, the Treasury
Department and the IRS are publishing
in the Proposed Rule section of this
edition of the Federal Register (RIN
1545–BO76) a notice of proposed
rulemaking providing additional
proposed regulations under section
163(j) (REG–107911–18) (Concurrent
NPRM). The Concurrent NPRM includes
proposed regulations relating to changes
made to section 163(j) under the CARES
Act.
On September 10, 2019, the Treasury
Department and the IRS published
proposed regulations under section
382(h) (REG–125710–18) in the Federal
Register (84 FR 47455) (the September
2019 section 382 proposed regulations).
The September 2019 section 382
proposed regulations included a rule to
clarify that section 382 disallowed
business interest carryforwards are not
treated as recognized built-in losses
(RBILs). No formal comments were
received on this rule during the
comment period for the September 2019
section 382 proposed regulations.
On April 10, 2020, the Treasury
Department and the IRS released
Revenue Procedure 2020–22, 2020–18
I.R.B. 745, to provide the time and
manner of making a late election, or
withdrawing an election under section
163(j)(7)(B) to be an electing real
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property trade or business, or under
section 163(j)(7)(C) to be an electing
farming business, for taxable years
beginning in 2018, 2019, or 2020.
Revenue Procedure 2020–22 also
provides the time and manner of making
or revoking elections provided by the
CARES Act under section 163(j)(10) for
taxable years beginning in 2019 or 2020.
As described earlier in this Background
section, these elections are: (1) To not
apply the 50 percent ATI limitation
under section 163(j)(10)(A)(iii); (2) to
use the taxpayer’s ATI for the last
taxable year beginning in 2019 to
calculate the taxpayer’s section 163(j)
limitation in 2020 under section
163(j)(10)(B); and (3) for a partner to
elect out of the 50 percent EBIE rule
under section 163(j)(10)(A)(ii)(II).
Summary of Comments and
Explanation of Revisions
I. Overview
The Treasury Department and the IRS
received approximately 120 written
comments in response to the notice of
proposed rulemaking. Most of the
comments addressing the proposed
regulations are summarized in this
Summary of Comments and Explanation
of Revisions section. However,
comments merely summarizing or
interpreting the proposed regulations or
recommending statutory revisions
generally are not discussed in this
preamble. Additionally, comments
outside the scope of this rulemaking are
generally not addressed in this
Summary of Comments and Explanation
of Revisions section.
The Treasury Department and the IRS
continue to study comments on certain
issues related to section 163(j),
including issues that are beyond the
scope of the final regulations (or the
Concurrent NPRM in the Proposed
Rules section of this issue of the Federal
Register), and may discuss those
comments if future guidance on those
issues is published.
The final regulations retain the same
basic structure as the proposed
regulations, with certain revisions.
II. Comments on and Changes to
Proposed § 1.163(j)–1: Definitions
Section 1.163(j)–1 provides
definitions of the terms used in the final
regulations. The following discussion
addresses comments relating to
proposed § 1.163(j)–1.
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A. Definition and Calculation of
Adjusted Taxable Income (ATI)—
Proposed § 1.163(j)–1(b)(1)
1. Taxable Income and Tentative
Taxable Income
Consistent with section 163(j)(8),
proposed § 1.163(j)–1(b)(1) defines ATI
as the ‘‘taxable income’’ of the taxpayer
for the taxable year, with certain
specified adjustments. Thus, in
calculating ATI, the proposed
regulations begin with taxable income
as the amount to which adjustments are
made when calculating ATI. Proposed
§ 1.163(j)–1(b)(37)(i) generally provides
that the term ‘‘taxable income’’ has the
meaning provided in section 63, but for
purposes of section 163(j), is computed
without regard to the application of
section 163(j) and the section 163(j)
regulations. However, in some instances
in the section 163(j) regulations the term
‘‘taxable income’’ is used to indicate the
amount calculated under section 63 for
purposes other than calculating ATI.
To prevent confusion from using the
term ‘‘taxable income’’ in different
contexts (in determining ATI, and for
purposes other than determining ATI),
the final regulations use a new term,
‘‘tentative taxable income,’’ to refer to
the amount to which adjustments are
made in calculating ATI. See § 1.163(j)–
1(b)(43). Tentative taxable income is
generally determined in the same
manner as taxable income under section
63, but is computed without regard to
the application of the section 163(j)
limitation, and without regard to any
disallowed business interest expense
carryforwards. This definitional change
avoids confusion with section 63
taxable income, avoids creating an
iterative loop that takes into account the
section 163(j) limitation, and ensures
that disallowed business interest
expense carryforwards are taken into
account only once in testing business
interest expense against the limitation.
Therefore, ‘‘tentative taxable income’’
is used in the final regulations and,
where appropriate, in this Summary of
Comments and Explanation of
Provisions section, to describe the
starting point for the calculation of ATI
in the final regulations. See part II(G)(1)
of this Summary of Comments and
Explanation of Revisions section.
2. Adjustments to ATI for Amounts
Incurred as Depreciation, Amortization,
and Depletion
Section 163(j)(8)(A)(v) defines ATI as
the taxable income of the taxpayer
computed without regard to certain
items, including any deduction
allowable for depreciation,
amortization, or depletion for taxable
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years beginning before January 1, 2022.
Consistent with section 163(j)(8)(A)(v),
proposed § 1.163(j)–1(b)(1)(i) requires an
addback to taxable income of
deductions for depreciation,
amortization, and depletion for taxable
years beginning before January 1, 2022.
In general, section 263A requires certain
taxpayers that manufacture or produce
inventory to capitalize all direct costs
and certain indirect costs into the basis
of the property produced or acquired for
resale. Depreciation, amortization or
depletion that is capitalized into
inventory under section 263A is
recovered through cost of goods sold as
an offset to gross receipts in computing
gross income; cost of goods sold reduces
the amount realized upon the sale of
goods that is used to calculate gross
income and is technically not a
deduction that is applied against gross
income in determining taxable income.
See §§ 1.61–3(a) and 1.263A–
1(e)(3)(ii)(I) and (J). Thus, proposed
§ 1.163(j)–1(b)(1)(iii) provides that
depreciation, amortization, or depletion
expense capitalized into inventory
under section 263A is not a
depreciation, amortization, or depletion
deduction, that may be added back to
taxable income in computing ATI. The
preamble to the proposed regulations
further noted that an amount that is
incurred as depreciation, amortization,
or depletion, but that is capitalized to
inventory under section 263A and
included in costs of goods sold, is not
a deduction for depreciation,
amortization, or depletion for purposes
of section 163(j).
Many commenters raised questions
and concerns regarding proposed
§ 1.163(j)–1(b)(1)(iii) and requested that
the addback of deductions for
depreciation, amortization, and
depletion include any amount that is
required to be capitalized into inventory
under section 263A. First, commenters
stated that the provision does not reflect
congressional intent, which was to
determine ATI using earnings before
interest, tax, depreciation, and
amortization (EBITDA) through taxable
year 2021 and using earnings before
interest and tax (EBIT) thereafter.
Commenters noted that the proposed
rule would eliminate this distinction for
certain manufacturers or producers of
property for sale. Commenters pointed
out that capital-intensive businesses
that manufacture or produce inventory
are at a disadvantage in comparison to
other types of businesses because the
manufacturers or producers would have
to compute ATI without an addback for
a substantial amount of their
depreciation, and that neither section
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163(j) nor its legislative history
indicates an intent by Congress to treat
manufacturers or producers of inventory
differently from other trades or
businesses. Commenters also contrasted
the language in section 163(j)(8)(A)(iv),
which allows an addback of ‘‘the
amount of any deduction allowed under
section 199A,’’ with section
163(j)(8)(A)(v), which allows an
addback of ‘‘any deduction allowable
for depreciation, amortization, or
depletion’’ (emphasis added).
The phrase ‘‘allowed or allowable’’ is
used in other Code provisions. Section
1016(a)(2) provides that, in calculating
tax basis, adjustments are required for
depreciation to the extent such amounts
are allowed as deductions in computing
taxable income but not less than the
amounts allowable. Some commenters
noted that depreciation allowable as a
deduction for purposes of section
1016(a)(2) should be read consistently
with depreciation allowable as a
deduction for purposes of section 163(j),
and that section 1016(a)(2) treats
depreciation capitalized into inventory
under section 263A as deductions
allowable. As provided in section
263A(a)(2) and § 1.263A–1(c)(2), an
amount is not subject to capitalization
under section 263A unless such cost
may be taken into account in computing
taxable income.
The Treasury Department and the IRS
have reconsidered proposed § 1.163(j)–
1(b)(1)(iii). Accordingly, under the final
regulations, the amount of any
depreciation, amortization, or depletion
that is capitalized into inventory under
section 263A during taxable years
beginning before January 1, 2022, is
added back to tentative taxable income
as a deduction for depreciation,
amortization, or depletion when
calculating ATI for that taxable year,
regardless of the period in which the
capitalized amount is recovered through
cost of goods sold. For example, if a
taxpayer capitalized an amount of
depreciation to inventory under section
263A in the 2020 taxable year, but the
inventory is not sold until the 2021
taxable year, the entire capitalized
amount of depreciation is added back to
tentative taxable income in the 2020
taxable year, and such capitalized
amount of depreciation is not added
back to tentative taxable income when
the inventory is sold and recovered
through cost of goods sold in the 2021
taxable year. Under such facts, the
entire capitalized amount is deemed to
be included in the calculation of the
taxpayer’s tentative taxable income for
the 2020 taxable year, regardless of the
period in which the capitalized amount
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is actually recovered. See §§ 1.163(j)–
1(b)(1)(iii) and 1.163(j)–2(h)(3).
Further, in order to treat similarly
situated taxpayers similarly, the final
regulations allow taxpayers, and their
related parties within the meaning of
sections 267(b) and 707(b)(1), otherwise
relying on the proposed regulations in
their entirety under § 1.163(j)–1(c) to
alternatively choose to follow § 1.163(j)–
1(b)(1)(iii) rather than proposed
§ 1.163(j)–1(b)(1)(iii). See § 1.163(j)–1(c).
The Treasury Department and the IRS
note that neither proposed § 1.163(j)–
1(b)(1) nor § 1.163(j)–1(b)(1) determines
the amount of allowed or allowable
depreciation, amortization, or depletion
for purposes of any other Code section
(for example, sections 167(c), 1016(a)(2),
1245, and 1250). Accordingly, no
inference should be drawn regarding the
determination of the amount of allowed
or allowable depreciation, amortization,
or depletion under any other Code
section based on proposed § 1.163(j)–
1(b)(1) or § 1.163(j)–1(b)(1).
In addition to comments about
whether depreciation, amortization, and
depletion include amounts recovered
through cost of goods sold, a commenter
requested clarification that section 179
deductions are depreciation deductions
for purposes of section 163(j)(8)(A)(v)
and proposed § 1.163(j)–1(b)(1)(i)(D).
Section 179 deductions are allowed to
be added back as amortization under
proposed § 1.163(j)–1(b)(1)(i)(E), which
allows an addback of any deduction for
the amortization of intangibles (for
example, under section 167 or 197) and
other amortized expenditures (for
example, under section 195(b)(1)(B),
248, or 1245(a)(2)(C)), for taxable years
beginning before January 1, 2022.
Section 1245(a)(2)(C) provides ‘‘any
deduction allowable under sections 179,
179B, 179C, 179D, 179E, 181, 190, 193,
or 194 shall be treated as if it were a
deduction allowable for amortization.’’
Because section 179 deductions are
included as amortization under
proposed § 1.163(j)–1(b)(1)(i)(E), rather
than as depreciation under proposed
§ 1.163(j)–1(b)(1)(i)(D), no clarification
is necessary in the final regulations. See
§ 1.163(j)–1(b)(1)(i)(E).
3. ATI and Floor Plan Financing Interest
Consistent with section
163(j)(8)(A)(ii), the proposed regulations
provide that any business interest
expense or business interest income is
added back to (in the case of business
interest expense) or subtracted from (in
the case of business interest income)
taxable income in computing ATI.
Because business interest expense
includes floor plan financing interest
expense, ATI is further adjusted by
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subtracting from it any floor plan
financing interest expense under
proposed § 1.163(j)–1(b)(1)(ii)(B). Floor
plan financing interest expense is also
separately included in the section 163(j)
limitation as provided in section
163(j)(1)(C).
One commenter suggested that floor
plan financing interest expense should
not be subtracted from ATI because
such adjustment is inconsistent with the
statute and the ordering implied by
section 168(k)(9)(B). The addition of
floor plan financing interest expense as
business interest in the calculation of
ATI is consistent with section
163(j)(8)(A)(ii). The purpose of
subtracting floor plan financing interest
expense from tentative taxable income
to compute ATI is to avoid the double
benefit that would result upon
separately including floor plan
financing interest expense in the
computation of the section 163(j)
limitation. If floor plan financing
interest expense were included in ATI
without a corresponding subtraction,
thus resulting in an increased ATI,
taxpayers with such expense would be
able to increase their section 163(j)
limitation not only by the separately
stated floor plan financing interest
under section 163(j)(1)(C), but also by
the inclusion of such amount in ATI,
which would permit a deduction of
$1.30 (or $1.50, if the 50 percent ATI
limitation is applicable) of business
interest expense for each $1 of floor
plan financing interest expense.
Although it is clear that Congress did
not intend to limit the deduction for
floor plan financing interest expense
under section 163(j), there is no
indication that Congress also intended
to provide the additional benefit of an
increased ATI related to floor plan
financing interest expense. Therefore,
under the authority granted in section
163(j)(8)(B), the final regulations adopt
the proposed rule without change to
include a subtraction of floor plan
financing interest expense from
tentative taxable income in computing
ATI.
Several commenters also requested
clarification and submitted
recommendations on the interaction
between section 168(k)(9) and section
163(j). Section 168(k)(9)(B) provides that
the additional first-year depreciation
deduction is not allowed for any
property used in a trade or business that
has had floor plan financing
indebtedness (as defined in section
163(j)(9)), if the floor plan financing
interest related to such indebtedness
was taken into account under section
163(j)(1)(C).
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First, commenters requested that floor
plan financing indebtedness not be
treated as taken into account if the sum
of business interest income and 30
percent of ATI (the sum of section
163(j)(1)(A) and section 163(j)(1)(B)) is
greater than the business interest
expense paid or accrued in the taxable
year. Second, if the sum of business
interest income and 30 percent of ATI
is less than the business interest
expense paid or accrued in the taxable
year, commenters requested that
taxpayers be given the option to either
include floor plan financing interest to
increase the section 163(j) limitation, or
to forgo the use of floor plan financing
interest to increase the section 163(j)
limitation (any forgone floor plan
financing interest would be included in
the disallowed business interest
expense carryforward under proposed
§ 1.163(j)–2(c)) in order to utilize the
additional first-year depreciation
deduction under section 168(k).
Section 163(j) does not provide any
guidance on the availability of section
168(k) for taxpayers that have had floor
plan financing interest expense. As
these comments relate to the operation
of section 168(k)(9), taxpayers should
look to Treasury Department or IRS
guidance provided under section 168(k)
for clarification. On September 24, 2019,
the Treasury Department and the IRS
published in the Federal Register final
regulations (TD 9874, 84 FR 50108) and
proposed regulations (REG–106808–19,
84 FR 50152) under section 168(k). The
rules regarding when floor plan
financing interest expense is ‘‘taken into
account’’ for purposes of 168(k) are in
the proposed regulations under
§ 1.168(k)–2(b)(2)(ii)(G). Accordingly,
these final regulations do not address
the interaction between section 163(j)
and section 168(k)(9) regarding floor
plan financing interest expense.
4. Adjustments to Taxable Income in
Computing ATI Under Section
163(j)(8)(A)
Section 163(j)(8)(A) provides that ATI
means taxable income ‘‘computed
without regard to’’ the specified
adjustments. The purpose of the
adjustments listed in section
163(j)(8)(A) is to keep certain items,
such as deductions for depreciation,
amortization, depletion, or NOL
carryforward amounts, from directly
increasing or decreasing the amount of
the deduction for business interest
expense. Therefore, the Treasury
Department and the IRS have
determined that the adjustments listed
in section 163(j)(8)(A) should adjust
tentative taxable income for purposes of
calculating ATI under § 1.163(j)–1(b)(1)
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only to the extent that they have been
reflected (or deemed reflected, as in the
case of certain amounts capitalized into
inventory under section 263A as
discussed in part II(A)(2) of this
Summary of Comments and Explanation
of Revisions section) in tentative taxable
income under § 1.163(j)–1(b)(43).
A commenter requested that the
definition of ATI not include some of
the adjustments listed in section
163(j)(8)(A), such as the adjustments for
NOL deductions and deductions under
section 199A. The Treasury Department
and the IRS do not have authority to
ignore these clear and unambiguous
statutory adjustments. Thus, the final
regulations do not incorporate the
commenter’s suggestion.
5. Certain Adjustments to Tentative
Taxable Income in Computing ATI
Under Section 163(j)(8)(B)
Under the authority granted in section
163(j)(8)(B), the proposed regulations
include several adjustments to taxable
income in computing ATI to address
certain sales or other dispositions of
depreciable property, stock of a
consolidated group member, or interests
in a partnership. Proposed § 1.163(j)–
1(b)(1)(ii)(C) provides that, if property is
sold or otherwise disposed of, the lesser
of the amount of gain on the disposition
or the amount of depreciation,
amortization, or depletion deductions
(collectively, depreciation deductions)
with respect to the property for the
taxable years beginning after December
31, 2017 and before January 1, 2022
(such years, the EBITDA period) is
subtracted from taxable income to
determine ATI. Proposed § 1.163(j)–
1(b)(1)(ii)(D) provides that, with respect
to the sale or other disposition of stock
of a member of a consolidated group
that includes the selling member, the
investment adjustments (see § 1.1502–
32) with respect to such stock that are
attributable to deductions described in
proposed § 1.163(j)–1(b)(1)(ii)(C) are
subtracted from taxable income. In turn,
proposed § 1.163(j)–1(b)(1)(ii)(E)
provides that, with respect to the sale or
other disposition of an interest in a
partnership, the taxpayer’s distributive
share of deductions described in
proposed § 1.163(j)–1(b)(1)(ii)(C) with
respect to property held by the
partnership at the time of such
disposition is subtracted from taxable
income to the extent such deductions
were allowable under section 704(d).
In general, when a taxpayer takes
depreciation deductions with respect to
an asset, the taxpayer must reduce its
adjusted basis in the asset accordingly.
As a result, the taxpayer will realize
additional gain (or less loss) upon the
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subsequent disposition of the asset than
the taxpayer would have realized absent
depreciation deductions. Thus, except
with regard to timing (and, in some
cases, character), depreciation
deductions should have no net effect on
a taxpayer’s taxable income.
In order to mitigate the effects of the
section 163(j) limitation during the
EBITDA period, Congress provided an
adjustment to taxable income for
depreciation deductions. More
specifically, as discussed in part II(A)(2)
of this Summary of Comments and
Explanation of Revisions section,
depreciation deductions are added back
to taxable income during the EBITDA
period, thereby increasing a taxpayer’s
ATI and its section 163(j) limitation.
Congress intended this adjustment to be
a timing provision that delays the
inclusion of depreciation deductions in
calculating a taxpayer’s section 163(j)
limitation. Stated differently, Congress
intended to allow taxpayers to
accelerate the recognition of gain
attributable to depreciation deductions
when computing ATI.
However, if a taxpayer were to sell its
depreciable property after making the
foregoing adjustment to ATI, the
taxpayer would realize additional gain
(or less loss) on the disposition as a
result of its depreciation deductions,
and the taxpayer’s ATI would be
increased yet again. Similarly, if the
depreciable property were held by a
member of a consolidated group (S), and
if another member of the group were to
sell S’s stock after making negative
adjustments to its basis in S’s stock
under § 1.1502–32 to reflect S’s
depreciation deductions, the
consolidated group’s ATI would be
increased yet again. A similar double
benefit would arise with respect to
interests in a partnership if, after the
partner’s basis in its partnership interest
is reduced by depreciation deductions
associated with the depreciable
property, ATI were to reflect that
reduced basis upon a subsequent sale of
the partnership interest.
Proposed § 1.163(j)–1(b)(1)(ii)(C), (D),
and (E) were intended to address these
situations and ensure that the positive
adjustment for depreciation deductions
during the EBITDA period merely defers
(rather than permanently excludes)
depreciation deductions from a
taxpayer’s calculation of the section
163(j) limitation.
Commenters submitted various
questions and comments about these
provisions. First, a commenter
questioned whether these proposed
subtractions from taxable income are an
advisable exercise of the authority
granted in section 163(j)(8)(B) in light of
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congressional silence on the issue.
However, the 1991 Proposed
Regulations contained similar
subtractions from taxable income in
computing ATI. The 1991 Proposed
Regulations had been outstanding for
more than 25 years when Congress
enacted the TCJA. Thus, Congress likely
was well aware of these adjustments
when it granted the Secretary of the
Treasury the authority to make
adjustments in new section 163(j)(8)(B).
Moreover, there is no indication that
Congress intended to preclude the
Secretary from making adjustments
similar to those in the 1991 Proposed
Regulations.
Second, commenters asked why the
subtraction from taxable income in
proposed § 1.163(j)–1(b)(1)(ii)(D) does
not include a ‘‘lesser of’’ calculation
similar to proposed § 1.163(j)–
1(b)(1)(ii)(C), and they questioned
whether the ‘‘lesser of’’ calculation in
proposed § 1.163(j)–1(b)(1)(ii)(C)
captures the correct amount. For
example, if a taxpayer purchased
property for $100x, fully depreciated the
property, and then sold the property for
$60x, should the amount that is backed
out under proposed § 1.163(j)–
1(b)(1)(ii)(C) be $60x or $100x?
Commenters also stated that the
presence of a ‘‘lesser of’’ limitation in
proposed § 1.163(j)–1(b)(1)(ii)(C) and the
absence of such a limitation in proposed
§ 1.163(j)–1(b)(1)(ii)(D) can yield
discontinuities. For example, if S (a
member of P’s consolidated group) uses
$50x to purchase an asset that it fully
depreciates under section 168(k)
(resulting in a $50x reduction in P’s
basis in its S stock under § 1.1502–32),
and if S sells the depreciated asset for
$25x the following year, the P group
would have to subtract $25x from
taxable income under proposed
§ 1.163(j)–1(b)(1)(ii)(C), whereas the
group would have had to reduce its
taxable income by $50x under proposed
§ 1.163(j)–1(b)(1)(ii)(D) if P had sold its
S stock instead. Commenters
recommended several solutions to
address this discontinuity, including
eliminating the ‘‘lesser of’’ test.
Proposed § 1.163(j)–1(b)(1)(ii)(D) does
not include a ‘‘lesser of’’ calculation
because such a calculation would
require consolidated groups to value
their assets each time there is a sale of
member stock. However, the Treasury
Department and the IRS recognize the
discrepancy in taxable income
adjustments between asset dispositions
and member stock dispositions under
the proposed regulations. To eliminate
this discrepancy, the final regulations
revise proposed § 1.163(j)–1(b)(1)(ii)(C)
by eliminating the ‘‘lesser of’’ standard
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and requiring taxpayers to back out
depreciation deductions that were
allowed or allowable during the
EBITDA period with respect to sales or
dispositions of property. This revised
approach is consistent with the
adjustment for asset sales in the 1991
Proposed Regulations, is simpler for
taxpayers to administer than the ‘‘lesser
of’’ approach in the proposed
regulations, and renders moot questions
as to whether that ‘‘lesser of’’
calculation captures the correct amount.
However, the Treasury Department and
the IRS also recognize that, in certain
cases, a ‘‘lesser of’’ computation would
not be difficult to administer. Thus, the
Concurrent NPRM provides taxpayers
the option to apply the ‘‘lesser of’’
standard, so long as they do so
consistently. See proposed § 1.163(j)–
1(b)(1)(iv)(E) of the Concurrent NPRM.
Third, commenters asked whether the
application of proposed § 1.163(j)–
1(b)(1)(ii)(C) and (D) to the same
consolidated group member would
result in an inappropriate double
inclusion if the asset sale precedes the
stock sale, and whether proposed
§ 1.163(j)–1(b)(1)(ii)(C) should continue
to apply to a group member if the sale
of member stock precedes the asset sale.
For example, S (a member of P’s
consolidated group) takes a $50x
depreciation deduction in 2020 with
respect to asset X, P’s basis in its S stock
is reduced accordingly under § 1.1502–
32, and $50x is added back to the P
group’s tentative taxable income in
computing its 2020 ATI. In 2021, S
realizes a $50x gain upon the sale of
asset X, P’s basis in its S stock is
increased accordingly by $50x under
§ 1.1502–32, and the P group subtracts
$50x from its tentative taxable income
under proposed § 1.163(j)–1(b)(1)(ii)(C)
in computing its 2021 ATI. Then, in
2022, P sells the S stock to an unrelated
buyer. Must P subtract another $50x
from its tentative taxable income under
proposed § 1.163(j)–1(b)(1)(ii)(D)? What
if the order of sales were reversed (with
P selling its S stock to a member of
another consolidated group in 2021 and
S selling asset X in 2022)—would both
consolidated groups be required to
subtract $50x from tentative taxable
income in computing ATI? To prevent
duplicative adjustments under proposed
§ 1.163(j)–1(b)(1)(ii)(C) and (D),
commenters recommended that these
rules ‘‘turn off’’ further subtractions
once a subtraction already has been
made under either provision, and that
the application of proposed § 1.163(j)–
1(b)(1)(ii)(C) be limited to the group in
which the depreciation deductions
accrued.
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The Treasury Department and the IRS
agree that the application of § 1.163(j)–
1(b)(1)(ii)(C) and (D) to the same
consolidated group member would
result in an inappropriate double
inclusion, and that proposed § 1.163(j)–
1(b)(1)(ii)(C) should not apply to a
former group member with respect to
depreciation deductions claimed by the
member in a former group. Thus,
§ 1.163(j)–1(b)(1)(iv)(D) provides antiduplication rules to ensure that neither
§ 1.163(j)–1(b)(1)(ii)(C) nor § 1.163(j)–
1(b)(1)(ii)(D) applies if a subtraction for
the same economic amount already has
been required under either provision.
For example, assume that P wholly
owns S1, which wholly owns S2, which
owns depreciable asset Q, and that S1
and S2 are members of P’s consolidated
group. Further assume that S2’s
depreciation deductions with respect to
asset Q have resulted in investment
adjustments in S1’s stock in S2 and in
P’s stock in S1. If S1 were to sell its S2
stock to a third party, adjustments to the
P group’s tentative taxable income
would be required under proposed
§ 1.163(j)–1(b)(1)(ii)(D). If P later were to
sell its S1 stock to a third party, an
additional adjustment under proposed
§ 1.163(j)–1(b)(1)(ii)(D) would not be
required with respect to investment
adjustments attributable to asset Q.
Fourth, commenters observed that
these proposed subtractions from
taxable income in computing ATI are
required even if the disposition of the
depreciable property, member stock, or
partnership interest occurs many years
after the EBITDA period. Commenters
expressed concern that tracking
depreciation deductions for purposes of
these adjustments could become
burdensome, and a commenter
questioned the appropriateness in
proposed § 1.163(j)–1(b)(1)(ii)(C) of
treating all gain upon the disposition of
property after the EBITDA period as
attributable to depreciation deductions
during the EBITDA period.
Commenters are correct in observing
that these proposed adjustments to
taxable income in computing ATI must
be made even if the relevant depreciable
asset, member stock, or partnership
interest is disposed of after the EBITDA
period. However, the Treasury
Department and the IRS note that
members of consolidated groups already
must track depreciation deductions to
calculate separate taxable income (see
§ 1.1502–12) and to preserve the
location of tax items (see § 1.1502–13).
Additionally, all taxpayers must track
depreciation deductions on an asset-byasset basis for purposes of section 1245.
Thus, the Treasury Department and the
IRS have determined that the
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adjustments proposed in § 1.163(j)–
1(b)(1)(ii)(C), (D), and (E) should not
impose a significant administrative
burden in many situations. The
Treasury Department and the IRS
further note that eliminating the ‘‘lesser
of’’ standard in proposed § 1.163(j)–
1(b)(1)(ii)(C) (see the response to the
second comment in this part of the
Summary of Comments and Explanation
of Revisions section) will render moot
the commenter’s concern about the
calculation of gain.
Fifth, a commenter asked whether the
term ‘‘sale or other disposition’’ in
proposed § 1.163(j)–1(b)(1)(ii)(C), (D),
and (E) is intended to apply to the
transfer of stock of a consolidated group
member in an intercompany transaction
(within the meaning of § 1.1502–
13(b)(1)(i)) or to the transfer of assets in
a nonrecognition transaction to which
section 381 applies (a section 381
transaction).
As provided in proposed § 1.163(j)–
4(d)(2), a consolidated group has a
single section 163(j) limitation, and
intercompany items and corresponding
items are disregarded for purposes of
calculating the group’s ATI to the extent
they offset in amount. The Treasury
Department and the IRS have
determined that regarding intercompany
items and corresponding items for
purposes of § 1.163(j)–1(b)(1)(ii)(C) and
(D) would be inconsistent with this
general approach. Thus, § 1.163(j)–
1(b)(1)(iv)(A)(2) provides that an
intercompany transaction should not be
treated as a ‘‘sale or other disposition’’
for purposes of § 1.163(j)–1(b)(1)(ii)(C)
and (D).
In turn, the transfer of depreciable
assets in a section 381 transaction
generally should not be treated as a
‘‘sale or other disposition’’ because the
transfer does not affect ATI and because
the transferee corporation is the
successor to the transferor corporation.
Thus, the final regulations generally
provide that a transfer of an asset to an
acquiring corporation in a transaction to
which section 381(a) applies is not
treated as a ‘‘sale or other disposition’’
for purposes of § 1.163(j)–1(b)(1)(ii)(C),
(D), and (E). However, if a member
leaves a consolidated group, that
transaction generally is treated as a sale
or other disposition under the final
regulations for purposes of § 1.163(j)–
1(b)(1)(ii)(C) and (D), regardless of
whether the transaction is a section 381
transaction, because the adjustment to
ATI under these provisions should be
reflected on the tax return of the group
that received the benefit of the earlier
increase in ATI.
Sixth, a commenter asked for
clarification as to when the adjustment
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in proposed § 1.163(j)–1(b)(1)(ii)(D) is
required and which investment
adjustments under § 1.1502–32 are
treated as ‘‘attributable to’’ depreciation
deductions for purposes of this
provision. For example, P wholly and
directly owns both S and S1 (members
of P’s consolidated group). In 2021, S
purchases asset X for $100x and fully
depreciates asset X under section
168(k), and P reduces its basis in its S
stock by $100x under § 1.1502–32. In
2022, P contributes the stock of S to S1
in an intercompany transaction (which,
as noted previously, is not treated as a
‘‘sale or other disposition’’ for purposes
of proposed § 1.163(j)–1(b)(1)(ii)(C) and
(D)). If P later sells the S1 stock, is the
adjustment in proposed § 1.163(j)–
1(b)(1)(ii)(D) required even though no
adjustment to P’s basis in the S1 stock
under § 1.1502–32 is ‘‘attributable to’’
the $100x of depreciation deductions
taken with respect to asset X?
The Treasury Department and the IRS
have determined that the adjustment to
tentative taxable income in proposed
§ 1.163(j)–1(b)(1)(ii)(D) should apply in
the foregoing situation. The final
regulations have been revised to provide
that, for these purposes, P’s stock in S1
would be treated as a successor asset
(within the meaning of § 1.1502–
13(j)(1)) to P’s stock in S.
Seventh, commenters stated that there
should be no adjustments to taxable
income under proposed § 1.163(j)–
1(b)(1)(ii)(C), (D), and (E) if and to the
extent that adding back depreciation
deductions pursuant to section
163(j)(8)(A)(v) and proposed § 1.163(j)–
1(b)(1)(i) did not increase the amount of
business interest expense the taxpayer
could have deducted in the year the
deductions were incurred. For example,
in 2021, corporation C has $500x of ATI
(computed by adding back $50x of
depreciation deductions with respect to
asset X) and $100x of business interest
expense. Without adding back the
depreciation deductions, C’s ATI would
have been $450x, C’s section 163(j)
limitation would have been $135x
($450x × 30 percent), and C still could
have deducted all $100x of its business
interest expense in that year. In 2022, C
has $90x of business interest expense
and $300x of ATI. C sells asset X for a
$50x gain in that year. If C were
required to reduce its ATI by $50x (from
$300x to $250x) in 2022 under proposed
§ 1.163(j)–1(b)(1)(ii)(C), its section 163(j)
limitation would be reduced to $75x
($250x × 30 percent), and C would not
be able to deduct all $90x of its business
interest expense in 2022 even though C
derived no benefit from adding back its
depreciation deductions to taxable
income in 2021.
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The Treasury Department and the IRS
have determined that predicating the
application of proposed § 1.163(j)–
1(b)(1)(ii)(C), (D), and (E) upon whether
a taxpayer derived a benefit under
section 163(j) from adding back its
depreciation deductions to taxable
income would involve significant
additional complexity. In addition, this
approach would have an effect similar
to allowing a carryforward of these
amounts to the taxable year in which
gain on the related items is recognized
on a sale or other disposition. Such a
carryforward is inconsistent with the
general approach of section 163(j),
which does not permit a carryforward of
excess ATI to later taxable years. As
noted earlier in this part II(A)(5) of this
Summary of Comments and Explanation
of Revisions section, depreciation
deductions should have no net effect on
the amount of a taxpayer’s taxable
income (except with respect to timing
and, perhaps, character). Thus, if a
taxpayer sells an asset with respect to
which the taxpayer has taken
depreciation deductions, the increase in
gain (or decrease in loss) upon the sale
should be reversed under proposed
§ 1.163(j)–1(b)(1)(ii)(C).
6. Adjustments to Adjusted Taxable
Income in Respect of United States
Shareholders of CFCs
Some commenters argued that United
States shareholders, as defined in
section 951(b) (U.S. shareholders), of
controlled foreign corporations, as
defined in section 957(a) (CFCs), should
be allowed to include in their ATI the
amounts included in gross income
under section 951(a) (subpart F
inclusions), section 951A(a) global
intangible low-taxed income (GILTI)
inclusions, and section 78 ‘‘gross-up’’
inclusions (collectively, CFC income
inclusions) attributable to non-excepted
trades or businesses. Because section
163(j) applies to CFCs, the Treasury
Department and the IRS have
determined that allowing a U.S.
shareholder to include its CFC income
inclusions in its ATI would not be
appropriate. The income of the CFC that
gives rise to such income is taken into
account in computing the ATI of the
CFC for purposes of determining its
section 163(j) limitation, and allowing
the same income to also be taken into
account in computing the ATI of a U.S.
shareholder would result in an
inappropriate double-counting of
income.
Furthermore, the Treasury
Department and the IRS question the
premise of several comments that, if the
business interest expense of a CFC were
excluded from the application of section
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163(j), including the income of a CFC in
a U.S. shareholder’s ATI would be
appropriate. Even if section 163(j) did
not apply to CFCs, CFCs are entities that
also may be leveraged. Thus, permitting
the income of the CFC that gives rise to
CFC income inclusions attributable to
non-excepted trades or businesses of
CFCs to be included in the ATI of U.S.
shareholders would be inconsistent
with the principles of section 163(j).
In particular, consider a case in which
a CFC has interest expense of $100x,
trade or business gross income of $300x
treated as subpart F income, and no
foreign tax liability. In such a case, a
U.S. shareholder that wholly owns the
CFC would have a subpart F inclusion
of $200x (if section 163(j) did not apply
to CFCs). If the $200x subpart F
inclusion were included in the ATI of
the U.S. shareholder, the U.S.
shareholder could deduct an additional
$60x of business interest expense
($200x × 30 percent). As a result, $300x
of gross income could support $160x of
interest expense deductions rather than
the $90x permitted under section
163(j)(1).
Finally, under the final regulations
(and consistent with proposed
§ 1.163(j)–7(d)(1)(ii)), if a domestic
partnership includes amounts in gross
income under sections 951(a) and
951A(a) with respect to an applicable
CFC and such amounts are investment
income to the partnership, then, a
domestic C corporation partner’s
distributive share of such amounts that
are properly allocable to a non-excepted
trade or business of the domestic C
corporation by reason of §§ 1.163(j)–
4(b)(3) and 1.163(j)–10(c) are excluded
from the domestic C corporation
partner’s ATI.
B. Definition of Business Interest
Expense—Proposed § 1.163(j)–1(b)(2)
The proposed regulations provide that
business interest expense includes
interest expense allocable to a nonexcepted trade or business, floor plan
financing interest expense, and
disallowed business interest expense
carryforwards. The Treasury
Department and the IRS received
informal questions about the interaction
between section 163(j) and sections 465
and 469, which may operate to disallow
a deduction for business interest
expense even if such expense was
allowable after the application of
section 163(j). More specifically,
questions have arisen regarding how to
treat amounts of business interest
expense that are disallowed under
section 465 or 469, including which
amounts carry forward to subsequent
taxable years but keep their character as
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interest expense, and which amounts, if
any, are business interest expense in
such subsequent taxable years.
If amounts of business interest
expense that are disallowed under
section 465 or 469 are treated as
business interest expense in subsequent
taxable years, the section 163(j)
limitation could operate to disallow a
deduction even though such amounts
were allowable in the prior taxable year
after application of the section 163(j)
limitation. The Treasury Department
and the IRS do not intend such a result.
Therefore, the final regulations clarify
that amounts allowable as a deduction
after application of the section 163(j)
limitation but disallowed by section 465
or 469 are not business interest expense
subject to the section 163(j) limitation in
subsequent taxable years.
C. Definition of Excepted Regulated
Utility Trade or Business—Proposed
§ 1.163(j)–1(b)(13)
Numerous comments were submitted
concerning the definition of an
‘‘excepted regulated utility trade or
business’’ under proposed § 1.163(j)–
1(b)(13). Proposed § 1.163(j)–1(b)(13),
which implements the exception in
section 163(j)(7)(A)(iv) to the definition
of a ‘‘trade or business,’’ generally
provides that an excepted regulated
utility trade or business is a trade or
business that sells or furnishes the items
listed in section 163(j)(7)(A)(iv) at rates
that are established or approved by
certain regulatory bodies described in
proposed § 1.163(j)–1(b)(13)(i)(B)(1) and
(2).
The proposed regulations provide that
utilities that sell or furnish the regulated
items at rates that are established or
approved by a regulatory body
described in proposed § 1.163(j)–
1(b)(13)(i)(B)(1), other than an electric
cooperative, are considered to be
excepted only to the extent that such
rates are determined on a ‘‘cost of
service and rate of return’’ basis. The
‘‘cost of service and rate of return’’
requirement was intended to provide
certainty to taxpayers because many
utilities are familiar with the definition
of ‘‘cost of service and rate of return,’’
which is used to determine whether a
public utility company must use a
normalization method of accounting
under section 168 for certain properties.
However, several commenters
questioned whether a ‘‘cost of service
and rate of return’’ requirement would
be satisfied in specific fact patterns.
Commenters questioned whether certain
negotiated rates are established or
approved on a ‘‘cost of service and rate
of return’’ basis if (1) the applicable
regulatory body has the authority to
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impose a cost-based rate instead of the
negotiated rate, (2) the rates are
computed with reference to cost but
discounted from the recourse (or
maximum) rate allowed by the
regulatory body, or (3) the rates are
computed with reference to cost and a
set rate of return but are subject to a
market-based cap. Commenters also
asked whether the inclusion of certain
amounts in determining ‘‘cost of
service,’’ specifically the costs of
affiliates and some revenues attributable
to market-rate sales, would affect the
determination of whether rates are
established or approved on a ‘‘cost of
service and rate of return’’ basis.
One commenter noted that the
normalization rules operate logically
only in the ‘‘cost of service and rate of
return’’ context. The commenter stated
that, because section 163(j)(7)(A)(iv)
does not reference the normalization
rules, there is no need to include the
‘‘cost of service and rate of return’’
requirement in the section 163(j)
regulations.
The Treasury Department and the IRS
note that, in private letter rulings and
informal guidance related to section
168(i)(9) and (10), the IRS has stated
that, for purposes of applying the
normalization rules, the definition of
‘‘public utility property’’ must contain
the requirement that the regulated rates
be established or approved on a ‘‘rate of
return’’ basis. In this guidance, the IRS
explained that the normalization
method, which must be used for public
utility property to be eligible for the
depreciation allowance available under
section 168, is defined in terms of the
method the taxpayer uses in computing
its tax expense in establishing its ‘‘cost
of service’’ for ratemaking purposes and
reflecting operating results in its
regulated books of account.
Furthermore, the IRS has issued
numerous private letter rulings
regarding whether under the specific
facts of the taxpayer, the cost of service
and rate of return requirement has been
met for purposes of section 168(i). Thus,
it is clear that, in the context of section
168, the ‘‘cost of service and rate of
return’’ requirement is necessary.
Neither the text of section 163(j) nor
the legislative history specifically
references the normalization rules or the
‘‘cost of service and rate of return’’
requirement under section 168(i)(10).
With the omission of such references,
the exception in section 163(j) for
regulated utility trade or business could
be applied broadly without reference to
specific requirements applicable in the
normalization rules. However, the
Treasury Department and the IRS note
that under section 168(k)(9), the
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additional first-year depreciation
deduction is not available to any
property that is primarily used in an
excepted regulated utility trade or
business. Therefore, to ease the
administrative burden of determining
whether businesses qualify as excepted
regulated utility trades or businesses,
and to allow taxpayers the option of
claiming the additional first-year
depreciation deduction under section
168(k) in lieu of being treated as an
excepted regulated utility trade or
business, the final regulations retain the
‘‘cost of service and rate of return’’
requirement from the proposed
regulations, and also allow taxpayers to
make an election to be an excepted
regulated utility trade or business to the
extent that the rates for the furnishing
or sale of the items described in
§ 1.163(j)–1(b)(15)(i)(A)(1) have been
established or approved by a regulatory
body described in § 1.163(j)–
1(b)(15)(i)(A)(2), if the rates are not
determined on a ‘‘cost of service and
rate of return’’ basis. See § 1.163(j)–
1(b)(15)(i) and (iii).
For purposes of the election, the focus
of section 163(j)(7)(A)(iv) is the phrase
‘‘established or approved’’ in section
163(j)(7)(A)(iv), which describes the
authority of the regulatory body
described in § 1.163(j)–1(b)(15)(i)(A)(2).
Ratemaking programs similar to those
described by commenters and discussed
previously in this part II(C) of this
Summary of Comments and Explanation
of Revisions section, including
discounted rates, negotiated rates, and
regulatory rate caps, are established or
approved by a regulatory body if the
taxpayer files a schedule of such rates
with a regulatory body that has the
power to approve, disapprove, alter the
rates, or substitute a rate determined in
an alternate manner.
Similar to elections for electing real
property trades or businesses and
electing farming businesses, the election
to be an excepted regulated utility trade
or business is irrevocable. Taxpayers
making the election to be an excepted
regulated utility trade or business are
not required to allocate items between
regulated utility trades or businesses
that are described in § 1.163(j)–
1(b)(15)(i) and trades or businesses that
are described in § 1.163(j)–
1(b)(15)(iii)(A) as to which the taxpayer
makes an election because they are
treated as operating an entirely excepted
regulated utility trade or business.
Electing taxpayers cannot claim the
additional first-year depreciation
deduction under section 168(k).
The rules set forth in the final
regulations are limited solely to the
determination of an ‘‘excepted regulated
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utility trade or business’’ for purposes of
section 163(j)(7)(A)(iv). As a result of
this limited application, the rules in the
final regulations are not applicable to
the determination of ‘‘public utility
property’’ or the application of the
normalization rules within the meaning
of section 46(f), as in effect on the day
before the date of the enactment of the
Revenue Reconciliation Act of 1990,
section 168(i)(9) and (10) and the
regulations thereunder, or to the
determination of any depreciation
allowance available under sections 167
and 168.
Comments also were received on the
application of the rules for excepted
regulated utility trades or businesses to
electric cooperatives. The definition of
an ‘‘excepted regulated utility trade or
business’’ under proposed § 1.163(j)–
1(b)(13) includes trades or businesses
that sell or furnish the items listed in
section 163(j)(7)(A)(iv) at rates
established or approved by an electric
cooperative. Unlike utility businesses
regulated by public authorities, utilities
that sell items at rates regulated by a
cooperative are not described in section
168(i)(10). However, there is a longstanding body of law regulating the
taxation of electric cooperatives. Electric
cooperatives described in section
501(c)(12) are generally exempt from
income tax but are subject to taxation
under section 511. The application of
section 163(j) and the section 163(j)
regulations with respect to exempt
electric cooperatives is governed by
proposed § 1.163(j)–4(b)(5). Other
electric cooperatives are subject to
taxation under sections 1381 through
1388 in subchapter T of chapter 1 of
subtitle A of the Code (subchapter T),
except for certain rural electric
cooperatives specifically excluded from
subchapter T by section 1381(a)(2)(C).
Generally, the exception in section
163(j)(7)(A)(iv) for the trade or business
of selling or furnishing items at rates
established or approved by the
governing or ratemaking body of an
electric cooperative applies both to sales
and furnishing by an electric
cooperative and to sales and furnishing
to an electric cooperative by another
utility provider, as long as the rates for
the sale or furnishing have been
established or approved in the manner
required by section 163(j). Thus, an
electric cooperative exempt from
Federal income tax under section
501(c)(12) may not be subject to section
163(j) for the sale or furnishing of
electricity due to the operation of
proposed § 1.163(j)–4(b)(5), and another
utility provider may be in an excepted
regulated utility trade or business to the
extent that it sells electricity to the
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section 501(c)(12) cooperative at rates
established or approved by the
governing or ratemaking body of the
cooperative.
A commenter asked whether
proposed § 1.163(j)–1(b)(13) requires
that, for sales involving electric
cooperatives to qualify as an excepted
regulated utility trade or business, the
rates for the sales be established or
approved by the governing or
ratemaking body of an electric
cooperative on a ‘‘cost of service and
rate of return’’ basis, or if all sales made
subject to a contract or tariff approved
by an electric cooperative’s governing or
ratemaking body would qualify. Under
the proposed regulations, the specific
requirement that rates for the sale or
furnishing of items listed in proposed
§ 1.163(j)–1(b)(13)(i)(A) be established
or approved on a ‘‘cost of service and
rate of return’’ basis did not extend to
rates established or approved by the
governing or ratemaking body of an
electric cooperative. These regulations
adopt the proposed rule, and do not
impose a requirement that rates for the
sale or furnishing of items listed in
§ 1.163(j)–1(b)(15)(i)(A) by an electric
cooperative be established or approved
on a ‘‘cost of service and rate of return’’
basis.
Comments also were submitted
regarding the allocation of tax items
between excepted regulated utility
trades or businesses and non-excepted
trades or businesses. These comments
are discussed with other comments on
proposed § 1.163(j)–10 in part XI of this
Summary of Comments and Explanation
of Revisions section.
D. Definition of Floor Plan Financing
Interest Expense—Proposed § 1.163(j)–
1(b)(17)
Commenters recommended that
interest paid on commercial financing
liabilities or trade financing (in which a
taxpayer borrows to fund the purchase
or transport of commodities and then
sells the inventory to pay off the debt)
should not be subject to section 163(j).
Commenters noted that trade financing
is different from normal financing
because it is short-term and backed by
inventory that is monetizable (rather
than plant and equipment). Thus,
commenters suggested that section
163(j) should not apply to trade
financing because there is no
depreciation trade-off for inventory
purchased with trade financing.
Commenters compared trade financing
to floor plan financing (because both are
used to finance the purchase of
inventory), and they noted that the 1991
Proposed Regulations under old section
163(j) excluded commercial financing
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liabilities from debt taken into account
for purposes of applying the debt-equity
ratio under old section 163(j). See 1991
Proposed Regulations § 1.163(j)–
3(b)(2)(ii).
The Treasury Department and the IRS
decline to exclude commercial
financing liabilities from the section
163(j) limitation. Section 163(j) does not
contain a provision analogous to the
debt-equity ratio safe harbor that was
present in old section 163(j) and for
which rules were proposed in the 1991
Proposed Regulations. In addition,
because Congress specifically excluded
interest paid on floor plan financing
from the section 163(j) limitation, but
not all commercial financing liabilities
and trade financing, Congress does not
appear to have intended to exclude all
commercial financing liabilities from
the section 163(j) limitation.
E. Definition of Interest—Proposed
§ 1.163(j)–1(b)(20)
1. In General
Commenters submitted numerous
comments on the definition of
‘‘interest’’ in the proposed regulations.
Proposed § 1.163(j)–1(b)(20) contains a
relatively broad definition of the term
‘‘interest’’ for purposes of section 163(j).
This definition was proposed to provide
a complete definition of interest that
addresses all transactions that are
commonly understood to produce
interest income and expense, including
transactions that otherwise may have
been entered into to avoid the
application of section 163(j).
Under the proposed regulations, the
term ‘‘interest’’ means any amount
described in one of four categories.
First, proposed § 1.163(j)–1(b)(20)(i)
generally provides that interest is an
amount paid, received, or accrued as
compensation for the use or forbearance
of money under the terms of an
instrument or contractual arrangement,
including a series of transactions, that is
treated as a debt instrument, or an
amount that is treated as interest under
other provisions of the Code or the
Income Tax Regulations. For example,
this category includes qualified stated
interest, original issue discount (OID),
and accrued market discount.
Commenters agree that this definition of
interest has long been accepted, is
consistent with longstanding precedent,
and reduces the risk of inconsistency
within the Code and regulations. No
commenters requested any changes to
this category, and the final regulations
adopt this category in the definition of
the term ‘‘interest’’ without any
substantive changes.
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Second, proposed § 1.163(j)–
1(b)(20)(ii) treats a swap (other than a
cleared swap) with significant
nonperiodic payments as two separate
transactions consisting of an on-market,
level payment swap and a loan. Under
the proposed regulations, the time value
component of the loan is recognized as
interest expense to the payor and as
interest income to the recipient. Several
comments were received on this
category in the definition and are
described in part II(E)(2) of this
Summary of Comments and Explanation
of Revisions section.
Third, proposed § 1.163(j)–1(b)(20)(iii)
treats as interest certain amounts that
are closely related to interest and that
affect the economic yield or cost of
funds of a transaction involving interest,
but that may not be compensation for
the use or forbearance of money on a
stand-alone basis. For example, this
category includes substitute interest
payments, debt issuance costs,
commitment fees, and hedging gains
and losses that affect the yield of a debt
instrument. Numerous comments were
received on this category and are
described in part II(E)(3) of this
Summary of Comments and Explanation
of Revisions section.
Fourth, proposed § 1.163(j)–
1(b)(20)(iv) provides an anti-avoidance
rule. Under this rule, an expense or loss
predominantly incurred in
consideration of the time value of
money in a transaction or series of
integrated or related transactions in
which a taxpayer secures the use of
funds for a period of time is treated as
interest expense for purposes of section
163(j). Numerous comments were
received on this category and are
described in part II(E)(4) of this
Summary of Comments and Explanation
of Revisions section.
2. Swaps With Significant Nonperiodic
Payments
The proposed regulations treat a noncleared swap with significant
nonperiodic payments as two separate
transactions consisting of an on-market,
level payment swap and a loan (the
embedded loan rule). The embedded
loan rule did not apply to a
collateralized swap that was cleared by
a derivatives clearing organization or by
a clearing agency (a cleared swap)
because the treatment of cleared swaps
was reserved. In the preamble to the
proposed regulations, the Treasury
Department and the IRS requested
comments on the proper treatment of
collateralized swaps under the
embedded loan rule.
One commenter recommended that
the final regulations provide an
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exception to the embedded loan rule for
cleared swaps and for non-cleared
swaps that are substantially
collateralized. This commenter further
suggested that the final regulations not
include any specific rules regarding the
type of collateral that is required to be
posted to qualify for the exception. The
commenter also recommended that the
final regulations provide objective rules
for determining if a nonperiodic
payment is ‘‘significant’’ and if a
financial instrument is treated as a
‘‘swap’’ for purposes of these rules.
Another commenter agreed with the
embedded loan rule, including use of
the ‘‘significant’’ standard, and also
recommended exceptions to the
embedded loan rule for both cleared
swaps and non-cleared swaps that are
required to be fully collateralized by the
terms of the swap contract or by a
federal regulator. However, this
commenter interpreted the embedded
loan rule in the proposed regulations to
apply solely for purposes of section
163(j) and recommended that the
embedded loan rule, as well as timing
and character rules for nonperiodic
payments on swaps, be issued under
section 446. Until that guidance is
issued, the commenter requested that
the application of the embedded loan
rule for purposes of section 163(j) be
delayed. The proposed regulations
provide that the time value component
of the embedded loan is determined in
accordance with § 1.446–3(f)(2)(iii)(A).
This commenter questioned the
reference to § 1.446–3(f)(2)(iii)(A)
because, under that rule, the time value
component is not treated as interest;
rather, the time value component is only
used to compute the amortization of the
nonperiodic payment.
As a result of the cross-reference in
proposed § 1.446–3(g)(4) to proposed
§ 1.163(j)–1(b)(20)(ii), the embedded
loan rule set forth in the proposed
regulations applies for purposes of both
sections 163(j) and 446. In addition, and
as noted in the preamble to the
proposed regulations, the embedded
loan rule set forth in the proposed
regulations applies in the same manner
that former § 1.446–3(g)(4) applied
before it was amended by the now
expired temporary regulations in T.D.
9719 (80 FR 26437) (May 8, 2015) (as
corrected by 80 FR 61308 (October 13,
2015)). The Treasury Department and
the IRS do not adopt commenters’
suggestions to delay finalizing the
embedded loan rule or to provide
guidance on determining if a
nonperiodic payment is ‘‘significant’’
because the same embedded loan rule
applied in the context of section 446 for
over 20 years from 1993 to 2015. See
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T.D. 8491 (58 FR 53125) (October 14,
1993). Instead, subject to the exceptions
discussed in this part II(E)(2) of this
Summary of Comments and Explanation
of Revisions section, the final
regulations adopt the embedded loan
rule without change. The final
regulations retain the reference to
§ 1.446–3(f)(2)(iii)(A), which provides a
known method for computing the time
value component associated with the
loan component that is treated as
interest under §§ 1.163(j)–1(b)(22)(ii)
and 1.446–3(g)(4).
Further, to eliminate the possibility of
confusion regarding the application of
the embedded loan rule for purposes of
sections 163(j) and 446, the final
regulations add the substantive text of
the embedded loan rule and the
exceptions to that rule to both §§ 1.446–
3(g)(4) and 1.163(j)–1(b)(22)(ii) instead
of merely including a cross-reference in
§ 1.446–3(g)(4) to § 1.163(j)–1(b)(22)(ii).
In response to comments, the final
regulations add two exceptions to the
embedded loan rule. Specifically, the
final regulations add exceptions for
cleared swaps and for non-cleared
swaps that require the parties to meet
the margin or collateral requirements of
a federal regulator or that provide for
margin or collateral requirements that
are substantially similar to a cleared
swap or a non-cleared swap subject to
the margin or collateral requirements of
a federal regulator. For purposes of this
exception, the term ‘‘federal regulator’’
means the Securities and Exchange
Commission (SEC), the Commodity
Futures Trading Commission (CFTC), or
a prudential regulator, as defined in
section 1a(39) of the Commodity
Exchange Act (7 U.S.C. 1a), as amended
by section 721 of the Dodd-Frank Wall
Street Reform and Consumer Protection
Act of 2010, Public Law 111–203, 124
Stat. 1376, Title VII (the Dodd-Frank
Act). Because federal regulators have
adopted final requirements for noncleared swaps that permit netting of
swap exposures and specify the types of
collateral required to be posted, the final
regulations do not address netting or
require that the margin or collateral be
paid or received in cash.
In addition, § 1.163(j)–1(c)(3)(i) delays
the applicability date of the embedded
loan rule for purposes of section 163(j)
to allow taxpayers additional time to
develop systems to implement these
rules (the delayed applicability date),
though taxpayers may choose to apply
the rules to swaps entered into before
the delayed applicability date. See also
§ 1.446–3(j)(2), which provides
applicability date rules similar to those
in § 1.163(j)–1(c)(3)(i). However, the
delayed applicability date does not
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apply for purposes of the anti-avoidance
rules in § 1.163(j)–1(b)(22)(iv) (described
in part II(E)(4) of this Summary of
Comments and Explanation of Revisions
section). Instead, the applicability date
in § 1.163(j)–1(c)(3)(ii) applies. As a
result, the anti-avoidance rules in
§ 1.163(j)–1(b)(22)(iv) apply to a
notional principal contract entered into
on or after September 14, 2020.
However, for a notional principal
contract entered into before September
14, 2021, the anti-avoidance rules in
§ 1.163(j)–1(b)(22)(iv) apply without
regard to the references in those rules to
§ 1.163(j)–1(b)(22)(ii). For example, if a
taxpayer enters into a swap with a
significant nonperiodic payment that
does not meet the exceptions in
§ 1.163(j)–1(b)(22)(ii)(B) or (C) before the
delayed applicability date, and a
principal purpose of the taxpayer is to
reduce the amount that otherwise would
be interest expense, the anti-avoidance
rules apply and the taxpayer must treat
the time value component associated
with the loan component of the swap as
interest expense.
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary
Income or Loss on Certain Debt
Instruments, Section 1258 Gain, and
Factoring Income
Proposed § 1.163(j)–1(b)(20)(iii)(A)
treats any bond issuance premium
treated as ordinary income under
§ 1.163–13(d)(4) as interest income of
the issuer and any amount deductible as
a bond premium deduction under
§ 1.171–2(a)(4)(i)(A) or (C) as interest
expense of the holder. Proposed
§ 1.163(j)–1(b)(20)(iii)(B) treats any
ordinary income recognized by an issuer
of a debt instrument, and any ordinary
loss recognized by a holder of a debt
instrument, under the rules for a
contingent payment debt instrument, a
nonfunctional currency contingent
payment debt instrument, or an
inflation-indexed debt instrument, as
interest income of the issuer and as
interest expense of the holder,
respectively. Proposed § 1.163(j)–
1(b)(20)(iii)(D) treats any ordinary gain
under section 1258 as interest income.
Commenters supported treating the
amounts in proposed § 1.163(j)–
1(b)(20)(iii)(A), (B), and (D) as interest
income or interest expense for purposes
of section 163(j). Accordingly, the final
regulations adopt the rules in the
proposed regulations for these three
items without any substantive changes.
Proposed § 1.163(j)–1(b)(20)(iii)(J)
treats factoring income as interest
income. Several commenters supported
treating factoring income as interest
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income. However, one commenter
questioned the differences between the
provisions related to the inclusion of
factoring income and § 1.954–2(h)(4).
The inclusion of factoring income in the
definition of interest is generally
supported by the commenters, is a
taxpayer-favorable rule, is generally
consistent with the rules in § 1.954–
2(h)(4), and is consistent with the
treatment of other types of discount,
such as acquisition discount and market
discount. Accordingly, the final
regulations adopt the rules in the
proposed regulations for factoring
income without any substantive
changes. In the case of a factoring
transaction with a principal purpose of
artificially increasing a taxpayer’s
business interest income, the antiavoidance rules in § 1.163(j)–1(b)(22)(iv)
(described in part II(E)(4) of this
Summary of Comments and Explanation
of Revisions section) would not permit
the taxpayer to treat factoring income as
interest income for purposes of section
163(j).
ii. Substitute Interest Payments
Proposed § 1.163(j)–1(b)(20)(iii)(C)
generally provides that a substitute
interest payment described in § 1.861–
2(a)(7) and made in connection with a
sale-repurchase or securities lending
transaction is treated as interest expense
to the payor and interest income to the
recipient. In general, substitute interest
payments are economically equivalent
to interest. A few commenters
questioned the inclusion of substitute
interest payments in the definition of
interest in the proposed regulations.
Commenters stated that treating these
amounts as interest would be contrary
to longstanding tax law, including the
holding in Deputy v. Du Pont, 308 U.S.
488, 498 (1940). However, commenters
recommended that, if the Treasury
Department and the IRS decide to
include substitute interest payments in
the definition of interest in the final
regulations, the inclusion be limited to
the extent the substitute interest
payments relate to transactions that are
economically similar to a borrowing.
Commenters recommended that the
following factors be taken into
consideration in making this
determination: (a) Whether the taxpayer
posted (or has received) collateral
consisting of cash or liquid assets; (b)
whether the borrowed security is due to
mature shortly after the scheduled
termination date of the securities
borrowing; (c) the type of security being
lent (for example, Treasury bonds as
compared to riskier corporate bonds);
and (d) whether the securities
borrowing was entered into in the
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ordinary course of the taxpayer’s trade
or business.
The final regulations retain substitute
interest payments in the definition of
interest because the payments generally
are economically equivalent to interest
and should be treated as such for
purposes of section 163(j). However, in
response to comments, the final
regulations provide that a substitute
interest payment is treated as interest
expense to the payor only if the
payment relates to a sale-repurchase or
securities lending transaction that is not
entered into by the payor in the payor’s
ordinary course of business, and that a
substitute interest payment is treated as
interest income to the recipient only if
the payment relates to a sale-repurchase
or securities lending transaction that is
not entered into by the recipient in the
recipient’s ordinary course of business.
The final regulations do not adopt the
other suggested factors because the
Treasury Department and the IRS have
determined that the ordinary course rule
in the final regulations provides an
appropriate and effective limit on the
scope of the definition. Specifically, the
Treasury Department and the IRS have
determined that these transactions are
rarely entered into outside the payor’s
ordinary course of business, and that
any such non-ordinary course
transactions likely would involve an
intention to avoid section 163(j).
iii. Commitment Fees
Proposed § 1.163(j)–1(b)(20)(iii)(G)(1)
treats any fees in respect of a lender
commitment to provide financing as
interest if any portion of such financing
is actually provided. Commenters
recommended that commitment fees
and other debt-related fees not be
included in the definition of interest
until general substantive guidance is
provided on the treatment of the fees in
the separate fee-related project on the
Office of Tax Policy and IRS 2019–2020
Priority Guidance Plan (REG–132517–
17). According to the commenters,
uncertainty exists as to whether to
characterize these fees for Federal
income tax purposes as fees for services
or property or for compensation for the
use or forbearance of money. In
addition, under existing guidance,
commitment fees are treated differently
by the borrower (similar to an option
premium) and the lender (service
income). See Rev. Rul. 81–160, 1981–1
C.B. 312, and Rev. Rul. 70–540, 1970–
2 C.B. 101, Situation (3). Some
taxpayers, however, argue that a
commitment fee should be treated as
creating or increasing discount on a debt
instrument and that the fee should be
treated consistently by both the
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borrower and the lender. If commitment
fees are included in the definition of
interest in the final regulations,
commenters recommended that only the
portion of the commitment fee that is
proportionate to the amount drawn be
treated as interest.
In response to comments, the final
regulations do not include commitment
fees in the definition of interest. The
treatment of commitment fees and other
fees paid in connection with lending
transactions will be addressed in future
guidance that applies for all purposes of
the Code.
iv. Debt Issuance Costs
Proposed § 1.163(j)–1(b)(20)(iii)(H)
treats debt issuance costs as interest
expense of the issuer. Commenters
argued that debt issuance costs should
not be treated as interest expense
because these costs are paid to third
parties in connection with the issuance
of debt and are not paid or incurred for
the use or forbearance of money under
a debt instrument. For tax purposes,
these costs are capitalized by the issuer
and are treated as deductible under
section 162 over the term of the debt
instrument as if the costs adjust the
instrument’s yield by reducing the
instrument’s issue price by the amount
of the costs. See § 1.446–5.
In response to comments, the final
regulations exclude debt issuance costs
from the definition of interest.
v. Guaranteed Payments
Proposed § 1.163(j)–1(b)(20)(iii)(I)
provides that any guaranteed payments
for the use of capital under section
707(c) are treated as interest. Some
commenters stated that a guaranteed
payment for the use of capital should
not be treated as interest for purposes of
section 163(j) unless the guaranteed
payment was structured with a
principal purpose of circumventing
section 163(j). Other commenters stated
that section 163(j) never should apply to
guaranteed payments for the use of
capital.
In response to comments, the final
regulations do not explicitly include
guaranteed payments for the use of
capital under section 707(c) in the
definition of interest. However,
consistent with the recommendations of
some commenters, the anti-avoidance
rules in § 1.163(j)–1(b)(22)(iv) (described
in part II(E)(4) of this Summary of
Comments and Explanation of Revisions
section) include an example of a
situation in which a guaranteed
payment for the use of capital is treated
as interest expense and interest income
for purposes of section 163(j). See
§ 1.163(j)–1(b)(22)(v)(E), Example 5.
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vi. Hedging Transactions
Proposed § 1.163(j)–1(b)(20)(iii)(E)
generally treats income, deduction, gain,
or loss from a derivative that alters a
taxpayer’s effective cost of borrowing
with respect to a liability of the taxpayer
as an adjustment to the taxpayer’s
interest expense. Proposed § 1.163(j)–
1(b)(20)(iii)(F) generally treats income,
deduction, gain, or loss from a
derivative that alters a taxpayer’s
effective yield with respect to a debt
instrument held by the taxpayer as an
adjustment to the taxpayer’s interest
income. The rules in the two provisions
are referred to as the ‘‘hedging rules’’ in
this preamble.
Numerous comments were received
on the hedging rules. The commenters
questioned the administrability of the
broad hedging rules, especially if the
taxpayer hedges on a macro (that is, on
an aggregate) basis. Also, the
commenters noted that it is not clear
how to apply the rules in certain
situations, including a situation in
which the hedge relates to non-debt
items (for example, if the taxpayer
hedges the mismatch or ‘‘gap’’ between
its assets and liabilities), the debt
instrument is not subject to section
163(j), or the debt instrument is subject
to other interest deferral provisions for
Federal tax purposes. In addition, the
commenters noted that the proposed
regulations effectively would require
integration, even if the hedge otherwise
would not be integrated with the debt
instrument for Federal tax purposes and
the income, deduction, gain, and loss
from the hedge ordinarily would be
accounted for separately, which the
commenters suggested would require
taxpayers to maintain two sets of books.
Moreover, the commenters stated that,
under the proposed regulations, any
gain or loss on the underlying debt
instrument (for example, due to changes
in interest rates) would not be treated as
an adjustment to interest income or
expense, whereas the corresponding
loss or gain on the hedge would be
treated as an adjustment to interest
expense or income. Some commenters
stated that the yield on third-party
borrowings reflects the true cost of the
borrowing, and that hedges are not
relevant to the cost of the borrowing.
Commenters recommended that, if the
hedging rules are retained in the final
regulations as a separate item, the final
regulations precisely define (a) what
standard is used to include a derivative
in section 163(j) (for example, a primary
purpose or principal motivation
standard), and (b) the standard for
determining whether the effect of a
derivative on the cost of borrowing or
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effective yield is sufficiently significant
for the income, deduction, gain, or loss
from the derivative to be included in the
computation. Commenters noted that
one approach would be to apply the
hedging rules only to derivatives that
qualify for integration under § 1.988–5
or § 1.1275–6. Another approach would
be to apply the hedging rules to
derivatives that have a sufficiently close
connection with the liability to qualify
as hedging transactions under §§ 1.446–
4 and 1.1221–2. Some commenters
indicated that the hedging rules could
apply if the derivative is treated as a
hedge of a borrowing or liability for
financial reporting purposes, and that
the hedging rules should not apply to
broker-dealers, active traders in
derivatives, and financial institutions
acting in the ordinary course of
business.
One commenter recommended that
section 163(j) not alter the timing of
taxable items from hedging transactions
that are subject to § 1.446–4, regardless
of whether interest expense on the
hedged item is deferred under section
163(j). Other commenters noted that the
proposed regulations do not provide
guidance on the interaction between the
hedging rules and the straddle rules.
With respect to foreign currency
hedging transactions, a commenter
noted that foreign currency gain or loss
is due to the time value of money only
to a limited extent; thus, the commenter
recommended that section 163(j) not
apply to a taxpayer’s foreign currency
hedging transactions (other than an
integrable transaction under § 1.988–5).
In response to comments, the final
regulations do not include the hedging
rules in the definition of interest.
However, in certain circumstances, the
anti-avoidance rules in § 1.163(j)–
1(b)(22)(iv) (described in part II(E)(4) of
this Summary of Comments and
Explanation of Revisions section) may
apply to require income, deduction,
gain, or loss from a hedging transaction
to be taken into account for purposes of
section 163(j).
Department and the IRS have proposed
rules under which a RIC that earns
business interest income may pay
section 163(j) interest dividends that
certain shareholders may treat as
interest income for purposes of section
163(j). See paragraphs (b)(22)(iii)(F) and
(b)(35) in proposed § 1.163(j)–1 in the
Concurrent NPRM.
vii. Other Items
Commenters recommended other
items to be included in, or excluded
from, the definition of interest as
follows:
b. MMF Income
A few commenters recommended that
the final regulations allow look-through
treatment for earnings from certain
foreign entities, such as foreign money
market funds (MMFs), so that dividends
from foreign MMFs would be treated as
interest income to the extent the
underlying income derived by a foreign
MMF was interest income. According to
the commenters, this treatment would
alleviate issues for a CFC that borrows
money from related parties and invests
in foreign MMFs. In general, the
commenters stated that any interest
limitation under section 163(j) could
lead to unexpected results in this
situation, such as section 952(c)
recapture accounts solely generated by
the section 163(j) interest expense
limitation.
The final regulations do not adopt this
recommendation because it is beyond
the scope of the final regulations and
because there are significant differences
between the rules governing income
inclusions in respect of passive foreign
investment companies (PFICs), such as
foreign MMFs, and RICs. These
differences make it difficult to adopt a
rule that would provide for lookthrough treatment in the context of
dividends or inclusions from a PFIC. In
particular, the regime for taxing income
from a PFIC that shareholders have
elected to treat as a qualified electing
fund (QEF) under section 1295 generally
focuses only on inclusions related to
ordinary income or net capital gain
income and does not separately report
amounts of interest income for Federal
income tax purposes. In the case of a
PFIC for which a QEF election has not
been made, there would be no
information about the underlying
taxable income of the PFIC and no
reason or ability to treat an interest in
the PFIC differently from the treatment
of stock held in other C corporations.
a. Dividends From Regulated
Investment Company (RIC) Shares
Some commenters recommended that
dividend income from a RIC be treated
as interest income for a shareholder in
a RIC, to the extent that the dividend is
attributable to interest income earned by
the RIC. To address this comment, in
the Concurrent NPRM, the Treasury
c. Negative Interest
One commenter requested
clarification on the treatment of negative
interest (an amount that a depositor may
owe a bank in a negative interest rate
environment) and inquired whether
such payments are more similar to
payments for custodial or service fees
rather than for interest. The final
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regulations do not address this issue
because it is beyond the scope of the
final regulations. However, in certain
cases (for example, a Treasury bill
acquired with a negative yield), a
payment may be treated as bond
premium subject to the rules in section
171, including the rules in § 1.171–
2(a)(4)(i)(C).
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d. Leases
A commenter recommended that the
Treasury Department and the IRS adopt
rules that clearly describe the
circumstances in which fleet leases are
treated as generating interest for
purposes of section 163(j). The
commenter noted that there is a timevalue-of-money portion of a fleet lease
payment similar to the time-value-ofmoney portion of other items treated as
interest under the proposed regulations,
such as guaranteed payments,
commitment fees, debt issuance costs,
and items of income or loss from a
derivative instrument that alters a
taxpayer’s effective yield or effective
cost of borrowing. In addition, to the
extent that the anti-avoidance rule in
the proposed regulations is retained, the
commenter asked that the final
regulations clearly define the
circumstances (if any) in which the antiavoidance rule would operate to
recharacterize any portion of a fleet
lease payment as interest expense, and
modify the anti-avoidance rule to apply
to both interest expense of the fleet
lessee and interest income of the fleet
lessor.
The Treasury Department and the IRS
do not adopt the commenter’s
suggestions in the final regulations
because the suggestions generally are no
longer relevant after the revisions made
to the definition of interest in the final
regulations. For example, as explained
in this part II(E)(3) of this Summary of
Comments and Explanation of Revisions
section, no portion of the items
generally cited by the commenter is
explicitly treated as interest in the final
regulations. Moreover, there are explicit
provisions in the Code that determine
whether a portion of a lease payment is
treated as interest for Federal income
tax purposes depending on the terms of
a lease, such as sections 467 and 483. In
addition, as explained in part II(E)(4) of
this Summary of Comments and
Explanation of Revisions section, the
anti-avoidance rule in the final
regulations is revised to include a
principal purpose test and to generally
align the treatment of income and
expense, which should address the
commenter’s concerns.
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4. Anti-Avoidance Rule for Amounts
Predominantly Associated With the
Time Value of Money
Proposed § 1.163(j)–1(b)(20)(iv)
provides that any expense or loss, to the
extent deductible, incurred by a
taxpayer in a transaction or series of
integrated or related transactions in
which the taxpayer secures the use of
funds for a period of time is treated as
interest expense of the taxpayer if such
expense or loss is predominantly
incurred in consideration of the time
value of money. Numerous comments
were received on this anti-avoidance
rule in the proposed regulations. Most
commenters recommended that any
anti-avoidance rule in the final
regulations contain a requirement that
the taxpayer have a principal purpose to
avoid section 163(j). Several
commenters asserted that the antiavoidance rule should cover only
transactions that are economically
equivalent to interest and should set
forth examples of transactions that are
and are not covered. Most commenters
recommended that the anti-avoidance
rule be symmetrical and apply to
income or gain, as well as to expense or
loss. One commenter suggested that,
based on section 1258 concepts, the
anti-avoidance rule should apply only
if, at the time of the relevant transaction
or series of transactions that secure the
use of funds for a period of time for the
taxpayer, substantially all of the
expense or loss was expected to be
attributable to the time value of money.
In addition, commenters noted that it
should be clear when a taxpayer should
test whether a transaction falls within
the anti-avoidance rule. Other
commenters requested specific rules
coordinating this anti-avoidance rule
with the general anti-avoidance rule in
proposed § 1.163(j)–2(h).
Some commenters stated that an
interest anti-avoidance rule should not
be included in the final regulations
because, for example, the rule would
impose substantial compliance costs,
the Treasury Department and the IRS
have other tools to combat any abuse,
and there already is a general antiavoidance rule in proposed § 1.163(j)–
2(h). Commenters also noted that the
interest anti-avoidance rule in the
proposed regulations has the potential
to capture ordinary market transactions
that possess a time value component but
that are not generally treated as
financings with disguised interest for
tax purposes.
In response to comments, the
Treasury Department and the IRS have
modified the anti-avoidance rule in the
final regulations. Under § 1.163(j)–
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1(b)(22)(iv)(A)(1), any expense or loss
economically equivalent to interest is
treated as interest expense for purposes
of section 163(j) if a principal purpose
of structuring the transaction(s) is to
reduce an amount incurred by the
taxpayer that otherwise would have
been interest expense or treated as
interest expense under § 1.163(j)–
1(b)(22)(i) through (iii). For this
purpose, the fact that the taxpayer has
a business purpose for obtaining the use
of funds does not affect the
determination of whether the manner in
which the taxpayer structures the
transaction(s) is with a principal
purpose of reducing the taxpayer’s
interest expense. In addition, the fact
that the taxpayer has obtained funds at
a lower pre-tax cost based on the
structure of the transaction(s) does not
affect the determination of whether the
manner in which the taxpayer structures
the transaction(s) is with a principal
purpose of reducing the taxpayer’s
interest expense.
For purposes of § 1.163(j)–
1(b)(22)(iv)(A)(1), any expense or loss is
economically equivalent to interest to
the extent that the expense or loss is (1)
deductible by the taxpayer; (2) incurred
by the taxpayer in a transaction or series
of integrated or related transactions in
which the taxpayer secures the use of
funds for a period of time; (3)
substantially incurred in consideration
of the time value of money; and (4) not
described in § 1.163(j)–1(b)(22)(i), (ii), or
(iii).
Under § 1.163(j)–1(b)(22)(iv)(A)(2), if a
taxpayer knows that an expense or loss
is treated by the payor as interest
expense under § 1.163(j)–
1(b)(22)(iv)(A)(1), the taxpayer provides
the use of funds for a period of time in
the transaction(s) subject to § 1.163(j)–
1(b)(22)(iv)(A)(1), the taxpayer earns
income or gain with respect to the
transaction(s), and such income or gain
is substantially earned in consideration
of the time value of money provided by
the taxpayer, such income or gain is
treated as interest income for purposes
of section 163(j) to the extent of the
expense or loss treated by the payor as
interest expense under § 1.163(j)–
1(b)(22)(iv)(A)(1).
Under § 1.163(j)–1(b)(22)(iv)(B),
notwithstanding § 1.163(j)–1(b)(22)(i)
through (iii), any income realized by a
taxpayer in a transaction or series of
integrated or related transactions is not
treated as interest income of the
taxpayer for purposes of section 163(j) if
and to the extent that a principal
purpose for structuring the
transaction(s) is to artificially increase
the taxpayer’s business interest income.
For this purpose, the fact that the
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taxpayer has a business purpose for
holding interest-generating assets does
not affect the determination of whether
the manner in which the taxpayer
structures the transaction(s) is with a
principal purpose of artificially
increasing the taxpayer’s business
interest income.
For purposes of the foregoing antiavoidance rules, § 1.163(j)–
1(b)(22)(iv)(C) provides that whether a
transaction or a series of integrated or
related transactions is entered into with
a principal purpose depends on all the
facts and circumstances related to the
transaction(s), except that the fact that
the taxpayer has obtained funds at a
lower pre-tax cost based on the structure
of the transaction(s) or the fact that the
taxpayer has a business purpose related
to the item is ignored for this purpose.
A purpose may be a principal purpose
even though it is outweighed by other
purposes taken together or separately.
Factors to be taken into account in
determining whether one of the
taxpayer’s principal purposes for
entering into the transaction(s) include
the taxpayer’s normal borrowing rate in
the taxpayer’s functional currency,
whether the taxpayer would enter into
the transaction(s) in the ordinary course
of the taxpayer’s trade or business,
whether the parties to the transaction(s)
are related persons (within the meaning
of section 267(b) or section 707(b)),
whether there is a significant and bona
fide business purpose for the structure
of the transaction(s), whether the
transactions are transitory, for example,
due to a circular flow of cash or other
property, and the substance of the
transaction(s).
In response to comments, § 1.163(j)–
1(b)(22)(iv)(D) provides that the antiavoidance rules in § 1.163(j)–
1(b)(22)(iv), rather than the general antiavoidance rules in § 1.163(j)–2(j), apply
to determine whether an item is treated
as interest expense or interest income.
Section 1.163(j)–1(b)(22)(v) contains
examples illustrating the application of
the interest anti-avoidance rules in a
number of situations, including
examples relating to a hedging
transaction involving a foreign currency
swap transaction, a forward contract
involving gold, a loan guaranteed by a
related party in which the related party
receives guarantee fees, and guaranteed
payments for the use of capital.
However, these examples are not
intended to represent the only situations
in which the anti-avoidance rules might
apply.
The anti-avoidance rules in § 1.163(j)–
1(b)(22)(iv) apply to transactions
entered into on or after September 14,
2020. See § 1.163(j)–1(c)(2).
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5. Authority Comments
Most of the commenters on the
definition of interest in the proposed
regulations questioned whether the
Treasury Department and the IRS have
the authority to expand the definition of
interest for purposes of section 163(j) to
include ‘‘interest equivalents’’ (the
items listed in proposed § 1.163(j)–
1(b)(20)(iii) and the expenses or losses
subject to the anti-avoidance rule in
proposed § 1.163(j)–1(b)(20)(iv)). The
commenters asserted that the term
‘‘business interest’’ in section 163(j)(5)
means any interest paid or accrued on
indebtedness properly allocable to a
trade or business, and that expanding
the definition to include interest
equivalents would capture amounts that
do not fall within the scope of the
general rule in section 163(a) that
‘‘[t]here shall be allowed as a deduction
all interest paid or accrued within the
taxable year on indebtedness.’’ Even
though section 163(j)(1) refers to an
‘‘amount allowed as a deduction under
this chapter for business interest’’ when
describing the amounts limited by
section 163(j), the commenters argued
that the deduction otherwise allowed
must be with respect to ‘‘business
interest’’ (which is defined in section
163(j)(5)) and that the phrase
‘‘deduction under this chapter’’ does not
and should not modify the definition of
‘‘business interest’’ in section 163(j)(5).
The commenters noted that section
163(j), as amended by the TCJA, does
not contain a specific delegation of
regulatory authority to expand the
definition of interest. The commenters
further asserted that the Treasury
Department and the IRS may issue only
‘‘interpretive regulations’’ under section
7805, and that any such regulations may
not go beyond the stated meaning of the
statutory language. The commenters
noted that old section 163(j)(9) provided
broad regulatory authority to prescribe
regulations, including regulations
appropriate to prevent the avoidance of
old section 163(j). In addition, the
commenters noted that the legislative
history for old section 163(j) indicated
that the Treasury Department could
issue guidance treating ‘‘items not
denominated as interest but
appropriately characterized as
equivalent to interest’’ as interest
income or interest expense. The
commenters stated that there is no
similar regulatory authority or
legislative history relating to section
163(j) as amended by the TCJA.
Commenters also noted that, when
Congress has chosen to expand the
definition of interest in other parts of
the Code, Congress has done so
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explicitly. For example, section 263(g)
provides that, ‘‘[for purposes of section
263(g)(2)(A)], the term ‘interest’
includes any amount paid or incurred in
connection with personal property used
in a short sale.’’ As noted in the
preamble to the proposed regulations,
most of the rules treating interest
equivalent items as interest income or
expense in proposed § 1.163(j)–
1(b)(20)(iii) were developed in §§ 1.861–
9T and 1.954–2. However, commenters
argued that the use of the interest
equivalent provisions in §§ 1.861–9T
and 1.954–2 by analogy to define
interest for purposes of section 163(j) is
inappropriate because different policy
considerations underlie those sections,
there is statutory or regulatory authority
to address interest equivalents under
those sections (unlike section 163(j)),
and those sections apply only for
limited purposes (for example, for
sourcing purposes).
In addition, because the broad
definition of interest in the proposed
regulations applies only for purposes of
section 163(j), commenters asserted that
there will be additional compliance
burdens and costs for taxpayers to
separately track amounts treated as
interest for purposes of section 163(j)
and for other purposes. Commenters
asserted that the broad definition of
interest for purposes of section 163(j) in
the proposed regulations may create
uncertainty and confusion for taxpayers
with respect to other sections of the
Code.
Contrary to the assertions made by
many of the commenters, the Treasury
Department and the IRS have the
authority to prescribe rules relating to
interest equivalents and an antiavoidance rule. As noted in the
preamble to the proposed regulations,
there are no generally applicable
regulations or statutory provisions
addressing when financial instruments
are treated as indebtedness for Federal
income tax purposes or when a payment
is ‘‘interest.’’ Therefore, a regulatory
definition of interest is needed in order
to implement the statutory language of
section 163(j).
In addition, it would be inconsistent
with the purpose of section 163(j) to
allow transactions that are essentially
financing transactions to avoid the
application of section 163(j). Thus, an
anti-avoidance rule is needed to address
situations in which a taxpayer’s
principal purpose in structuring a
transaction or series of transactions is to
artificially reduce the taxpayer’s
business interest expense or to increase
the taxpayer’s business interest income.
Moreover, at least one commenter
suggested the inclusion of the type of
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anti-avoidance rule that is included in
the final regulations and that the
Treasury Department and the IRS have
the authority to include such a rule.
Section 7805(a) provides the Treasury
Department and the IRS with the
authority to prescribe all rules and
regulations needed for enforcement of
the Code, including all rules and
regulations as may be necessary by
reason of any alteration of law in
relation to internal revenue. Providing a
regulatory definition of interest for
purposes of section 163(j) and the antiavoidance rule falls within this
authority. The statutory language of
section 163(j)(1) (‘‘The amount allowed
as a deduction under this chapter for
any taxable year for business interest
. . .’’) (emphasis added) also supports
the application of section 163(j) to more
items than merely items traditionally
deducted under section 163(a).
Although the Treasury Department
and the IRS have the authority to
prescribe regulations addressing interest
equivalents and anti-avoidance
transactions, as noted earlier in parts
II(E)(3) and (4) of this Summary of
Comments and Explanation of Revisions
section, in response to comments, the
final regulations nevertheless limit the
interest equivalent items to those items
commenters agreed should be treated as
interest expense or interest income,
substitute interest payments made in
connection with a sale-repurchase
agreement or securities lending
transaction that is not entered into by
the taxpayer in the taxpayer’s ordinary
course of business, and certain amounts
relating to transaction(s) entered into by
a taxpayer with a principal purpose of
artificially reducing interest expense or
increasing interest income.
F. Definition of Motor Vehicle—
Proposed § 1.163(j)–1(b)(25)
Proposed § 1.163(j)–1(b)(25) provides
that the term ‘‘motor vehicle’’ means a
motor vehicle as defined in section
163(j)(9)(C). Under section 163(j)(9)(C), a
motor vehicle means any self-propelled
vehicle designed for transporting
persons or property on a public street,
highway, or road; a boat; and farm
machinery or equipment. A few
commenters questioned whether towed
recreational vehicles and trailers are
included in the definition of ‘‘motor
vehicle.’’ One commenter requested that
the final regulations define motor
vehicle to include any trailer or camper
that is designed to provide temporary
living quarters for recreational,
camping, travel, or seasonal use and is
designed to be towed by, or affixed to,
a motor vehicle. Another commenter
recommended allowing motor vehicle
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2. Interaction With Section 250
intangible income and GILTI. Section
250(a)(2) limits the amount of this
deduction based on the taxpayer’s
taxable income—the greater the amount
of a taxpayer’s taxable income for
purposes of section 250(a)(2), the greater
the amount of the taxpayer’s allowable
deduction under section 250(a)(1).
In particular, proposed § 1.163(j)–
1(b)(37)(ii) provides that, if a taxpayer is
allowed a deduction for a taxable year
under section 250(a)(1) that is properly
allocable to a non-excepted trade or
business, then the taxpayer’s taxable
income for that year is determined
without regard to the limitation in
section 250(a)(2). Some commenters
observed that this proposed rule results
in a lower ATI and section 163(j)
limitation for the taxpayer than if the
limitation in section 250(a)(2) were
taken into account. Commenters also
stated that the rationale for this
approach (which does not reflect the
taxpayer’s actual taxable income) is
unclear, and they recommended that
this provision be withdrawn or made
elective for taxpayers.
The Treasury Department and the IRS
have determined that further study is
required to determine the appropriate
rule for coordinating sections 250(a)(2),
163(j), and other Code provisions (such
as sections 170(b)(2) and 172(a)(2)) that
limit the availability of deductions
based, directly or indirectly, upon a
taxpayer’s taxable income (taxable
income-based provisions). Therefore,
the final regulations do not contain the
rule in proposed § 1.163(j)–1(b)(37)(ii).
Until such additional guidance is
effective, taxpayers may choose any
reasonable approach (which could
include an ordering rule or the use of
simultaneous equations) for
coordinating taxable income-based
provisions as long as such approach is
applied consistently for all relevant
taxable years. For this purpose, the
ordering rule contained in proposed
§§ 1.163(j)–1(b)(37)(ii) (83 FR 67490
(Dec. 28, 2018)) and 1.250(a)–1(c)(4)
(contained in 84 FR 8188 (March 6,
2019)) is treated as a reasonable
approach for coordinating sections
163(j) and 250. Comments are welcome
on what rules should be provided, and
whether an option to use simultaneous
equations in lieu of an ordering rule
would be appropriate in order to
coordinate taxable income-based
provisions.
Proposed § 1.163(j)–1(b)(37)(ii)
provides a rule to coordinate the
application of sections 163(j) and 250.
Section 250(a)(1) generally provides a
deduction based on the amount of a
domestic corporation’s foreign-derived
3. When Disallowed Business Interest
Expense Is ‘‘Paid or Accrued’’
As noted in the Background section of
this preamble, section 163(j)(2) provides
that the amount of any business interest
not allowed as a deduction for any
dealers to deduct floor plan financing
interest on both motor vehicles and
trailers that are offered for sale in
integrated or related businesses.
Because section 163(j)(9)(C)
specifically defines motor vehicles as
self-propelled vehicles, the Treasury
Department and the IRS do not have the
authority to expand the definition of
motor vehicles in the final regulations to
include vehicles that are not selfpropelled, such as towed recreational
vehicles and trailers. For this reason, the
Treasury Department and the IRS
decline to adopt these comments in the
final regulations. Therefore, the
definition of motor vehicles in the final
regulations continues to incorporate the
definition in section 163(j)(9)(C) by
cross-reference.
G. Definition of Taxable Income—
Proposed § 1.163(j)–1(b)(37)
1. Calculation of Taxable Income
Proposed § 1.163(j)–1(b)(1)(i)(A)
provides that business interest expense
is added to taxable income to determine
ATI. Some commenters noted that this
provision could be construed as
distorting ATI if a taxpayer has a
disallowed business interest expense
carryforward from a prior taxable year.
Under such facts, the proposed
regulations would not have reduced
taxable income by the amount of the
carryforward, because proposed
§ 1.163(j)–1(b)(37) disregards the
carryforward as part of section 163(j)
and the section 163(j) regulations.
However, in calculating ATI, taxpayers
might argue that taxable income should
be increased by the amount of the
disallowed business interest expense
carryforward because the term
‘‘business interest expense’’ in the
proposed regulations includes
disallowed business interest expense
carryforwards.
The Treasury Department and the IRS
did not intend to create a net positive
adjustment to ATI for disallowed
business interest expense carryforwards.
To address this potential distortion, the
final regulations clarify that tentative
taxable income is computed without
regard to the section 163(j) limitation,
and that disallowed business interest
expense carryforwards are not added to
tentative taxable income in computing
ATI under § 1.163(j)–1(b)(1).
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taxable year under section 163(j)(1) is
treated as business interest ‘‘paid or
accrued’’ in the succeeding taxable year.
Commenters asked for clarification as to
whether disallowed business interest
expense should be treated as ‘‘paid or
accrued’’ in the taxable year in which
such expense is taken into account for
Federal income tax purposes (without
regard to section 163(j)), or whether
such expense instead should be treated
as paid or accrued in the succeeding
taxable year in which the expense can
be deducted by the taxpayer under
section 163(j).
For purposes of section 163(j) and the
section 163(j) regulations, the term
‘‘paid or accrued’’ in section 163(j)(2)
must be construed in such a way as to
further congressional intent. Although
the use of this term in section 163(j)(2)
provides a mechanism for disallowed
business interest expense to be carried
forward to and deducted in a
subsequent taxable year, it does not
mean that a disallowed business interest
expense carryforward is treated as paid
or accrued in a subsequent year for all
purposes. In certain contexts, a
disallowed business interest expense
must be treated as paid or accrued in the
year the expense was paid or accrued
without regard to section 163(j) to give
effect to congressional intent. For
example, if a disallowed business
interest expense were treated as paid or
accrued only in a future taxable year in
which such expense could be deducted
after the application of section 163(j),
then section 382 never would apply to
such expense (because disallowed
business interest expense carryforwards
never would be pre-change losses). This
outcome is clearly contrary to
congressional intent (see section
382(d)(3)). Similarly, if a disallowed
business interest expense were treated
as paid or accrued in a future taxable
year for purposes of section
163(j)(8)(A)(ii), then such expense
would be added back to tentative
taxable income in determining ATI for
that taxable year (and for all future
taxable years to which such expense is
carried forward under section 163(j)(2)),
thereby artificially increasing the
taxpayer’s section 163(j) limitation. (See
part II(A) of this Summary of Comments
and Explanation of Revisions section.)
This outcome also is inconsistent with
congressional intent. However, in other
contexts, a disallowed business interest
expense must be treated as paid or
accrued in a succeeding taxable year to
allow for the deduction of the
carryforward in that year.
The definition of ‘‘disallowed
business interest expense’’ has been
revised in the final regulations to reflect
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that, solely for purposes of section 163(j)
and the section 163(j) regulations,
disallowed business interest expense is
treated as ‘‘paid or accrued’’ in the
taxable year in which the expense is
taken into account for Federal income
tax purposes (without regard to section
163(j)), or in a succeeding taxable year
in which the expense can be deducted
by the taxpayer under section 163(j), as
the context may require.
4. Interaction With Sections 461(l), 465,
and 469—Proposed § 1.163(j)–1(b)(37)
The Treasury Department and the IRS
received questions asking for
clarification of the interaction between
proposed § 1.163(j)–1(b)(37) and the
limitations in sections 461(l), 465, and
469. The final regulations clarify that
sections 461(l), 465, and 469 are taken
into account when determining
tentative taxable income. Then, as
provided in proposed § 1.163(j)–3(b)(4),
sections 461(l), 465, and 469 are applied
after the application of the section 163(j)
limitation. See part II(B) of this
Summary of Comments and Explanation
of Revisions section.
H. Definition of Trade or Business—
Proposed § 1.163(j)–1(b)(38)
1. In General
The section 163(j) limitation applies
to taxpayers with ‘‘business interest,’’
which is defined in section 163(j)(5) as
any interest properly allocable to a trade
or business. Neither section 163(j) nor
the legislative history defines the term
‘‘trade or business.’’ However, section
163(j)(7) provides that the term ‘‘trade or
business’’ does not include the trade or
business of performing services as an
employee, as well as electing real
property, electing farming, and certain
utility trades or businesses.
As described in the preamble to the
proposed regulations, the proposed
regulations define the term ‘‘trade or
business’’ by reference to section 162.
Section 162(a) permits a deduction for
all the ordinary and necessary expenses
paid or incurred in carrying on a trade
or business. Commenters requested
additional guidance in determining
whether an activity constitutes a section
162 trade or business.
The rules under section 162 for
determining the existence of a trade or
business are well-established and
illustrated through a large body of case
law and administrative guidance.
Additionally, whether an activity is a
section 162 trade or business is
inherently a factual question. Higgins v.
Commissioner, 312 U.S. 212, 217 (1941)
(determining ‘‘whether the activities of
a taxpayer are ‘carrying on a business’
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requires an examination of the facts in
each case’’).
The courts have developed two
definitional requirements. One, in
relation to profit motive, requires the
taxpayer to enter into and carry on the
activity with a good-faith intention to
make a profit or with the belief that a
profit can be made from the activity.
The second, in relation to the scope of
the activities, requires considerable,
regular, and continuous activity. See
generally Commissioner v. Groetzinger,
480 U.S. 23 (1987). In the seminal case
of Groetzinger, the Supreme Court
stated that, ‘‘[w]e do not overrule or cut
back on the Court’s holding in Higgins
when we conclude that if one’s
gambling activity is pursued full time,
in good faith, and with regularity, to the
production of income for a livelihood,
and is not a mere hobby, it is a trade or
business within the meaning of the
statutes with which we are here
concerned.’’ Id. at 35.
2. Multiple Trades or Businesses Within
an Entity
Commenters also suggested there
should be factors to determine how to
delineate separate section 162 trades or
businesses within an entity and when
an entity’s combined activities should
be considered a single section 162 trade
or business for purposes of section
163(j). One commenter suggested
adopting the rules for separate trades or
businesses provided in section 446 and
the regulations thereunder.
The Treasury Department and the IRS
decline to adopt these recommendations
because specific guidance under section
162 is beyond the scope of the final
regulations. Further, § 1.446–1(d) does
not provide guidance on when trades or
businesses will be considered separate
and distinct. Instead, it provides that a
taxpayer may use different methods of
accounting for separate and distinct
trades or businesses, and it specifies two
circumstances in which trades or
businesses will not be considered
separate and distinct. For example,
§ 1.446–1(d)(2) provides that no trade or
business will be considered separate
and distinct unless a complete and
separable set of books and records is
kept for such trade or business.
The Treasury Department and the IRS
recognize that an entity can conduct
more than one trade or business under
section 162. This position is inherent in
the allocation rules detailed in proposed
§ 1.163(j)–10(c)(3), which require a
taxpayer with an asset used in more
than one trade or business to allocate its
adjusted basis in the asset to each trade
or business using the permissible
methodology described therein. In this
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context, the final regulations provide,
consistent with the proposed
regulations, that maintaining separate
books and records for all excepted and
non-excepted trades or businesses is one
indication that a particular asset is used
in a particular trade or business.
Whether an entity has multiple trades
or businesses is a factual determination,
and numerous court decisions that
define the meaning of ‘‘trade or
business’’ also provide taxpayers
guidance in determining whether more
than one trade or business exists. See
Groetzinger, 480 U.S. at 35. For
example, some court decisions discuss
whether the activities have separate
books and records, facilities, locations,
employees, management, and capital
structures, and whether the activities
are housed in separate legal entities.
Accordingly, the final regulations
define ‘‘trade or business’’ as a trade or
business within the meaning of section
162, which should aid taxpayers in the
proper allocation of interest expense,
interest income, and other tax items to
a trade or business and to an excepted
or non-excepted trade or business.
3. Rental Real Estate Activities as a
Trade or Business
See the discussion of elections for real
property trades or businesses that may
not qualify as section 162 trades or
businesses in part X of this Summary of
Comments and Explanation of Revisions
section.
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4. Separate Entities
One commenter requested
clarification that the determination of
whether an entity generates interest
attributable to a trade or business within
the meaning of section 162 is made at
the entity level without regard to the
classification of the entity’s owners.
Except in the context of a consolidated
group, or if § 1.163(j)–10 provides
otherwise, the determination of whether
an entity generates interest and whether
such interest is properly allocable to a
trade or business is determined at the
entity level, without regard to the
classification of the entity’s owners. See
also the discussion of trading
partnerships and CFC groups in the
Concurrent NPRM.
I. Applicability Dates
The proposed regulations provide
generally that the final regulations
would apply to taxable years ending
after the date that this Treasury Decision
is published in the Federal Register.
The proposed applicability date has
been changed in the final regulations to
avoid the application of the changes
reflected in the final regulations to a
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taxpayer at the end of the taxable year,
which may result in unexpected effects
on the taxpayer under section 163(j).
Accordingly, the final regulations
generally apply to taxable years
beginning on or after the date that is 60
days after the date that this Treasury
Decision is published in the Federal
Register.
III. Comments on and Changes to
Proposed § 1.163(j)–2: Deduction for
Business Interest Expense Limited
Proposed § 1.163(j)–2 provides
general rules regarding the section 163(j)
limitation, including rules on how to
calculate the limitation, how to treat
disallowed business interest expense
carryforwards, and how the small
business exemption and the aggregation
rules apply with the limitation. The
following discussion addresses
comments relating to proposed
§ 1.163(j)–2.
A. Whether the Section 163(j) Limitation
Is a Method of Accounting
A few commenters requested
clarification that the section 163(j)
limitation is not a method of accounting
under section 446 and the regulations
thereunder. The commenters requested
clarification on whether the application
of the section 163(j) limitation is a
method of accounting because the rules
under section 163(j) appear to defer,
rather than permanently disallow, a
deduction for disallowed business
interest expense and disallowed
disqualified interest (as defined in
proposed § 1.163(j)–1(b)(10)).
Specifically, section 163(j)(2) and
proposed § 1.163(j)–2(c) allow the
carryforward of disallowed business
interest expense, and proposed
§ 1.163(j)–2(c) allows the carryforward
of disallowed disqualified interest, to
succeeding taxable years.
Section 1.446–1(a)(1) defines the term
‘‘method of accounting’’ to include not
only the overall method of accounting of
a taxpayer, but also the accounting
treatment of any item of gross income or
deduction. Under § 1.446–1(e)(2)(ii)(a),
an accounting method change includes
a change in the overall plan of
accounting for gross income or
deductions or a change in the treatment
of any material item used in such
overall plan of accounting. Moreover,
§ 1.446–1(e)(2)(ii)(a) provides that a
‘‘material item’’ is any item that
involves the proper time for the
inclusion of the item in income or the
taking of a deduction. The key
characteristic of a material item ‘‘is that
it determines the timing of income or
deductions.’’ Knight-Ridder
Newspapers, Inc. v. United States, 743
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56705
F.2d 781, 798 (11th Cir. 1984). Once a
taxpayer has established a method of
accounting for an item of income or
expense, the taxpayer must obtain the
consent of the Commissioner under
section 446(e) before changing to a
different method of accounting for that
item.
For purposes of § 1.446–1(e)(2)(ii)(a),
if there is a change in the application of
the section 163(j) limitation, the item
involved is the taxpayer’s deduction for
business interest expense. The taxpayer
is not changing its treatment of this
item; instead, the taxpayer is changing
the limitation placed upon that specific
item. The effect of removing the section
163(j) limitation is that the taxpayer
would be able to recognize the full
amount of the interest expense that is
otherwise deductible under its
accounting method in a given taxable
year before it was limited by section
163(j).
The Treasury Department and the IRS
do not view the section 163(j) limitation
as a method of accounting under section
446(e) and the regulations thereunder.
The determination of whether a
taxpayer is subject to the section 163(j)
limitation is determined for each taxable
year. The carryover rules in section
163(j)(2) and proposed § 1.163(j)–2(c)
provide that disallowed business
interest expense and disallowed
disqualified interest may be carried
forward to a future taxable year.
However, section 163(j) does not
provide a mechanism to ensure that, in
every situation, a taxpayer will be able
to deduct the business interest expense
that the taxpayer was not permitted to
deduct in one taxable year and was
required to carry forward to succeeding
taxable years. Thus, the section 163(j)
limitation is not a method of accounting
under § 1.446–1(e)(2)(ii)(a) because the
change in practice may result in a
permanent change in the taxpayer’s
lifetime taxable income. Further, the
section 163(j) limitation does not
involve an ‘‘item’’ as it is not a recurring
element of income or expense.
B. General Gross Receipts Test and
Aggregation
As noted in the preamble to the
proposed regulations, section 163(j)(3)
exempts certain small businesses from
the section 163(j) limitation. See
proposed § 1.163(j)–2(d). Under section
163(j), a small business taxpayer is one
that meets the gross receipts test in
section 448(c) and is not a tax shelter
under section 448(a)(3). The gross
receipts test is met if a taxpayer has
average annual gross receipts for the
three taxable years prior to the current
taxable year of $25 million or less. For
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taxable years beginning after December
31, 2018, the gross receipts threshold
reflects an annual adjustment for
inflation as provided for in section
448(c)(4); thus, the gross receipts
threshold for taxable years beginning in
2020 is $26 million. See section 3.31 of
Rev. Proc. 2019–44, 2019–47 I.R.B.1093.
Section 448(c)(2) aggregates the gross
receipts of multiple taxpayers that are
treated as a single employer under
sections 52(a) and (b) and 414(m) and
(o). The gross receipts test under section
448(c) normally applies only to
corporations and to partnerships with C
corporation partners. However, section
163(j)(3) and proposed § 1.163(j)–
2(d)(2)(i) provide that, for a taxpayer
that is not a corporation or a
partnership, the gross receipts test of
section 448(c) applies as if the taxpayer
were a corporation or a partnership.
Some commenters noted that the
aggregation rules in sections 52(a) and
(b) and sections 414(m) and (o) could be
difficult to apply in certain instances
due to their complexity. Other
commenters asked that the final
regulations clarify the application of the
aggregation rules to the gross receipts
test under section 448(c). Addressing
the application of the aggregation rules
to the gross receipts test is beyond the
scope of the final regulations. The
section 52(a) and (b) aggregation rules
were enacted as part of the work
opportunity tax credit, but have also
been applied to numerous Code
provisions, including sections 45A, 45S,
264, 280C and 448. The affiliated
service group rules under section
414(m) were enacted to address certain
abuses related to qualified retirement
plans, but also have been applied to
several other Code provisions, including
sections 45R, 162(m), 414(t), 4980H, and
4980I.
However, the Treasury Department
and the IRS are aware that the
aggregation rules set forth in sections
52(a) and (b) and sections 414(m) and
(o) are complex. Therefore, Frequently
Asked Questions that explain the basic
operation of these rules are provided on
https://irs.gov/newsroom. See FAQs
Regarding the Aggregation Rules Under
Section 448(c)(2) that Apply to the
Section 163(j) Small Business
Exemption. The Treasury Department
and the IRS continue to study the
application of the aggregation rules to
the gross receipts test, and request
comments on issues relating to such
application, taking into account the
application of the aggregation rules
beyond the gross receipts test.
The Treasury Department and the IRS
continue to review and consider issues
relating to the affiliated service group
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rules under section 414(m), and a
guidance project regarding the
aggregation rules under section 414(m)
is listed on the 2019–2020 Priority
Guidance Plan (RIN 1545–BO34). As
guidance is published relating to the
affiliated service group rules, the FAQs
will be updated, taking into account the
various Code provisions to which these
aggregation rules apply.
In addition, the Treasury Department
and the IRS recognize that proposed
§ 1.163(j)–2(d)(2)(i) may generate
confusion with respect to the
aggregation rules. Although section
448(c) applies only to corporations and
to partnerships with a C corporation
partner, sections 52(a), 52(b), 414(m),
and 414(o) apply to a broader array of
entities. These statutes contain different
ownership thresholds for different types
of entities that apply in determining
whether multiple entities are treated as
a single employer. To resolve potential
confusion, the final regulations remove
the reference to the aggregation rules
from proposed § 1.163(j)–2(d)(2)(i).
Taxpayers that are not a corporation or
a partnership with a C corporation
partner must apply section 448(c) as if
they were a corporation or a partnership
in accordance with section 163(j)(3) and
proposed § 1.163(j)–2(d)(2)(i). However,
taxpayers should treat themselves as the
type of entity that they actually are in
applying sections 52(a), 52(b), 414(m),
and 414(o).
C. Small Business Exemption and Single
Employer Aggregation Rules—Proposed
§§ 1.163(j)–2(d) and 1.52–1(d)(1)(i)
Section 52(b) treats trades or
businesses under common control as a
single employer. Section 1.52–1(b)
through (d) defines ‘‘trades or
businesses under common control’’ to
include parent-subsidiary groups and
brother-sister groups. Commenters
noted that the version of § 1.52–
1(d)(1)(i) in effect at the time of the
proposed regulations defined ‘‘brothersister groups’’ to include entities a
controlling interest in which is owned
by the same 5 or fewer people who are
individuals, estates, or trusts (directly
and with the application of § 1.414(c)–
4(b)(1)).
Section 1.414(c)–4(b)(1) provides that,
if a person has an option to purchase an
interest in an organization, the person is
deemed to own an interest in that
organization. Other provisions under
§ 1.414(c)–4 apply attribution on a
broader scale, such as through familial
relationships and for closely held
partnerships and S corporations.
Commenters questioned whether the
cross-reference in § 1.52–1(d)(1)(i) was
correct, and whether the cross-reference
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should have been to § 1.414(c)–4 instead
of § 1.414(c)–4(b)(1). The Treasury
Department and the IRS agree that there
is no discernible reason why § 1.52–
1(d)(1)(i) aggregation should be limited
solely to options holders. Taxpayers
need to know how to aggregate gross
receipts properly in order to know if
they are subject to section 163(j).
On July 11, 2019, a correcting
amendment to T.D. 8179 was published
in the Federal Register to clarify that
the cross-reference in § 1.52–1(d)(1)(i)
should be to § 1.414(c)–4. See 84 FR
33002. This correcting amendment
should eliminate uncertainty for
taxpayers that need to determine how to
aggregate gross receipts in the context of
a brother-sister group under common
control.
D. Small Business Exemption and Tax
Shelters—Proposed § 1.163(j)–2(d)(1)
Consistent with section 163(j)(3),
proposed § 1.163(j)–2(d)(1) provides that
the exemption for certain small
businesses that meet the gross receipts
test of section 448(c) does not apply to
a tax shelter as defined in section
448(d)(3). Several commenters
requested clarification on the
application of the small business
exemption under section 163(j)(3) to a
tax shelter.
Section 448(d)(3) defines a tax shelter
by cross-reference to section 461(i)(3),
which defines a tax shelter, in relevant
part, as a syndicate within the meaning
of section 1256(e)(3)(B). Section 1.448–
1T(b)(3) provides, in part, that a
syndicate is a partnership or other entity
(other than a C corporation) if more than
35 percent of its losses during the
taxable year are allocated to limited
partners or limited entrepreneurs,
whereas section 1256(e)(3)(B) refers to
losses that are allocable to limited
partners or limited entrepreneurs. As a
result, the scope of the small business
exemption in section 163(j)(3) is
unclear. Commenters requested that an
entity be a syndicate in a taxable year
only if it has net losses in that year and
more than 35 percent of those net losses
are actually allocated to limited partners
or limited entrepreneurs. To provide a
consistent definition of the term
‘‘syndicate’’ for purposes of sections
163(j), 448, and 1256, the Treasury
Department and the IRS propose to
define the term ‘‘syndicate’’ using the
actual allocation rule from the
definition in § 1.448–1T(b)(3). This
definition is also consistent with the
definition used in a number of private
letter rulings under section 1256. See
proposed § 1.1256(e)–2(a) in the
Concurrent NPRM.
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Commenters also requested specific
relief for small business taxpayers from
the definition of a syndicate based on
the ‘‘active management’’ exception
under section 1256(e)(3)(C). Section
1256(e)(3)(C) lists several examples of
interests in an entity that ‘‘shall not be
treated as held by a limited partner or
a limited entrepreneur,’’ thus excluding
the entity from the definition of a
syndicate. In particular, section
1256(e)(3)(C)(v) allows the Secretary to
determine (by regulations or otherwise)
‘‘that such interest should be treated as
held by an individual who actively
participates in the management of such
entity, and that such entity and such
interest are not used (or to be used) for
tax-avoidance purposes.’’
The commenters requested that the
Treasury Department use its authority
under section 1256(e)(3)(C)(v) to
provide relief from the definition of a
syndicate to small business entities that
(1) qualify under the gross receipts test
of section 448(c), (2) meet the definition
of a syndicate, and (3) do not qualify to
make an election as an electing real
property business or electing farming
business. If a small business satisfies
these three conditions, the commenters
requested that the Treasury Department
and the IRS provide a rule that all
interests in the entity are treated as held
by partners or owners who actively
participate in the management of such
entity.
The Treasury Department and the IRS
have determined that the request
deeming limited partners in small
partnerships to be active participants
even if those owners would not be
treated as active participants under
section 1256(e)(3)(C) is contrary to the
statutory language and legislative
history in section 163(j)(3). Therefore,
the Treasury Department and the IRS
decline to adopt the comments.
Another commenter asked for
clarification on how to compute the
amount of loss to be tested under
§ 1.448–1T(b)(3) and section
1256(e)(3)(B). The commenter provided
a particular fact pattern in which a
small business would be caught in an
iterative loop of (a) of having net losses
due to a business interest deduction, (b)
which would trigger disallowance of the
exemption for small businesses in
section 163(j)(3) if more than 35 percent
of the losses were allocated to a limited
partner, (c) which would trigger the
application of the section 163(j)(1)
limitation to reduce the amount of the
interest deduction, (d) which would
then lead to the taxpayer having no net
losses and therefore being eligible for
the application of the exemption for
small businesses under section 163(j)(3).
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To address this fact pattern, in the
Concurrent NPRM, the Treasury
Department and the IRS have added an
ordering rule providing that, for
purposes of section 1256(e)(3)(B) and
§ 1.448–1T(b)(3), losses are determined
without regard to section 163(j). See
proposed § 1.1256(e)–2(b) and the
example provided in proposed
§ 1.1256(e)–2(c) in the Concurrent
NPRM.
E. Gross Receipts for Partners in
Partnerships and Shareholders of S
Corporation Stock—Proposed § 1.163(j)–
2(d)(2)(iii)
Proposed § 1.163(j)–2(d)(iii) provides
that, in determining whether a taxpayer
meets the gross receipts test of section
448(c), each partner in a partnership
includes a share of partnership gross
receipts in proportion to such partner’s
distributive share of items of gross
income that were taken into account by
the partnership under section 703.
Similarly, shareholders of S
corporations include a pro rata share of
the S corporation’s gross receipts. See
Rev. Rul. 71–455, 1971–2 C.B. 318
(holding that a partner’s distributive
share of the partnership’s gross receipts
is used in applying the passive
investment income test under section
1372(e)(5)).
This approach would be applicable
only in situations in which the partner
and the partnership (or a shareholder
and the S corporation) are not treated as
one person under the aggregation rules
of sections 52(a) and (b) and 414(m) and
(o). The Treasury Department and the
IRS requested comments in the
preamble to the proposed regulations on
this approach and on whether other
approaches to determining the gross
receipts of partners and S corporation
shareholders for purposes of section
163(j) would measure the gross receipts
of such partners and shareholders more
accurately.
In response, several commenters
suggested different approaches for
determining the gross receipts of
partners and S corporation
shareholders. One commenter
recommended that a taxpayer should
include gross receipts only from entities
eligible for the small business
exemption (exempt entities). In other
words, the commenter recommended
that a taxpayer’s gross receipts should
not include gross receipts from (1) any
electing real property trade or business
or electing farming business; (2) any
entities utilizing the floor plan financing
interest exception under section
163(j)(1)(C); and (3) any other entities
subject to section 163(j). The commenter
noted that this modification would
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simplify the computation of gross
receipts and prevent the same gross
receipts from being double-counted both
at the entity level and the partner or S
corporation shareholder level. However,
the determination of gross receipts
generally is not affected by whether any
other entity is subject to section 163(j).
One commenter noted that
passthrough entities generally do not
provide information regarding gross
receipts to their partners. As it is
difficult for partners to determine the
partnership’s gross receipts, the
commenter suggested various
approaches, such as a de minimis rule
whereby a less-than-10 percent owner of
a passthrough entity may use the taxable
income from such entity rather than
gross receipts; use the current-year gross
receipts as a reasonable estimate of the
past three years; or not exclude the gross
receipts of the exempt entity in certain
situations.
Another commenter recommended
that, in situations in which a partner
and a partnership are not subject to the
aggregation rules of section 448(c), a
partner should not be required to
include any share of partnership gross
receipts when determining its partnerlevel eligibility for the small business
exemption. The commenter noted that
section 163(j) is applied at the
partnership level. The commenter stated
it is inconsistent to take an aggregate
view of partnerships for purposes of the
small business exemption without a
specific rule under section 163(j)
requiring such attribution or
aggregation. The commenter also stated
that requiring a partner to include a
share of partnership gross receipts
would discourage taxpayers who
operate small businesses from investing
in partnerships.
The Treasury Department and the IRS
understand that passthrough entities
might not have reported gross receipts
to their partners or shareholders in the
past. However, the statute is clear that
a taxpayer must meet the gross receipts
test of section 448(c), and that, if the
taxpayer is not subject to section 448(c),
the section 448(c) rules must be applied
in the same manner as if such taxpayer
were a corporation or partnership. The
alternatives presented either do not
have universal application or do not
adequately reflect a passthrough entity’s
gross receipts.
Additionally, there is no authority
under section 448 and the regulations
thereunder to substitute taxable income
for gross receipts or to estimate gross
receipts. Accordingly, the Treasury
Department and the IRS do not adopt
the suggested approaches, and the
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proposed rules are finalized without any
change.
IV. Comments on and Changes to
Section Proposed § 1.163(j)–3:
Relationship of Section 163(j) Limitation
to Other Provisions Affecting Interest
Proposed § 1.163(j)–3 provides
ordering and operating rules that control
the interaction of the section 163(j)
limitation with other provisions of the
Code that defer, capitalize or disallow
interest expense. The ordering and
operating rules provide that section
163(j) applies before the operation of the
loss limitation rules in section 465 and
469, and before the application of
section 461(l), and after other provisions
of the Code that defer, capitalize, or
disallow interest expense. The ordering
and operating rules in proposed
§ 1.163(j)–3 apply only in determining
the amount of interest expense that
could be deducted without regard to the
section 163(j) limitation, and not for
other purposes, such as the calculation
of ATI. The following discussion
addresses comments relating to
proposed § 1.163(j)–3.
A. Capitalized Interest
Proposed § 1.163(j)–3(b)(5) provides
that provisions that require interest to
be capitalized, such as sections 263A
and 263(g), apply before section 163(j).
Commenters suggested that this section
is too restrictive by referring solely to
sections 263(A) and 263(g), and that
other provisions could require interest
to be capitalized. The Treasury
Department and the IRS agree with this
comment, and an appropriate revision
has been made in the final regulations
to account for any possible additional
provisions that could require interest to
be capitalized.
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B. Provisions That Characterize Interest
Expense as Something Other Than
Business Interest Expense
Proposed § 1.163(j)–3(b)(9) generally
provides that provisions requiring
interest expense to be treated as
something other than business interest
expense, such as section 163(d)
governing investment interest expense,
govern the treatment of the interest
expense. Commenters expressed
confusion with the provision, suggesting
that, by virtue of the statute and the
proposed regulations, if interest expense
is treated as something other than
business interest expense, there is no
need to consult proposed § 1.163(j)–3.
The Treasury Department and the IRS
generally agree with the comment and
have removed this section from the final
regulations.
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C. Section 108
In the preamble to the proposed
regulations, the Treasury Department
and the IRS requested comments on the
interaction between section 163(j) and
the rules addressing income from the
discharge of indebtedness under section
108. In response, commenters noted, for
example, that it is unclear whether
cancellation of indebtedness income
under section 61(a)(11) arises when the
taxpayer only receives a benefit in the
form of a disallowed business interest
expense carryforward, or whether any
exclusions, such as sections 108(e)(2) or
111, or any tax benefit principles,
should apply. In light of the complex
and novel issues raised in these
comments, the Treasury Department
and the IRS have determined that the
interaction between section 163(j) and
section 108 requires further
consideration and may be the subject of
future guidance.
D. Sections 461(l), 465, and 469
The proposed regulations provide that
sections 461(l), 465, and 469 apply after
the application of section 163(j). The
Treasury Department and the IRS
received informal questions about the
effect of these sections on the
calculation of ATI. Therefore, the final
regulations clarify whether and how
sections 461(l), 465, and 469 are applied
when determining tentative taxable
income. The final regulations also
include examples to demonstrate the
calculation of ATI if a loss tentatively is
suspended in the calculation of
tentative taxable income, and if a loss is
carried forward from a prior taxable year
under section 469.
V. Comments on and Changes to
Proposed § 1.163(j)–4: General Rules
Applicable to C Corporations (Including
Real Estate Investment Trusts (REITs),
RICs, and Members of Consolidated
Groups) and Tax-Exempt Corporations
Section 1.163(j)–4 provides rules
regarding the computation of items of
income and expense under section
163(j) for taxpayers that are C
corporations (including members of a
consolidated group, REITs, and RICs)
and tax-exempt corporations. The
following discussion addresses
comments relating to proposed
§ 1.163(j)–4.
A. Aggregating Affiliated but NonConsolidated Entities
Under the proposed regulations,
members of a consolidated group are
aggregated for purposes of section
163(j), and the consolidated group has a
single section 163(j) limitation. In
contrast, partnerships that are wholly
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owned by members of a consolidated
group are not aggregated with the group
for purposes of section 163(j), and
members of an affiliated group that do
not file a consolidated return are not
aggregated with each other for purposes
of section 163(j).
Several commenters recommended
that aggregation rules be applied to
related taxpayers other than
consolidated group members. For
example, one commenter recommended
that aggregation rules similar to those
provided under section 199A be applied
for purposes of the section 163(j)
limitation to obviate the need for related
entities to shift debt or business assets
around to avoid this limitation. Several
other commenters noted that the 1991
Proposed Regulations applied section
163(j) to an affiliated group of
corporations (including all domestic
corporations controlled by the same
parent, whether consolidated or not)
and recommended that this ‘‘superaffiliation rule’’ be retained so that
affiliated but non-consolidated groups
are not disadvantaged under the section
163(j) regulations. In contrast, another
commenter agreed with the approach
taken in the proposed regulations with
respect to affiliated but nonconsolidated groups, in part because the
allocation of the section 163(j)
limitation among non-consolidated
affiliates can become quite complex.
Commenters also recommended that a
partnership owned by members of an
affiliated group (controlled partnership)
be treated as an aggregate rather than an
entity so that the section 163(j)
limitation would not apply separately at
the partnership level. Instead, each
partner would include its allocable
share of the controlled partnership’s tax
items in determining its own section
163(j) limitation, and transactions
between the controlled partnership and
its controlling partners would be
disregarded. Some commenters would
apply this approach to partnerships
wholly owned by members of a
controlled group of corporations (as
defined in section 1563). Others would
apply this approach to partnerships
wholly owned (or at least 80 percentowned) by members of a consolidated
group in order to reduce compliance
complexity, to ensure that similarly
situated taxpayers (namely,
consolidated groups that conduct
business activities directly and those
that conduct such activities through a
controlled partnership) are treated
similarly, and to discourage
consolidated groups from creating a
controlled partnership to obtain a better
result under section 163(j). Commenters
observed that the proposed regulations
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apply an aggregate approach to certain
controlled partnerships that own CFCs
(see proposed § 1.163(j)–7(f)(6)(ii)(B)),
and they recommended applying this
principle more broadly.
As explained in the preamble to the
proposed regulations, the Treasury
Department and the IRS have
determined that non-consolidated
entities generally should not be
aggregated for purposes of applying the
section 163(j) limitation. Whereas old
section 163(j)(6)(C) expressly provided
that ‘‘[a]ll members of the same
affiliated group (within the meaning of
section 1504(a)) shall be treated as 1
taxpayer,’’ section 163(j) no longer
contains such language, and nothing in
the legislative history of section 163(j)
suggests that Congress intended nonconsolidated entities to be treated as a
single taxpayer for purposes of section
163(j). See the Concurrent NPRM for a
discussion of a proposed exception to
this general rule for CFCs. Moreover, the
Treasury Department and the IRS have
determined that controlled partnerships
generally should not be treated as
aggregates because section 163(j) clearly
applies at the partnership level. See
section 163(j)(4). In other words,
Congress decided that partnerships
should be treated as entities rather than
aggregates for purposes of section 163(j).
Additionally, revising the regulations to
treat controlled partnerships as
aggregates would not necessarily
achieve the objectives sought by
commenters because the controlling
partners effectively could ‘‘elect’’ entity
or aggregate treatment for the
partnership simply by selling or
acquiring interests therein (thereby
causing the partnership to satisfy or fail
the ownership requirement for aggregate
treatment).
However, the Treasury Department
and the IRS are concerned that the
application of section 163(j) on an
entity-by-entity basis outside the
consolidated group context could create
the potential for abuse in certain
situations by facilitating the separation
of excepted and non-excepted trades or
businesses. For example, a consolidated
group that is engaged in both excepted
and non-excepted trades or businesses
could transfer its excepted trades or
businesses to a controlled partnership,
which in turn could borrow funds from
a third party and distribute those funds
to the consolidated group tax-free under
section 731 (unless the debt is
recharacterized as debt of the
consolidated group in substance; see
Plantation Patterns, Inc. v.
Commissioner, 462 F.2d 712 (5th Cir.
1972)). Similarly, an individual
taxpayer that is engaged in both
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excepted and non-excepted trades or
businesses could transfer its excepted
trades or businesses to a controlled
corporation, which in turn could borrow
funds from a third party and distribute
those funds to the individual tax-free
under section 301(c)(2) (assuming the
corporation has no earnings and profits).
Additionally, a partnership with two
trades or businesses—one that generates
ATI, and another that generates losses—
could separate the two trades or
businesses into a tiered partnership
structure solely for the purpose of
borrowing through the partnership that
generates ATI and avoiding a section
163(j) limitation.
The anti-avoidance rule in proposed
§ 1.163(j)–2(h) and the anti-abuse rule in
proposed § 1.163(j)–10(c)(8) would
preclude taxpayers from undertaking
the foregoing transfers in certain
circumstances. The final regulations add
an example illustrating the application
of the anti-avoidance rule in proposed
§ 1.163(j)–2(h) to the use of a controlled
corporation to avoid the section 163(j)
limitation, as well as an example
illustrating the application of this antiavoidance rule to the use of a lower-tier
partnership to avoid the section 163(j)
limitation in a similar manner.
Commenters further requested that
the Treasury Department and the IRS
simplify the rules applicable to
controlled partnerships if the final
regulations do not treat such
partnerships as aggregates rather than
entities. For example, commenters
recommended (i) eliminating steps 3
through 10 in proposed § 1.163(j)–6(f)(2)
for such partnerships, (ii) applying the
principles of the § 1.469–7 self-charged
interest rules to partnership interest
expense and income owed to or from
consolidated group members by treating
all members of the group as a single
taxpayer, or (iii) allowing excess taxable
income (ETI) that is allocated by a
partnership to one consolidated group
member to offset excess business
interest expense allocated by that
partnership to another group member.
The final regulations do not adopt
these recommendations. For a
discussion of steps 3 through 10 in
proposed § 1.163(j)–6(f)(2), see part
VII(A)(3) of this Summary of Comments
and Explanation of Revisions section.
For a discussion of the self-charged
interest rules, see the Concurrent
NPRM. For a discussion of the proposal
to allow ETI allocated by a partnership
to one member of a consolidated group
to offset excess business interest
expense allocated by that partnership to
another group member, see part V(D)(4)
of this Summary of Comments and
Explanation of Revisions section.
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B. Intercompany Transactions and
Intercompany Obligations
Proposed § 1.163(j)–4(d)(2) contains
rules governing the calculation of the
section 163(j) limitation for members of
a consolidated group. These rules
provide, in part, that: (i) A consolidated
group has a single section 163(j)
limitation; (ii) for purposes of
calculating the group’s ATI, the relevant
taxable income is the consolidated
group’s consolidated taxable income,
and intercompany items and
corresponding items are disregarded to
the extent they offset in amount; and
(iii) for purposes of calculating the
group’s ATI and determining the
business interest expense and business
interest income of each member, all
intercompany obligations (as defined in
§ 1.1502–13(g)(2)(ii)) are disregarded
(thus, interest expense and interest
income from intercompany obligations
are not treated as business interest
expense and business interest income
for purposes of section 163(j)).
In turn, proposed § 1.163(j)–5(b)(3)
contains rules governing the treatment
of disallowed business interest expense
carryforwards for consolidated groups.
These rules provide, in part, that if the
aggregate amount of members’ business
interest expense (including disallowed
business interest expense carryforwards)
exceeds the group’s section 163(j)
limitation, then: (i) Each member with
current-year business interest expense
and either current-year business interest
income or floor plan financing interest
expense deducts current-year business
interest expense to the extent of its
current-year business interest income
and floor plan financing interest
expense; (ii) if the group has any
remaining section 163(j) limitation, each
member with remaining current-year
business interest expense deducts a pro
rata portion of its expense; (iii) if the
group has any remaining section 163(j)
limitation, disallowed business interest
expense carryforwards are deducted on
a pro rata basis in the order of the
taxable years in which they arose; and
(iv) each member whose business
interest expense is not fully absorbed by
the group in the current taxable year
carries the expense forward to the
succeeding taxable year as a disallowed
business interest expense carryforward.
Commenters posed several questions
and comments with regard to these
proposed rules. One commenter
expressed concern that these provisions
would create noneconomic and
distortive allocations of disallowed
business interest expense within
consolidated groups. For example,
assume P (the parent of a consolidated
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group) acts as a group’s sole external
borrower, and P on-lends the loan
proceeds to S (a member of P’s
consolidated group) for use in S’s
business operations. Under the
proposed regulations, any disallowed
business interest expense would be
allocated to P even though S is the
economic user of the borrowed funds
and may generate the income that
supports the external debt. The
commenter also expressed concern that,
under the proposed regulations,
consolidated groups effectively may
decide which member will carry
forward disallowed business interest
expense by having that member borrow
funds from third parties, regardless of
whether that member actually uses the
funds. The commenter raised similar
concerns about business interest
income, noting that a group may choose
which member will loan funds outside
the group and thereby affect which
member’s business interest expense is
absorbed within the group.
To address the foregoing concerns, the
commenter suggested that the final
regulations (i) take intercompany
interest income and expense into
account for purposes of section 163(j),
(ii) allocate current-year disallowed
business interest expense to members
without regard to whether the interest
expense results from intercompany
obligations or external borrowings, and
(iii) de-link disallowed business interest
expenses from intercompany interest
income for purposes of the rules under
§ 1.1502–13. However, the commenter
acknowledged that this approach could
introduce unwarranted complexity.
Alternatively, the commenter suggested
that taxpayers be permitted to apply any
reasonable approach (apart from tracing)
consistent with the economics, subject
to a narrowly tailored anti-avoidance
rule.
In the proposed regulations, the
Treasury Department and the IRS
determined that intercompany
obligations should be disregarded for
purposes of section 163(j) for several
reasons. First, section 163(j) is
concerned with interest expense paid to
external lenders, not internal borrowing
between divisions of a single
corporation (or between members of a
consolidated group). In this regard, the
Treasury Department and the IRS note
that treating a member with
intercompany debt but no external debt
as having business interest expense
could lead to strange results.
Second, the approach taken in the
proposed regulations results in
application of the section 163(j)
limitation at the consolidated group
level, consistent with the expressed
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intent of Congress (see H. Rept. 115–
466, at 386 (2017)).
Third, such an approach is simpler for
taxpayers to administer than an
approach that would require
consolidated groups to track disallowed
business interest expense with regard to
intercompany obligations across taxable
years, as further discussed in the
following paragraph. Allowing
taxpayers to apply any reasonable
approach (and to ignore or take into
account interest expense on
intercompany obligations as they
determine to be appropriate) also would
further complicate rather than simplify
tax administration, particularly with
regard to the application of section
163(j) to consolidated groups.
Fourth, as the commenter
acknowledged, taking intercompany
obligations into account for purposes of
section 163(j) would complicate the
application of § 1.1502–13. Section
1.1502–13 achieves single-entity
treatment for a consolidated group by
preventing intercompany transactions
from creating, accelerating, avoiding, or
deferring consolidated taxable income
or liability. To this end, § 1.1502–13(c)
‘‘matches’’ the tax items of the members
that are parties to an intercompany
transaction. In the case of intercompany
interest, income and deductions do not
affect consolidated taxable income or
liability because each side of the
transaction ‘‘nets out’’ the other in each
taxable year. If section 163(j) applied to
intercompany payments of business
interest expense, and if a consolidated
group’s section 163(j) limitation did not
permit the deduction of all of the
group’s intercompany business interest
expense, the interest income and
expense would not net out each other.
Thus, the group would need to
separately track both the intercompany
borrower’s non-deductible expense and
the intercompany lender’s nonincludible income through future
taxable years.
The Treasury Department and the IRS
acknowledge that disregarding
intercompany obligations may lead to
results in some circumstances that are
less economically accurate than a
regime that takes such obligations into
account, but the Treasury Department
and the IRS considered administrability
as well as economic accuracy when
promulgating the proposed regulations.
Moreover, although disregarding
intercompany obligations may grant
consolidated groups the latitude to
decide which member will incur
business interest expense, consolidated
groups also would have significant
flexibility to allocate business interest
expense within a group using
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intercompany obligations if such
obligations were regarded for purposes
of section 163(j).
Although the proposed rules in the
Concurrent NPRM concerning CFC
group elections do regard inter-CFC
group net interest expense in allocating
CFC group disallowed business interest
expense, the CFC group setting is
materially different from that of a
consolidated group. First, in the context
of a CFC group, neither § 1.1502–13 nor
similar rules apply. Second, the location
of disallowed business interest expense
may have more effect on tax liability. In
particular, disallowed business interest
expense may affect the calculation of
foreign tax credits and the amount of
qualified business asset investment
within the meaning of section
951A(d)(1) (QBAI) taken into account in
determining a U.S. shareholder’s tax
liability under section 951A. This effect
depends entirely on the particular CFC
group member affected by disallowed
business interest expense. Although the
location of disallowed business interest
expense has an effect on consolidated
groups, this effect often will be less than
in the CFC group context.
For the foregoing reasons, the final
regulations do not apply section 163(j)
to business interest expense or business
interest income incurred on
intercompany obligations, with one
limited exception related to repurchase
premium on obligations that are deemed
satisfied and reissued, which is
described in part V(C) of this Summary
of Comments and Explanation of
Revisions section.
Commenters also expressed concern
that consolidated groups may have
difficulty determining which member is
the borrower on external debt if other
group members are co-obligors or
guarantors on the debt, and that, as a
result, each member may have difficulty
calculating its business interest expense
for each taxable year. Commenters
voiced similar concerns about the lack
of parameters for determining the
appropriate location of business interest
income and floor plan financing interest
expense within the group.
The Treasury Department and the IRS
do not find this comment persuasive.
Consolidated groups (and other related
parties) are required to determine which
member is entitled to a deduction for
interest expense. Specifically, a
consolidated group must use this
information for purposes of computing
consolidated taxable income under
§§ 1.1502–11 and 1.1502–12 and making
stock basis adjustments in members
under § 1.1502–32. Moreover,
consolidated groups must determine
which member has incurred business
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interest expense for purposes of
applying section 382 and the separate
return limitation year (SRLY) rules.
Consolidated groups must look to
existing law to determine which
member should be treated as incurring
business interest expense or business
interest income for purposes of section
163(j).
C. Repurchase Premium on Obligations
That Are Deemed Satisfied and
Reissued
As discussed in part V(B) of this
Summary of Comments and Explanation
of Revisions section, interest expense on
intercompany obligations generally is
disregarded for purposes of section
163(j). Thus, commenters asked whether
repurchase premium that is treated as
interest with respect to intercompany
obligations should be subject to the
section 163(j) limitation. In general, if
debt that is not an intercompany
obligation becomes an intercompany
obligation (for example, if a member of
a consolidated group acquires another
member’s debt from a non-member), the
debt is treated for all Federal income tax
purposes, immediately after it becomes
an intercompany obligation, as having
been satisfied by the issuer for cash in
an amount equal to the holder’s basis in
the note and as having been reissued as
a new intercompany obligation for the
same amount of cash. See § 1.1502–
13(g)(5)(ii)(A). Additionally, if a debt
instrument is repurchased by the issuer
for a price in excess of its adjusted issue
price (as defined in § 1.1275–1(b)), the
excess (repurchase premium) generally
is deductible as interest for the taxable
year in which the repurchase occurs.
See § 1.163–7(c).
For example, S is a member of P’s
consolidated group, and S has borrowed
$100x from unrelated X. At a time when
S’s note has increased in value to $130x
due to a decline in prevailing interest
rates, P purchases the note from X for
$130x. Under § 1.1502–13(g)(5)(ii), S’s
note is treated as satisfied for $130x
immediately after it becomes an
intercompany obligation. As a result of
the deemed satisfaction of the note, P
has no gain or loss, and S has $30x of
repurchase premium that is deductible
as interest. See § 1.1502–13(g)(7)(ii),
Example 10. Similarly, if S were to
repurchase its note from X for $130x, S
would have $30x of repurchase
premium that is deductible as interest.
If S were to repurchase its note from
X at a premium, the interest (in the form
of repurchase premium) paid on that
note would be subject to the section
163(j) limitation. See § 1.163(j)–
1(b)(22)(i)(H) (treating repurchase
premium that is deductible under
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§ 1.163–7(c) as interest for purposes of
section 163(j)). If section 163(j) does not
apply to repurchase premium paid by S
to P after P purchases S’s note from X,
the P group would obtain a different
(and better) result than if S were to
repurchase its own note. The Treasury
Department and the IRS have
determined that achieving different
results under section 163(j) depending
on which member repurchases external
debt would be inconsistent with treating
a consolidated group as a single entity
for purposes of section 163(j) and would
undermine the purpose of § 1.1502–13.
Thus, the final regulations provide that,
for purposes of section 163(j), if any
member of a consolidated group
purchases a member’s note from a third
party at a premium, the repurchase
premium that is deductible under
§ 1.163–7(c) is treated as interest
expense for purposes of section 163(j),
regardless of whether the repurchase
premium is treated as paid on
intercompany indebtedness.
D. Intercompany Transfers of
Partnership Interests
1. Overview of Proposed § 1.163(j)–
4(d)(4)
Proposed § 1.163(j)–4(d)(4) provides
that the transfer of a partnership interest
in an intercompany transaction that
does not result in the termination of the
partnership is treated as a disposition
for purposes of section
163(j)(4)(B)(iii)(II), regardless of whether
the transfer is one in which gain or loss
is recognized. Thus, the transferor
member’s excess business interest
expense is eliminated rather than
transferred to the transferee member.
Proposed § 1.163(j)–4(d)(4) further
provides that neither the allocation of
excess business interest expense to a
member from a partnership (and the
resulting decrease in basis in the
partnership interest) nor the elimination
of excess business interest expense of a
member upon a disposition of the
partnership interest (and the resulting
increase in basis in the partnership
interest) affects basis in the member’s
stock for purposes of § 1.1502–
32(b)(3)(ii). Instead, investment
adjustments are made under § 1.1502–
32(b)(3)(i) when the excess business
interest expense from the partnership is
absorbed by the consolidated group. See
§ 1.1502–32(b).
2. Intercompany Transfers of
Partnership Interests Treated as
Dispositions; Single-Entity Treatment;
Application of § 1.1502–13
Commenters posed various questions
and comments about the treatment of
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intercompany transfers of partnership
interests as dispositions for purposes of
section 163(j). For example, commenters
asked why, in applying section 163(j) to
consolidated groups, the proposed
regulations treat such transfers as
dispositions, rather than simply
disregard the transfers, given that the
proposed regulations generally treat
consolidated groups as a single entity
and disregard intercompany
transactions for purposes of section
163(j).
The proposed regulations provide that
intercompany transfers of partnership
interests are treated as dispositions for
purposes of section 163(j) because each
member’s separate ownership of
interests in a partnership generally is
respected (otherwise, a partnership
whose interests are wholly owned by
members of a consolidated group would
be treated as a disregarded entity), and
because the term ‘‘disposition’’ in
section 163(j)(4)(B)(iii)(II) has broad
application (for example, it applies to
nonrecognition transactions). Moreover,
if an intercompany transfer of
partnership interests were not treated as
a disposition (and if, as a result, basis
were not restored to the transferor
member), the amount of the transferor
member’s gain or loss on the
intercompany transfer would be
incorrect. Special rules also would be
needed to account for the transfer of
excess business interest expense from
one member to another in a manner
consistent with the purposes of
§ 1.1502–13 and to comply with the
directive of section 1502 to clearly
reflect the income of each member of
the group.
Several commenters also noted
problems with the approach in
proposed §§ 1.163(j)–4(d)(4) and
1.1502–13(c)(7)(ii)(R), Example 18.
These commenters pointed out that the
approach in the proposed regulations
does not achieve single-entity treatment
because one member’s transfer of its
partnership interest to another member
causes the transferor’s excess business
interest expense to be eliminated; thus,
an intercompany transaction may alter
the amount of business interest expense
that is absorbed by the group. One
commenter suggested a different
approach under which the transferee
could claim deductions for excess
business interest expense to the extent
the transferee is allocated excess taxable
income from the same partnership.
However, the commenter acknowledged
that this approach would require
additional rules under § 1.1502–13.
Another commenter suggested that
intercompany transfers in which the
transferee is the successor to the
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transferor (for example, in transactions
to which section 381(a) applies, or in
which the transferee’s basis in the
partnership interest is determined by
reference to the transferor’s basis)
should not be treated as dispositions for
purposes of section 163(j)(4)(B)(iii)(II).
However, this approach would not
result in an increase in the transferor
member’s (S’s) basis in its partnership
interest immediately before the transfer;
thus, this approach would be
inconsistent with § 1.1502–13, which
requires the clear reflection of income at
the level of the consolidated group
member. This approach also would be
inconsistent with section
163(j)(4)(B)(iii)(II), which clearly treats
‘‘a transaction in which gain is not
recognized in whole or in part’’ as a
disposition for purposes of that section.
Still another commenter observed that
the analysis in proposed § 1.1502–
13(c)(7)(ii)(R), Example 18, does not
work in certain other fact patterns. In
proposed § 1.1502–13(c)(7)(ii)(R),
Example 18, P wholly owns S and B,
both of which are members of P’s
consolidated group. S and A (an
unrelated third party) are equal partners
in PS1, which allocates $50x of excess
business interest expense to each
partner in Year 2. At the end of Year 2,
S sells its PS1 interest to B at a $50x loss
(S’s excess business interest expense is
eliminated, and S’s basis in its PS1
interest is increased by $50x
immediately before the sale). In Year 3,
PS1 allocates $25x of excess taxable
income to B. At the end of Year 4, B
sells its PS1 interest to Z (an unrelated
third party) for a $10x gain. The
example concludes that S takes into
account $25x of its loss in Year 3 as an
ordinary loss, which matches B’s
inclusion of $25x of ordinary income in
Year 3. The remaining $25x of S’s $50x
capital loss is taken into account in Year
4. The commenter noted that, although
the analysis in proposed § 1.1502–
13(c)(7)(ii)(R), Example 18, works under
the facts presented, it would not work
if, for example, S were to sell the PS1
interest to B at a gain (because S’s gain
and B’s income could not be offset).
The Treasury Department and the IRS
acknowledge the concerns raised by
these commenters. The Treasury
Department and the IRS are continuing
to study the proper treatment of
intercompany transfers of partnership
interests that do not result in the
termination of the partnership
(intercompany partnership interest
transfers), including whether such
transfers should be treated as
dispositions for purposes of section
163(j)(4)(B)(iii)(II). The final regulations
reserve on issues relating to
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intercompany partnership interest
transfers, and the Treasury Department
and the IRS welcome further comments
on such issues.
3. Possible Approach to Intercompany
Partnership Interest Transfers
The Treasury Department and the IRS
are considering various possible
approaches to intercompany partnership
interest transfers. Under one possible
approach, such a transfer would be
treated as a disposition by S; thus, S’s
excess business interest expense would
be eliminated (and its basis in its
partnership interest would be increased
accordingly immediately before the
transfer), as would S’s negative section
163(j) expense (within the meaning of
§ 1.163(j)–6(h)(1)). However, unlike the
approach in proposed § 1.163(j)–4(d)(4),
B would be treated as if B had been
allocated excess business interest
expense or negative section 163(j)
interest expense from the partnership in
an amount equal to the amount of S’s
excess business interest expense or
negative section 163(j) expense,
respectively, immediately before the
transfer. B’s basis in its partnership
interest would be adjusted under
section 163(j)(4)(B)(iii)(I) and § 1.163(j)–
6(h) to reflect the deemed allocation of
excess business interest expense from
the partnership. Similar rules would
apply to intercompany transfers of
partnership interests in nonrecognition
transactions.
The foregoing approach would
attempt to approximate single-entity
treatment while treating the
intercompany transfer of a partnership
interest as a disposition for purposes of
section 163(j)(4)(B)(iii)(II). To ensure
that B has the same amount of excess
business interest expense, negative
section 163(j) expense, and disallowed
business interest expense carryforwards
as if S and B were divisions of a single
corporation, this approach also would
include special basis rules. For example,
if S transfers its partnership interest to
B at a gain, the excess of B’s basis in the
partnership interest at any time after the
transfer over S’s basis in the partnership
interest immediately before the transfer
would not be available to convert
negative section 163(j) expense into
excess business interest expense in the
hands of B or to prevent excess business
interest expense from converting into
negative section 163(j) expense in the
hands of B. Additionally, if adjustments
to B’s basis in its partnership interest
under section 163(j)(4)(B)(iii)(I) and
§ 1.163(j)–6(h) (upon the deemed
allocation of excess business interest
expense from the partnership) would
exceed B’s basis, B would be treated as
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having a suspended negative basis
adjustment in the partnership interest
(similar to an excess loss account within
the meaning of § 1.1502–19(a)(2)(i)).
The Treasury Department and the IRS
request comments on possible
approaches to intercompany partnership
interest transfers, including the
approach outlined in this part V(D)(3) of
this Summary of Comments and
Explanation of Revisions section.
4. Offsetting Excess Business Interest
Expense and Adjusted Taxable Income
Within the Consolidated Group
A commenter also recommended that,
if the section 163(j) regulations do not
treat partnerships wholly owned by
members of the same consolidated
group as aggregates rather than as
entities (see part V(A) of this Summary
of Comments and Explanation of
Revisions section), the rules applicable
to such partnerships should be
simplified. For example, the excess
taxable income allocated to one member
partner could be made available to offset
excess business interest expense
allocated to another member partner.
The commenter’s recommendation
presents several issues. For example, the
commenter’s recommendation would
entail disregarding the location of
excess business interest expense and
excess taxable income within a
consolidated group. Such an approach
would not fully respect each member’s
separate interest in a partnership and
would not clearly reflect the taxable
income of the members of the group.
See section 1502; see also part V(D)(2)
of this Summary of Comments and
Explanation of Revisions section.
Further, to the extent the ownership
structure of the group is altered by an
intercompany transfer of the partnership
interest, substantial additional rules
under § 1.1502–13 would be required.
5. Intercompany Nonrecognition
Transactions
In proposed §§ 1.163(j)–4(d)(4) and
1.1502–13(c)(7)(ii)(S), Example 19, the
intercompany transfer of a partnership
interest in a nonrecognition transaction
is treated as a disposition for purposes
of section 163(j)(4)(B)(iii)(II). In the
preamble to the proposed regulations,
the Treasury Department and the IRS
requested comments as to whether such
transfers should constitute dispositions
for purposes of section
163(j)(4)(B)(iii)(II) and, if so, how
§ 1.1502–13(c) should apply if there is
excess taxable income in a succeeding
taxable year. In such a case, S would
have no intercompany item from the
intercompany transfer, and B would
take a carryover basis in the partnership
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interest (this amount would include any
basis increase to reflect S’s unused
excess business interest expense under
section 163(j)(4)(B)(iii)(II)).
One commenter agreed that, based on
the plain language of section
163(j)(4)(B)(iii)(II), intercompany
transfers that are nonrecognition
transactions should be treated as
dispositions. Another commenter stated
that such transfers generally should not
be treated as dispositions (if the
transferee is the successor to the
transferor, as previously discussed), but
that, if such transfers are treated as
dispositions, no redeterminations
should be made under § 1.1502–13(c)
with respect to S unless S recognizes
gain in the intercompany transfer.
The Treasury Department and the IRS
continue to study the proper treatment
of intercompany partnership interest
transfers and welcome further
comments on this issue.
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6. Basis Adjustments Under § 1.1502–32
A commenter stated that the approach
to basis adjustments under § 1.1502–32
in the proposed regulations may lead to
temporary inside/outside basis
disparities. Although the commenter
generally described this approach as
reasonable and consistent with the
application of both section 163(j) and
§ 1.1502–32, the commenter suggested
that it may lead to anomalous results in
certain cases. The commenter requested
an example to illustrate the application
of the matching and acceleration rules
in the case of an intercompany transfer
of an interest in a partnership with
disallowed business interest expense.
When S (a member of a consolidated
group that is not the common parent) is
allocated excess business interest
expense from a partnership, S’s basis in
the partnership is reduced under section
163(j)(4)(B)(iii)(I). Although S’s basis in
the partnership is reduced, S has excess
business interest expense in the same
amount, and S’s overall inside attribute
amount is unchanged. Because there is
no net change to S’s inside attribute
amount, § 1.1502–32 does not apply to
reduce other members’ basis in S’s
stock, and there is no inside/outside
disparity. Moreover, nothing in the final
regulations affects the operation of
§ 1.1502–32(a), which generally requires
adjustments to a member’s basis in its
S stock to reflect S’s distributions and
S’s items of income, gain, deduction,
and loss that are taken into account by
the group while S is a member. Thus,
the final regulations make no changes in
response to this comment.
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7. Partnership Terminations
In the preamble to the proposed
regulations, the Treasury Department
and the IRS requested comments on the
treatment of the transfer of a partnership
interest in an intercompany transaction
that results in the termination of the
partnership. Some commenters
recommended that the transfer be
treated as a disposition for purposes of
section 163(j)(4)(B)(iii)(II) and proposed
§ 1.163(j)–6(h)(3). Other commenters
recommended that, under Revenue
Ruling 99–6, 1999–1 C.B. 432, if the
transferee member (B) also were a
partner in the partnership before the
intercompany transfer, B should be
viewed as (i) receiving a distribution of
assets from the terminating partnership
with respect to its partnership interest,
and (ii) purchasing the partnership’s
assets deemed distributed to the
transferor member (S).
The Treasury Department and the IRS
are continuing to study the proper
treatment of intercompany transfers of
partnership interests that result in the
termination of the partnership. But see
§ 1.163(j)–6(h)(3) with respect to
partnership terminations generally.
E. Application of § 1.1502–36 to Excess
Business Interest Expense
Under proposed § 1.163(j)–4(d)(4), a
partner’s change in status as a member
of a consolidated group is not treated as
a disposition for purposes of section
163(j)(4)(B)(iii)(II) and proposed
§ 1.163(j)–6(h)(3). In other words, if a
corporation becomes or ceases to be a
member of a consolidated group, and if
that corporation is a partner in a
partnership, that corporation’s entry
into or departure from a consolidated
group does not trigger basis adjustments
under section 163(j)(4)(B)(iii)(II).
However, in the preamble to the
proposed regulations, the Treasury
Department and the IRS requested
comments as to whether additional
rules are needed to prevent loss
duplication upon the disposition of
stock of a subsidiary member (S)
holding partnership interests.
Section 1.1502–36 contains the
unified loss rule, which limits the
ability of a consolidated group to
recognize non-economic or duplicated
losses on the transfer of S stock. The
rule applies when a group member
transfers a loss share of S stock. If
§ 1.1502–36(d) applies to the transfer of
a loss share, the attributes of S and its
lower-tier subsidiaries generally are
reduced as needed to prevent the
duplication of any loss recognized on
the transferred stock. Such attributes
include capital loss carryovers, NOL
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56713
carryovers, deferred deductions, and
basis in assets other than cash and
general deposit accounts. See § 1.1502–
36(d)(4).
As noted in the preamble to the
proposed regulations, the Treasury
Department and the IRS have
determined that disallowed business
interest expenses should be treated as
deferred deductions for purposes of
§ 1.1502–36 (see proposed § 1.1502–
36(f)(2)). A commenter recommended
that excess business interest expense
also be treated as a deferred deduction
in determining the net inside attribute
amount for purposes of § 1.1502–36(c)
and (d). Additionally, the commenter
recommended that a consolidated group
be permitted to elect to reattribute
excess business interest expense from S
to the common parent under § 1.1502–
36(d)(6) if the common parent also is a
partner in the partnership that allocated
excess business interest expense to S.
The Treasury Department and the IRS
agree that excess business interest
expense should be treated as an
attribute that is taken into account in
determining the net inside attribute
amount for purposes of § 1.1502–36(c)
and (d). However, the Treasury
Department and the IRS have
determined that excess business interest
expense is more akin to basis (a
Category D attribute) than to deferred
deductions (a Category C attribute) (see
§ 1.1502–36(d)(4)(i)). Section 1.163(j)–
4(e)(4) reflects this conclusion.
The Treasury Department and the IRS
also have determined that excess
business interest expense should not be
eligible for reattribution under § 1.1502–
36(d)(6) because the election is not
available with respect to Category D
attributes. Thus, the final regulations do
not adopt this recommendation.
F. Calculating ATI for Cooperatives
Proposed § 1.163(j)–1(b)(1) defines
ATI as the taxable income of the
taxpayer for the taxable year, with
certain adjustments. Proposed
§ 1.163(j)–4(b)(4) provides a special rule
for calculating the ATI of a RIC or REIT,
allowing the RIC or REIT not to reduce
its taxable income by the amount of any
deduction for dividends paid. The
preamble to the proposed regulations
also requested comments on whether
additional special rules are needed for
specific types of taxpayers, including
cooperatives.
A commenter asked that the final
regulations include a special rule for
calculating the ATI of cooperatives
subject to taxation under subchapter T
of the Code. Under this special rule,
taxable income would not be reduced by
amounts deducted under section
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1382(b)(1) (patronage dividends),
section 1382(b)(2) (amounts paid in
redemption of nonqualified written
notices of allocation distributed as
patronage dividends), or section 1382(c)
(certain amounts incurred by farm
cooperatives described in sections 521
and 1381(a)(1)). The commenter
reasoned that such amounts are earnings
passed on to members and are therefore
analogous to dividends paid by a RIC or
REIT to its investor.
The Treasury Department and the IRS
agree that, for purposes of section 163(j),
amounts deducted by cooperatives
under sections 1382(b)(1), (b)(2), and (c)
are similar to amounts deducted by RICs
and REITs for dividends paid to their
investors. The final regulations adopt a
rule providing that, for purposes of
calculating ATI, the tentative taxable
income of a cooperative subject to
taxation under sections 1381 through
1388 is not reduced by such amounts.
In order to provide similar treatment to
similarly situated taxpayers, the final
regulations also provide that, for
purposes of calculating ATI, the
tentative taxable income of cooperatives
not subject to taxation under subchapter
T of the Code is not reduced by the
amount of deductions equivalent to the
amounts deducted by cooperatives
under sections 1382(b)(1), (b)(2), and (c).
G. Calculating ATI for a Consolidated
Group
Proposed § 1.163(j)–1(b)(1) defines
ATI as the taxable income of the
taxpayer for the taxable year, with
certain adjustments. For example, ATI is
computed without regard to the amount
of any NOL deduction under section
172. See proposed § 1.163(j)–
1(b)(1)(i)(B).
As noted in part V(B) of this Summary
of Comments and Explanation of
Revisions section, for purposes of
calculating the ATI of a consolidated
group, the relevant taxable income is the
group’s consolidated taxable income,
determined under § 1.1502–11 without
regard to any carryforwards or
disallowances under section 163(j). See
proposed § 1.163(j)–4(d)(2)(iv).
Commenters asked for clarification that
a consolidated group’s ATI does not
take into account any NOL deductions
available under section 172 and
§ 1.1502–11(a)(2) that result from either
the carryback or carryforward of NOLs.
Proposed § 1.163(j)–4(d)(2)(iv) does
not expressly mention the adjustments
made to ATI in proposed § 1.163(j)–
1(b)(1) because those adjustments are
generally applicable (for example, the
adjustment for NOLs applies to all
taxpayers to whom section 172 applies,
regardless of whether such taxpayers
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file a consolidated return). Moreover,
there is no exception in proposed
§ 1.163(j)–4(d)(2)(iv) to the adjustment
for NOLs in proposed § 1.163(j)–
1(b)(1)(i)(B). Thus, under these
provisions, a consolidated group’s ATI
would not take into account any NOL
deductions resulting from the carryback
or carryforward of NOLs. The Treasury
Department and the IRS have
determined that no change to proposed
§ 1.163(j)–4(d)(2)(iv) is needed to
effectuate this result.
H. Application of Section 163(j) to LifeNonlife Groups
Proposed § 1.163(j)–4(d)(2) provides
that a consolidated group has a single
section 163(j) limitation and that, for
purposes of calculating the group’s ATI,
the relevant taxable income is the
group’s consolidated taxable income.
However, § 1.1502–47 requires
consolidated groups whose members
include life insurance companies and
other companies (life-nonlife groups) to
adopt a subgroup method to determine
consolidated taxable income. (One
subgroup is the group’s nonlife
companies; the other subgroup is the
group’s life insurance companies.)
Under the subgroup method, each
subgroup initially computes its own
consolidated taxable income, and there
are limitations on a life-nonlife group’s
ability to offset one subgroup’s income
with the other subgroup’s loss.
In light of the apparent tension
between proposed § 1.163(j)–4(d)(2) and
the subgroup method in § 1.1502–47,
one commenter asked for clarification
that there are not separate section 163(j)
limitations for each subgroup in a lifenonlife group.
The subject matter of this comment is
beyond the scope of the final
regulations. The Treasury Department
and the IRS expect to issue future
guidance regarding the interaction of
section 163(j) and § 1.1502–47 and
welcome further comments on this
topic.
I. Application of Section 163(j) to TaxExempt Entities
Proposed § 1.163(j)–1(b)(36) defines a
tax-exempt corporation but does not
define other types of tax-exempt
organizations. Thus, a commenter asked
for clarification as to whether section
163(j) applies solely to tax-exempt
corporations or whether it also applies
to other entities subject to tax under
section 511. The final regulations clarify
that section 163(j) applies to all entities
that are subject to tax under section 511.
The commenter also suggested that
section 163(j) should not apply to state
colleges and universities described in
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section 511(a)(2)(B). The Treasury
Department and the IRS have found
nothing in the statute or legislative
history to suggest that Congress
intended special treatment for state
colleges and universities to the extent
such organizations are subject to tax
under section 511. Therefore, the final
regulations do not adopt this
recommendation.
J. Partnership Investment Income and
Corporate Partners
Under the proposed regulations, a
partnership’s investment interest
income and investment expense are
allocated to each partner in accordance
with section 704(b), and the effect of the
allocation is determined at the partner
level. In general, any investment
interest, investment income, and
investment expense allocated by a
partnership to a C corporation partner is
treated by the partner as allocable to a
non-excepted trade or business of the
partner for purposes of section 163(j).
See proposed §§ 1.163(j)–4(b)(3)(i) and
1.163(j)–10(b)(6).
In light of the statutory restriction
against including investment income in
a partner’s ATI (see section
163(j)(8)(A)(i)), a commenter requested
confirmation that a partnership’s
investment income is treated as
properly allocable to a trade or business
of (and thus is included in the ATI of)
a corporate partner, perhaps by adding
an example to illustrate the application
of this rule.
Proposed § 1.163(j)–10(b)(6) provides
that any investment income or
investment expenses that a partnership
receives, pays, or accrues and that is
treated as properly allocable to a trade
or business of a C corporation partner
under proposed § 1.163(j)–4(b)(3)(i) is
treated as properly allocable to a nonexcepted trade or business of the C
corporation partner. Thus, if a
partnership incurs investment interest
expense, any portion of that expense
that is allocable to a C corporation
partner is treated as a business interest
expense of that partner that is subject to
the section 163(j) limitation. However, if
the partnership also has investment
interest income, any portion thereof that
is allocable to a C corporation partner is
treated as business interest income of
the partner, and any other investment
income of the partnership that is
allocable to the C corporation partner
increases the partner’s ATI. See
§ 1.163(j)–4(b)(7)(ii), Example 2.
To the extent that an investment item
or other item of a partnership is with
respect to property for which an
election has been made by the
partnership to treat as an electing real
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property trade or business or electing
farming business, such item is treated as
properly allocable to an excepted trade
or business. This rule is necessary
because the final regulations permit
elections for some assets and activities
to be an excepted trade or business even
when such assets and activities are not
trades or businesses for section 162
purposes. See part X(A) of this
Summary of Comments and Explanation
of Revisions section.
The final regulations also expand
proposed § 1.163(j)–4(b)(3)(i) to cover
not only a partnership’s items of
investment interest, investment income,
and investment expense, but also a
partnership’s other separately stated tax
items that are subject to neither section
163(j) nor section 163(d). Such items
might include tax items allocable to
rental activities that do not rise to the
level of a section 162 trade or business
that otherwise give rise to allowable
deductions (such as under section 212
as it existed under prior law) that are
subject to section 469. Thus, such items
are treated as properly allocable to a
trade or business of a C corporation
partner as well.
K. Earnings and Profits of a Corporate
Partner
Proposed § 1.163(j)–4(c)(1) generally
provides that the disallowance and
carryforward of a deduction for a C
corporation’s business interest expense
under proposed § 1.163(j)–2 does not
affect whether or when the business
interest expense reduces the
corporation’s earnings and profits. Some
commenters suggested that, if the
business interest expense in question is
incurred by a partnership rather than by
the C corporation partner, the partner
should reduce its earnings and profits
twice with respect to that expense—
once when the expense is allocated from
the partnership to the partner, and again
when the partner claims a deduction
with respect to that expense (after the
excess business interest expense
allocated to that partner is treated as
business interest expense and deducted
by that partner).
The Treasury Department and the IRS
have determined that the proposed
regulations do not permit a C
corporation partner to reduce its
earnings and profits twice with respect
to business interest expense incurred by
a partnership. The final regulations are
modified to clarify this point.
Proposed § 1.163(j)–4(c)(3) also
provides a special earnings and profits
rule for C corporations (other than
REITs or RICs) with respect to excess
business interest expense allocated from
a partnership. Under this rule, the C
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corporation partner must increase its
earnings and profits upon the
disposition of the partnership interest to
reflect the amount of excess business
interest expense that the partner did not
take into account while it held the
partnership interest. The Treasury
Department and the IRS have
determined that the same rule should
apply with respect to negative section
163(j) expense, and the final regulations
have been modified accordingly.
VI. Comments on and Changes to
Proposed § 1.163(j)–5: General Rules
Governing Disallowed Business Interest
Expense Carryforwards for C
Corporations
Section 1.163(j)–5 provides rules
regarding disallowed business interest
expense carryforwards for taxpayers that
are C corporations, including members
of a consolidated group. The following
discussion addresses comments relating
to proposed § 1.163(j)–5.
A. Absorption of Disallowed Business
Interest Expense Carryforwards Before
Use of NOLs in Life-Nonlife Groups
Proposed § 1.163(j)–5(b)(3) provides
rules regarding the treatment of
disallowed business interest expense
carryforwards of a consolidated group.
Commenters asked for confirmation
that, in the context of a life-nonlife
group, such carryforwards are factored
into taxable income at the subgroup
level before NOLs are carried forward
and limited under section 1503(c)(1).
In general, a consolidated group must
determine the amount of business
interest expense (whether current-year
or carryforwards) that can be absorbed
in a particular taxable year before
determining whether NOLs can be
carried forward or back to that taxable
year. However, the specific subject
matter of this comment is beyond the
scope of the final regulations. The
Treasury Department and the IRS expect
to issue future guidance regarding the
interaction of section 163(j) and
§ 1.1502–47 and welcome further
comments in this regard.
B. Carryforwards From Separate Return
Limitation Years
Proposed § 1.163(j)–5(d) contains
rules for consolidated groups regarding
disallowed business interest expense
carryforwards from a separate return
limitation year (a SRLY; see § 1.1502–
1(f)). Under these rules, the disallowed
business interest expense carryforwards
of a member arising in a SRLY that are
included in a group’s business interest
expense deduction for any taxable year
may not exceed the group’s section
163(j) limitation for that year,
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56715
determined by reference only to the
member’s tax items for that year (the
section 163(j) SRLY limitation). See
proposed § 1.163(j)–5(d)(1).
Additionally, disallowed business
interest expense carryforwards of a
member arising in a SRLY would be
available for deduction by the
consolidated group in the current year
only to the extent the group had
remaining section 163(j) limitation after
deducting current-year business interest
expense and disallowed business
interest expense carryforwards from
earlier taxable years, and only to the
extent the section 163(j) SRLY
limitation for the current year exceeded
the amount of the member’s business
interest expense already deducted by
the group in that year. In addition,
SRLY-limited disallowed business
interest expense carryforwards must be
deducted on a pro rata basis with nonSRLY limited disallowed business
interest expense carryforwards from
taxable years ending on the same date.
See proposed § 1.163(j)–5(d)(2).
Commenters asked several questions
about the SRLY rules in proposed
§ 1.163(j)–5(d). In particular,
commenters asked why the section
163(j) SRLY limitation is calculated
annually rather than on an aggregate or
cumulative basis, as is the case for
NOLs. (Section 1.1502–21(c)(1)(i)
generally limits the amount of a
member’s NOL carryforwards and
carrybacks from a SRLY that may be
included in the group’s consolidated net
operating loss deduction to the
member’s aggregate contribution to the
group’s consolidated taxable income for
the entire period the member has been
a group member, not just for the taxable
year in question). More specifically, a
commenter noted that the SRLY rules in
§ 1.1502–21(c) were designed to
produce a result that roughly
approximates the absorption that would
have occurred if the SRLY member had
not joined a consolidated group. In
contrast, the annual section 163(j)
limitation in proposed § 1.163(j)–5(d)
could put the SRLY member in a worse
position than if such member had not
joined a consolidated group.
For example, if S were a standalone
corporation with $100x of disallowed
business interest expense carryforwards
at the start of Year 2, and if S’s section
163(j) limitation were $30 in Year 2, S
could deduct $30x of its carryforwards.
In comparison, if S joined a
consolidated group at the start of Year
2, and if the group’s section 163(j)
limitation were $0 in Year 2, S could
not deduct any of its $100x of
carryforwards in Year 2 even if S’s
standalone section 163(j) limitation
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were $30x in that year. This result is
correct for the P group for Year 2 given
Congress’s intent that the section 163(j)
limitation apply at the consolidated
group level. However, under the annual
measurement approach in the proposed
regulations, S also could not deduct any
of its carryforwards in Year 3 if S had
a standalone section 163(j) limitation of
$0 in that year, even if the group’s
section 163(j) limitation were positive in
that year. Thus, S would be in a worse
position (with respect to the deduction
of its disallowed business interest
expense carryforwards) than if S had not
joined a consolidated group.
To put S in roughly the same position
as if S were a standalone corporation,
commenters recommended the creation
of a cumulative section 163(j) register
under which the amount of a member’s
SRLY carryforwards that may be
absorbed by the consolidated group in a
taxable year may not exceed (i) the
member’s contributions (positive and
negative) to the group’s section 163(j)
limitation in all consolidated return
years, less (ii) the member’s business
interest expense (including
carryforwards) absorbed by the group in
all consolidated return years. For these
purposes, and unlike the general rule in
section 163(j)(1) and proposed
§ 1.163(j)–2(b)(2), the adjustment to a
member’s cumulative section 163(j)
SRLY register for any taxable year or its
total register for any taxable year could
be less than zero.
In the preamble to the proposed
regulations, the Treasury Department
and the IRS stated that applying an
aggregate or cumulative approach to the
section 163(j) SRLY limitation would be
inconsistent with congressional intent
because Congress did not retain the
excess limitation carryforward
provisions from old section 163(j). One
commenter expressed agreement with
this conclusion. However, other
commenters noted that applying a
cumulative section 163(j) SRLY register
would not effectuate the carryforward of
excess limitation at the level of the
consolidated group. In other words,
although the SRLY member would be
able to deduct its SRLY disallowed
business interest expense carryforwards
in a taxable year to the extent of that
member’s cumulative (rather than
annual) contribution to the group’s
section 163(j) limitation, the SRLY
member’s ability to deduct such
carryforwards still would be subject to
the group’s annual section 163(j)
limitation.
After considering the comments
received, the Treasury Department and
the IRS have determined that a
cumulative section 163(j) SRLY register
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would better approximate the results
under section 163(j) if the SRLY
member had not joined a consolidated
group, and that this approach is not
inconsistent with congressional intent.
Therefore, the final regulations adopt a
cumulative section 163(j) SRLY register.
The cumulative section 163(j) SRLY
register operates in a manner similar to,
but is separate and distinct from, the
cumulative register for NOLs described
in § 1.1502–21(c). In computing a
member’s section 163(j) SRLY register,
the intercompany transaction rules of
§ 1.1502–13 generally continue to apply;
thus, for example, intercompany income
items and intercompany deductions and
losses (to the extent absorbed by the
group) generally are taken into account
in computing the section 163(j) SRLY
register. However, interest income and
expense from intercompany obligations
are not taken into account in computing
the section 163(j) SRLY register. This
approach approximates the SRLY
member’s capacity to utilize
carryforwards on a standalone basis
while harmonizing with the singleentity application of section 163(j) to
consolidated groups. Under this
approach, intercompany interest income
and expense items will neither increase
nor decrease the SRLY register.
In the preamble to the proposed
regulations, the Treasury Department
and the IRS requested comments on
another alternative to both an annual
register and a cumulative register—
removing the SRLY limitation from a
member’s SRLY-limited disallowed
business interest expense carryforwards,
to the extent of the member’s standalone
section 163(j) limitation, in taxable
years in which the member’s standalone
section 163(j) limitation exceeds the
consolidated group’s section 163(j)
limitation. A commenter endorsed this
approach. However, other commenters
expressed concern that this approach
would be more distortive than a
cumulative register approach. The
Treasury Department and the IRS agree
that a cumulative register more closely
approximates the results on a
standalone basis than this alternative
approach. Thus, the final regulations
adopt a cumulative register approach
rather than this alternative approach.
Commenters also expressed concern
that proposed § 1.163(j)–5(d)(2) would
treat SRLY carryforwards as available
for deduction only to the extent the
amount of the SRLY member’s business
interest expense already deducted by
the group in the current year does not
exceed the member’s annual section
163(j) SRLY limitation. The adoption of
the cumulative section 163(j) SRLY
limitation mechanism, with the
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associated reduction to reflect all
business interest expense of that
member that is absorbed by the group,
obviates the issues highlighted in the
comment. The final regulations retain
the other SRLY limitations in proposed
§ 1.163(j)–5(d)(2).
C. Offsetting Business Interest Expense
With Business Interest Income and
Floor Plan Financing Interest Expense at
the Member Level
As described in part V(B) of this
Summary of Comments and Explanation
of Revisions section, proposed
§ 1.163(j)–5(b)(3) provides, in part, that
if the aggregate amount of members’
business interest expense (including
carryforwards) exceeds the consolidated
group’s section 163(j) limitation for the
current year, then each member with
current-year business interest expense
and current-year business interest
income or floor plan financing interest
expense deducts current-year business
interest expense to the extent of its
current-year business interest income
and floor plan financing interest
expense. Thereafter, if the group has any
remaining section 163(j) limitation, each
member with remaining current-year
business interest expense deducts a pro
rata portion thereof.
A commenter stated that offsetting
business interest expense with business
interest income or floor plan financing
interest expense at the member level
seems inconsistent with the singleentity principles adopted by the
proposed regulations. Moreover, the
commenter expressed concern that a
consolidated group could choose where
to incur business interest income within
a group and thereby affect which
member has disallowed business
interest expense carryforwards. In
addition, the commenter asserted that a
group may have difficulty determining
which member has incurred business
interest income and floor plan financing
interest expense (see the discussion in
part V(B) of this Summary of Comments
and Explanation of Revisions section).
Thus, the commenter recommended an
alternative approach that does not
require such offsetting at the member
level.
The Treasury Department and the IRS
acknowledge that netting business
interest income and floor plan financing
interest expense against business
interest expense at the member level
deviates from a ‘‘pure’’ single-entity
approach. This approach was adopted
in the proposed regulations to give
effect to section 163(j)(1) (which allows
taxpayers to deduct business interest
expense to the full extent of business
interest income and floor plan financing
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interest expense) and to ensure that
income tax liability is clearly reflected
at the member level in accordance with
section 1502 and § 1.1502–13. Further,
because consolidated groups are under
common control by definition (see
section 1504), a consolidated group
largely has control over the location of
interest expense, even before the
application of section 163(j). With
regard to the comment regarding the
difficulty of determining which member
actually has incurred an interest
expense, section 61 provides that
interest income is includible in gross
income, and section 163 provides rules
by which interest expense is deductible
in computing the taxable income.
Section 1.1502–12 also requires
consolidated group members to report
interest income and expense at the
member level for purposes of computing
separate taxable income. Thus, the final
regulations do not adopt the
commenter’s recommendation.
VII. Comments on and Changes to
Section 1.163(j)–6: Application of the
Business Interest Expense Deduction
Limitations to Partnerships and
Subchapter S Corporations
As discussed in the preamble to the
proposed regulations, § 1.163(j)–6
provides general rules regarding the
application of section 163(j)(4) to
partnerships, S corporations, and their
owners, including rules on how to
calculate the limitation and how to treat
disallowed business interest expense
carryforwards. The following discussion
addresses comments relating to
proposed § 1.163(j)–6.
A. Partnership-Level Calculation and
Allocation of Section 163(j) Excess
Items
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1. Nonseparately Stated Taxable Income
or Loss of the Partnership
Section 163(j)(4)(A)(ii)(II) states that a
partner’s excess taxable income is
determined in the same manner as the
nonseparately stated taxable income or
loss of the partnership. Section
163(j)(4)(B)(i)(II) states that excess
business interest expense is allocated to
each partner in the same manner as the
non-separately stated taxable income or
loss of the partnership. Similarly, excess
business interest income is allocated to
each partner in the same manner as the
nonseparately stated taxable income or
loss of the partnership.
As highlighted in the proposed
regulations, the phrase ‘‘nonseparately
stated taxable income or loss of the
partnership’’ is not defined in section
163(j), and it has not previously been
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defined by statute or regulations.1 The
phrase ‘‘in the same manner as’’ is also
undefined. The proposed regulations
interpreted the phrase ‘‘nonseparately
stated taxable income or loss,’’ as it is
used in sections 163(j)(4)(A)(ii)(II) and
163(j)(4)(B)(i)(II), as meaning the items
comprising adjusted taxable income,
business interest income, and business
interest expense of the partnership. The
legislative history and structure of the
statute suggest the purpose of the phrase
‘‘nonseparately stated taxable income or
loss of the partnership’’ is to help
coordinate the section 163(j) limit
imposed at the partnership and partner
levels.
Section 163(j)(4)(A)(i) uses this phrase
when describing business interest
expense that already has been tested at
the partnership level. In general, an item
included in nonseparately stated taxable
income or loss of a partnership under
section 702(a)(8) loses its tax character
in the hands of the partner to whom it
is allocated. By providing that such
business interest expense is treated as a
nonseparately stated item, section
163(j)(4)(A)(i) causes such business
interest expense to lose its character as
business interest expense, thus
preventing it from being subject to
retesting at the partner level under
section 163(j). Although it does not use
the same phrase, section
163(j)(4)(A)(ii)(I), in conjunction with
section 163(j)(4)(C), similarly provides
that, to the extent the partnership’s
adjusted taxable income was used in its
section 163(j) calculation, such adjusted
taxable income is not included in a
partner’s section 163(j) calculation.
Consistent with this principle, proposed
§ 1.163(j)–6(e)(4) provided similar rules
to prevent the double counting of
business interest income. Therefore,
interpreting the phrase ‘‘nonseparately
stated taxable income or loss of the
partnership,’’ as it is used in section
163(j)(4) as meaning the items
comprising adjusted taxable income,
business interest income, and business
interest expense of the partnership
(hereinafter, ‘‘section 163(j) items’’) is
supported by the statute, which requires
each of these items to be taken into
account at the partnership level and
prohibits the double counting of such
items in the partner’s section 163(j)
calculation.
To allocate excess taxable income,
excess business interest income, and
excess business interest expense
1 Sections 163(j)(4)(A)(i) and (B)(i)(II) use the
word ‘‘nonseparately’’ (no hyphen), but section
163(j)(4)(A)(ii)(II) uses the word ‘‘non-separately’’
(hyphen). For purposes of consistency, these final
regulations use ‘‘nonseparately’’ when discussing
the phrase at issue.
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(hereinafter, ‘‘section 163(j) excess
items’’) ‘‘in the same manner’’ as the
‘‘nonseparately stated taxable income or
loss of the partnership’’ (that is, the
section 163(j) items), proposed
§ 1.163(j)–6(f)(2) provided an 11-step
calculation that, when completed by the
partnership, provides the partnership
with an allocation of each of its section
163(j) excess items to each of its
partners. This resulting array of
allocations is consistent with the
Treasury Department and the IRS’s
resolution of the three descriptive (1
through 3) and two normative (4
through 5) issues outlined in part
6(D)(1) of the Explanation of Provisions
section in the proposed regulations: (1)
Section 163(j) is applied at the
partnership level; (2) a partnership
cannot have both excess taxable income
(or excess business interest income) and
excess business interest expense in the
same taxable year; (3) parity must be
preserved between a partnership’s
deductible business interest expense
and section 163(j) excess items and the
aggregate of each partner’s share of
deductible business interest expense
and section 163(j) excess items from
such partnership; (4) if, in a given year,
a partnership has both deductible
business interest expense and excess
business interest expense, a partnership
should not allocate excess business
interest expense to a partner to the
extent such partner was allocated the
items comprising ATI (or business
interest income) that supported the
partnership’s deductible business
interest expense; and (5) if, in a given
year, a partnership has excess taxable
income (or excess business interest
income), only partners allocated more
items comprising ATI (or business
interest income) than necessary to
support their allocation of business
interest expense should be allocated a
share of excess taxable income (or
excess business interest income).
In general, the 11-step calculation
preserves the entity-level calculation
required in section 163(j)(4) while also
preserving the economics of the
partnership, including respecting any
special allocations made in accordance
with section 704 and the regulations
under section 704 of the Code. Stated
otherwise, the allocations of section
163(j) excess items prescribed by the 11step calculation attempt to reflect the
aggregate nature of partnerships under
subchapter K of the Code while
remaining consistent with the
application of section 163(j) at the
partnership level.
The Treasury Department and the IRS
requested comments on the 11-step
calculation in the preamble to the
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proposed regulations. Specifically, the
Treasury Department and the IRS
requested comments regarding
alternative methods for allocating
deductible business interest expense
and section 163(j) excess items in a
manner that permits partners that bear
the taxable income supporting the
deductible business interest expense to
be allocated a disproportionate share of
deductible business interest expense
and excess taxable income.
2. Requested Clarifications and
Modifications
Commenters requested several
clarifications of and modifications to the
11-step calculation. First, commenters
requested confirmation that a
partnership’s allocations of section
163(j) excess items pursuant to the 11step calculation will be considered to
meet the requirements of section 704(b).
The final regulations confirm that
allocations pursuant to the 11-step
calculation meet the requirements of
section 704(b). Nothing in the 11-step
calculation prohibits a partnership from
making an allocation to a partner of any
section 163(j) item that is otherwise
permitted under section 704 and the
regulations thereunder. Accordingly,
any calculations in the 11-step
calculation are solely for the purpose of
determining each partner’s section
163(j) excess items, and do not
otherwise affect any other provision
under the Code, such as section 704(b).
Further, the statement in the proposed
regulations that the 11-step calculation
is solely for section 163(j) purposes and
does not apply for any other purposes
of the Code does not mean that section
163(j) excess items have no effect on
either outside basis or capital accounts.
To illustrate this point, § 1.163(j)–
6(o)(17), Example 17 has been revised to
show the beginning and ending outside
basis and capital accounts after applying
the 11-step calculation.
To further clarify that the allocation of
section 163(j) excess items pursuant to
the 11-step calculation will be sustained
under section 704, a special rule has
been added to § 1.704–1(b)(4). The
allocation of deductible and
nondeductible business interest expense
does not have economic effect because
classifying a portion of the interest
expense as nondeductible merely
changes the tax character of the item.
Accordingly, § 1.704–1(b)(4)(xi) is
added to clarify that, if § 1.163(j)–6(f) is
satisfied, the allocation of section 163(j)
excess items will be deemed to be in
accordance with the partners’ interests
in the partnership.
Second, commenters recommended
the 11-step calculation take remedial
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allocations into account. Commenters
noted that the exclusion of remedial
allocations from the partnership-level
computation could frustrate the ability
of the 11-step calculation to reach the
most equitable result given its purpose.
The Treasury Department and the IRS
acknowledge that taking remedial
allocations into account in the 11-step
calculation after 2021 might produce an
equitable result. However, because
remedial income would not always be
offset by remedial losses prior to 2022
for purposes of computing ATI, the
Treasury Department and that IRS have
determined that taking remedial
allocations into account in the 11-step
calculation would not achieve
appropriate results in all circumstances.
Therefore, the Treasury Department and
the IRS decline to accept the
recommendation.
Third, a commenter recommended
that the final regulations allow
partnerships to make remedial
allocations of excess taxable income.
Under this recommended modification
to the 11-step calculation, if a partner
receives an allocation of taxable income
in excess of such partner’s allocation of
excess taxable income, the partnership
could elect to create positive remedial
excess taxable income in the amount of
the excess and allocate such positive
remedial excess taxable income to the
affected partner. The partnership also
would create an offsetting negative
remedial excess taxable income item in
an equal amount that would be
allocated to the other partners. The
Treasury Department and the IRS do not
adopt this recommendation in the final
regulations in light of the fact that the
definition of ‘‘excess taxable income’’ is
statutory and the statute does not appear
to contemplate negative excess taxable
income.
3. Recommended Alternative Methods
Commenters recommended the final
regulations retain the 11-step
calculation. Additionally, commenters
recommended that the final regulations
provide alternative methods for
allocating section 163(j) excess items in
addition to the 11-step calculation. The
commenters seeking an alternative
method expressed concern about the
complexity of the 11-step calculation—
specifically, that the required
computations and recordkeeping are
excessive for many taxpayers.
Commenters argued that the attempted
precision of the 11-step calculation
should be weighed against its
complexity and compared to the
reduced precision that could be
achieved through simpler methods.
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As an alternative to the 11-step
calculation, commenters recommended
the final regulations allow taxpayers to
adopt any reasonable method for
allocating section 163(j) excess items,
provided the method does not produce
results inconsistent with the Treasury
Department and the IRS’s resolution of
the five issues articulated in the
preamble to the proposed regulations.
See part VII(A)(1) of this Summary of
Comments and Explanation of Revisions
section. Commenters provided multiple
examples of reasonable methods, and
they recommended that the final
regulations treat section 163(j) excess
item allocations as reasonable if the
allocations are: (1) Reasonably
consistent with the allocations of the
corresponding items under section
704(b); (2) in proportion to the
allocation of the underlying section
163(j) item; (3) in proportion to the
manner in which the partners bear
liability for the debt or, in the case of
non-recourse debt, in proportion to the
manner in which profits will be
allocated in order to repay the debt; or
(4) the result of arms-length bargaining
among partners with adverse tax
interests.
The Treasury Department and the IRS
do not adopt any of these alternatives in
the final regulations. Each of the
alternatives recommended by
commenters requires an application of
section 163(j) at the partnership level, a
determination of each partner’s share of
the partnership’s section 163(j) items,
and a final determination of each
partner’s section 163(j) excess items that
takes into account each partner’s share
of the partnership’s section 163(j) items.
These three determinations mirror steps
1, 2, and 11 (respectively) of the 11-step
calculation. The Treasury Department
and the IRS recognize the complexity of
the computations and recordkeeping
imposed by the statute on partnerships,
but the Treasury Department and the
IRS have concluded that the
computations and recordkeeping
associated with steps 1, 2, and 11 of the
11-step calculation are unavoidable
under any approach. As such, the
commenters’ recommendation is, in
effect, that the final regulations allow
alternatives to steps 3 through 10 of the
11-step calculation.
With respect to steps 3 through 10,
the Treasury Department and the IRS
agree that these computations add to the
complexity already required by the
statute; thus, a worksheet and multiple
examples have been provided to aid in
the completion of these computations.
However, the Treasury Department and
the IRS have concluded that these
computations are not overly
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burdensome given that the partnerships
required to perform these calculations
already are experienced with handling
the complexities associated with special
allocations or section 704(c) allocations.
In terms of recordkeeping, taxpayers are
not required to keep records of steps 3
through 10 because compliance with the
11-step calculation can be determined
solely based on the records associated
with steps 1, 2, and 11. Moreover, in
terms of accuracy, the alternatives fall
short of achieving the purpose of steps
3 through 10, which is to align
deductible business interest expense
with the ATI and business interest
income that supported such deduction
at the partnership level.
For example, consider the
recommended alternative of allocating
section 163(j) excess items in proportion
to the allocation of the underlying
section 163(j) item. If partnership AB’s
sole items of income, gain, loss, and
deduction were $30 of business interest
income, which it allocated solely to A,
and $40 of business interest expense,
which it allocated $20 to each of A and
B, then A and B each would have $15
of deductible business interest expense
and $5 of excess business interest
expense. In situations where, as in this
case, the partnership does not allocate
all of its section 163(j) items pro rata
this method could require a partnership
to allocate its section 163(j) excess items
in a manner inconsistent with the
Treasury Department and the IRS’s
resolution of issues four and five. See
part VII(A)(1) of this Summary of
Comments and Explanation of Revisions
section.
Applying the 11-step calculation to
the previous example, A would have
$20 of deductible business interest
expense, and B would have $10 of
deductible business interest expense
and $10 of excess business interest
expense. This result is consistent with
the Treasury Department and the IRS’s
resolution of the five issues described in
part VII(A)(1) of this Summary of
Comments and Explanation of Revisions
section. Because the alternative of
allocating section 163(j) excess items in
proportion to the allocation of the
underlying section 163(j) item could
require a partnership to allocate section
163(j) excess items to its partners in a
manner that does not attempt to align
deductible business interest expense
with the ATI and business interest
income that supported it at the
partnership level (which is inconsistent
with the resolution of the five issues
described in part VII(A)(1) of this
Summary of Comments and Explanation
of Revisions section), this alternative is
not adopted in the final regulations.
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Other commenters’ similar alternatives
were considered and were rejected on
the same grounds based on the foregoing
analysis.
One commenter recommended
another alternative method that, in a
more general way than the 11-step
calculation, attempts to align deductible
business interest expense with the ATI
and business interest income that
supported such deduction at the
partnership level. The commenter stated
that this objective could be
accomplished as follows. For each
partner that is allocated business
interest expense, determine the portion
of the business interest expense
allocated to such partner that would be
considered deductible business interest
expense, taking into account only the
business interest income and ATI
allocated to such partner. If the
aggregate amount determined for all
partners is equal to, or less than, the
amount of the partnership’s deductible
business interest expense, then each
partner would be allocated deductible
business interest expense in the amount
determined in the first step. If the first
step produced deductible business
interest expense in excess of the
limitation determined at the partnership
level, each partner’s allocation of
deductible business interest expense
would equal the proportion of the
partnership’s total deductible business
interest expense that the deductible
amount determined in the first step for
such partner constitutes of the
deductible amount determined for all
partners. Also, any deductible business
interest expense as determined at the
partnership level that is not allocated
through the first step then would be
allocated among the partners that have
been allocated business interest
deductions in proportion to the amount
of business interest expense of each
partner remaining after the first step.
The Treasury Department and the IRS
do not adopt this alternative method in
the final regulations. The commenter’s
approach provides a method for
allocating excess business interest
expense, but it does not provide any
guidance on allocating excess taxable
income or excess business interest
income. Further, it is not possible to
infer a manner for allocating excess
taxable income and excess business
interest income from this approach
because it fails to distinguish each
partner’s ATI from its business interest
income. By comingling ATI and
business interest income in its first step,
this method fails to account for the
ordering of ATI and business interest
income in the partnership context as
required by the statute. Section
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56719
163(j)(4)(C) provides that partnership
ATI does not begin offsetting
partnership business interest expense
until partnership business interest
income has been fully utilized. Because
this method is only capable of
addressing fact patterns in which there
is excess business interest expense, it is
not adopted in the final regulations.
Moreover, the Treasury Department
and the IRS have concluded that this
method for allocating excess business
interest expense does not sufficiently
reduce taxpayer burden given the tradeoff in precision and administrability. To
illustrate, the commenter applied its
recommended method to the facts of
Example 14 of § 1.163(j)–6(o) of the
proposed regulations. In that example,
partnership PRS has $140 of business
interest expense, $200 of ATI, and no
business interest income. Accordingly,
PRS has $60 of deductible business
interest expense. PRS allocates its items
of ATI such that A, B, and C have
income of $100, $100, and $400
respectively, while D has a loss of $400.
PRS allocates its business interest
expense $40 to B, $60 to C, and $40 to
D.
Under the suggested method, PRS first
would determine for each of B, C, and
D the amount of the business interest
expense allocated to each partner that
would be deductible under section
163(j) taking into account solely the ATI
and business interest income allocated
to such partner. In this case, the entire
$60 of business interest expense
allocated to C would have been
deductible, $30 of the business interest
expense allocated to B would have been
deductible, and no amount of business
interest expense allocable to D would
have been deductible. The total amount
of business interest expense determined
in the first step (or $90) exceeds the
total amount deductible under section
163(j) applied at the partnership level
(or $60). PRS then would determine the
proportion of the business interest
expense allocated to each partner that is
determined to be deductible in the first
step and allocate the total deduction in
those proportions. Thus, C would be
entitled to two-thirds ($60/$90) of the
$60 deduction ($40 of deductible
business interest expense) and B would
be entitled to one-third ($30/$90) of the
$60 deduction ($20 of deductible
business interest expense). D would not
be entitled to any business interest
expense deduction. Accordingly, B
would have $20 of excess business
interest expense, C would have $20 of
excess business interest expense, and D
would have $40 of excess business
interest expense.
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In contrast, applying the 11-step
calculation to the same example results
in an allocation of more deductible
business interest expense to C ($48)
than to B ($12) because C was allocated
more ATI ($400) from PRS than B
($100). Unlike the commenter’s method,
the 11-step calculation increases a
partner’s amount of deductible business
interest expense in response to an
increased allocation of ATI and business
interest income. The commenter’s
method allocates deductible business
interest expense based on a ratio that
does not take into account the fact that
C was allocated significantly more ATI
from PRS than B. To illustrate this
point, consider what would happen in
the previous example if the facts were
changed so that C was allocated $1,100
of ATI and D was allocated ($1,100) of
ATI. Applying the 11-step calculation, C
would have $55 of deductible business
interest expense. Applying the
commenter’s method, C’s increased
allocation of ATI from PRS would have
no effect on C’s deductible business
interest expense—C still would have
$40 of deductible business interest
expense and $20 of excess business
interest expense.
The Treasury Department and the IRS
have determined that the 11-step
calculation produces the result that is
most consistent with the normative
principle in the statute that the amount
of business interest expense a taxpayer
is capable of deducting should increase
as its ATI and business interest income
increase. Further, the Treasury
Department and the IRS view methods
that do not increase a partner’s amount
of deductible business interest expense
in response to an increased allocation of
ATI from the partnership as less
intuitive, and therefore more
burdensome in application. Therefore,
the final regulations do not adopt
commenters’ suggested alternative
methods.
4. Publicly Traded Partnerships
The Treasury Department and the IRS
received comments raising concerns
about the continued fungibility of
publicly traded partnership (PTP) units
if PTPs are required to allocate section
163(j) excess items pursuant to the 11step calculation. The effect of section
163(j) on the fungibility of PTP units is
being addressed in the Concurrent
NPRM. Therefore, these issues are not
addressed in the final regulations.
5. Pro Rata Exception
Multiple commenters recommended
that partnerships that allocate all items
of income and expense on a pro rata
basis (similar to S corporations) be
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exempt from the 11-step calculation.
Commenters stated that these
partnerships by nature do not make the
kinds of allocations the 11-step
calculation is designed to address.
Commenters asserted that simplifying
the 11-step calculation for these pro-rata
partnerships would reduce complexity
and reduce their administrative burden.
The Treasury Department and the IRS
agree with these comments.
Accordingly, the final regulations
provide an exception (pro rata
exception) from steps 3 through 11 of
the 11-step calculation for partnerships
that allocate all section 163(j) items in
step 2 proportionately. This pro rata
exception will not result in allocations
of section 163(j) excess items that vary
from the array of allocations of section
163(j) excess items that would have
resulted had steps 3 through 11 been
performed. See § 1.163(j)–6(f)(2)(ii) and
Example 1 through Example 16 of
§ 1.163(j)–6(o).
B. Basis Adjustments
1. Basis and Capital Account
Adjustments for Excess Business
Interest Expense Allocations
Pursuant to proposed § 1.163(j)–
6(f)(2), the adjusted basis of a partner’s
interest in a partnership is reduced, but
not below zero, by the amount of excess
business interest expense allocated to
the partner. If a partner is subject to a
loss limitation under section 704(d) and
the partner is allocated losses from a
partnership in a taxable year, the
limited losses are grouped based on the
character of each loss (each grouping of
losses based on character, a ‘‘section
704(d) loss class’’). If there are multiple
section 704(d) loss classes in a given
year, the partner apportions the
limitation to each section 704(d) loss
class proportionately. For purposes of
applying this proportionate rule, any
deductible business interest expense
and business interest expense of an
exempt entity (whether allocated to the
partner in the current taxable year or
suspended under section 704(d) in a
prior taxable year), any excess business
interest expense allocated to the partner
in the current taxable year, and any
excess business interest expense from a
prior taxable year that was suspended
under section 704(d) (negative section
163(j) expense) makes up the same
section 704(d) loss class (section 163(j)
loss class). Moreover, once the partner
determines the amount of limitation on
losses apportioned to the section 163(j)
loss class, any deductible business
interest expense is taken into account
before any excess business interest
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expense or negative section 163(j)
expense.
Proposed § 1.163(j)–6(h)(2) provides
that negative section 163(j) expense is
not treated as excess business interest
expense in any subsequent year until
such negative section 163(j) expense is
no longer suspended under section
704(d). Consequently, an allocation of
excess taxable income or excess
business interest income does not result
in the negative section 163(j) expense
being treated as business interest
expense paid or accrued by the partner.
Further, unlike excess business interest
expense, which prevents a partner from
including excess taxable income in its
ATI as described in section
163(j)(4)(B)(ii) (flush language), negative
section 163(j) expense does not affect,
and is not affected by, any allocation of
excess taxable income to the partner.
Accordingly, any excess taxable income
allocated to a partner from a partnership
while the partner still has a negative
section 163(j) expense will be included
in the partner’s ATI. However, once the
negative section 163(j) expense is no
longer suspended under section 704(d),
it becomes excess business interest
expense, which is subject to the general
rules in proposed § 1.163(j)–6(g).
Commenters noted that the rule in
proposed § 1.163(j)–6(h)(2) is helpful
and should be retained in the final
regulations. However, commenters
further noted that partners with no
business interest expense from other
sources generally would prefer to treat
their negative section 163(j) expense as
deductible business interest expense
suspended under section 704(d) and
utilize excess taxable income in the
current year for that purpose, even
though the resulting deductible business
interest expense would continue to be
non-deductible because of a section
704(d) limit. Thus, commenters
recommended allowing a partner to use
excess taxable income to treat negative
section 163(j) expense as deductible
business interest expense suspended
under section 704(d) instead of using it
to increase partner ATI.
The final regulations do not adopt this
recommendation. No precedent exists
for allowing items suspended under
section 704(d) to preemptively clear
limitations that apply after section
704(d) while remaining suspended
under section 704(d). For example, in
the section 469 context, a nonmaterially participating partner
allocated passive income cannot use
such passive income to recharacterize
passive losses allocated in a previous
year as non-passive while those losses
remain suspended under section 704(d).
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One commenter also recommended
adopting a silo approach under section
704(d). Under this approach, if a partner
had a section 704(d) limitation, it could
bifurcate its items between nonexcepted and excepted partnership
business items. If the non-excepted
portion was net positive, none of the
excess business interest expense
allocated from the partnership would be
negative section 163(j) expense.
However, this approach would be a
significant departure from the current
rule under section 704(d), which
generally requires the limitation on
losses under section 704(d) to be
allocated to a partner’s distributive
share of each loss proportionately,
regardless of whether such loss is from
an excepted or non-excepted trade or
business under section 163(j). Moreover,
nothing in section 163(j) indicates
Congress intended to give excess
business interest expense suspended
under section 704(d) a better result than
any other partnership losses suspended
under section 704(d). For that reason,
the final regulations do not adopt this
recommendation.
2. Basis Adjustments Upon Disposition
of Partnership Interests Pursuant to
Section 163(j)(4)(B)(iii)(II)
Under the proposed regulations, if a
partner disposes of all or substantially
all of its partnership interest, the
adjusted basis of the partnership interest
is increased immediately before the
disposition by the entire amount of the
remaining excess business interest
expense. Following such a disposition,
no deduction is permitted to either the
transferor or the transferee with respect
to the excess business interest expense
resulting in the basis increase. If a
partner disposes of less than
substantially all of its interest in a
partnership, the partner cannot increase
its basis by any portion of the remaining
excess business interest expense. The
Treasury Department and the IRS
requested comments on this approach in
the preamble to the proposed
regulations.
Commenters cited multiple concerns
with the approach adopted in the
proposed regulations. First, commenters
claimed that the absence of an excess
business interest expense basis addback
for a partial disposition of a partnership
interest could result in tax gain in
excess of economic gain in connection
with the sale of a partial interest, while
the addition of the entire adjustment to
outside basis in connection with a
complete disposition could result in
economic gain in excess of tax gain.
Commenters suggested this timing
difference between economic gain and
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tax gain inappropriately disconnects
taxable income from economic income.
Second, commenters expressed concern
that, because a partial disposition would
result in a partner holding a smaller
interest in a partnership than it held
prior to the partial disposition, the
partner would receive smaller
allocations of excess taxable income
(and excess business interest income) in
subsequent years. If none of the excess
business interest expense of the partner
is affected by the partial disposition,
this could extend the amount of time
needed for a partner to convert its
excess business interest expense to
business interest expense treated as paid
or accrued. Third, commenters noted
that, in the event of a partial disposition
of a partnership interest, the proposed
regulations may cause a discrepancy
between the capital accounts of the
transferor and the transferee and the
excess business interest expense
associated with each partner’s interest.
Commenters stated that neither the
statute nor its policy of limiting
business interest expense deductions
calls for the potentially harsh results
that could be imposed by the approach
provided in the proposed regulations.
The main purpose of the excess
business interest expense carryover rule
is to limit the partner’s ability to claim
a business interest expense deduction
that exceeds the statutory threshold
under section 163(j)(1). Commenters
stated that this statutory purpose can be
accomplished by denying the business
interest expense deduction and
eliminating the carryforward upon a
partial disposition of the partnership
interest. In other words, to the extent
that a partner foregoes its business
interest expense deduction, the purpose
of the statute is fulfilled. Thus, a
proportionate approach would fulfill the
purpose of the statute while not
subjecting taxpayers to outcomes that
are not plainly contemplated by the
statue.
As a solution, commenters
recommended that a partial disposition
of a partnership interest trigger a
proportionate excess business interest
expense basis addback and
corresponding decrease in such
partner’s excess business interest
expense carryover (proportionate
approach). Under the proportionate
approach, the partner would be required
to track its basis in its partnership
interest in a manner similar to that set
forth in Revenue Ruling 84–53, 1984–1
C.B. 159 (April 9, 1984). Commenters
advocating for a proportionate addback
rule varied in their recommendations
regarding where the addback should
occur. In general, commenters suggested
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56721
three options: (1) Increase the basis of
the partnership interest retained; (2)
apportion the basis increase
proportionally between the partnership
interest retained and the partnership
interest being disposed of; and (3)
increase the basis of the partnership
interest being disposed of.
As described in the preamble to the
proposed regulations, the Treasury
Department and the IRS originally
considered and rejected the
proportionate approach. One reason the
Treasury Department and the IRS
adopted the all or substantially all
approach in the proposed regulations
over the proportionate approach was
because the former appeared more
taxpayer-favorable in certain
circumstances. Under the all or
substantially all approach in the
proposed regulations, the excess
business interest expense basis addback
is delayed for the maximum amount of
time (until a partner disposes of all or
substantially all of its interest), giving
taxpayers more time to receive excess
taxable income (and excess business
interest income) and thus potentially
take an ordinary deduction. However, as
commenters pointed out, a smaller
partnership interest likely will result in
a correspondingly smaller allocation of
excess taxable income (and excess
business interest income) from the
partnership. For this reason,
commenters did not perceive the
proposed approach as taxpayerfavorable for preserving the possibility
of a future ordinary deduction, but
rather as taxpayer-unfavorable for
delaying what likely will be a capital
loss.
Accordingly, the Treasury Department
and the IRS adopt the recommended
proportionate approach in the final
regulations. In the preamble to the
proposed regulations, the Treasury
Department and the IRS indicated that,
if final regulations were to adopt a
proportionate approach, such approach
would increase the basis of the
partnership interest being retained by
the amount of the excess business
interest expense basis addback.
However, upon further consideration,
the Treasury Department and the IRS
agree with commenters that the basis
addback should instead increase the
basis of the partnership interest being
disposed of. Thus, the final regulations
adopt a proportionate approach that
increases the basis of the partnership
interest being disposed of.
For purposes of § 1.163(j)–6(h)(3), a
disposition includes a distribution of
money or other property by the
partnership to a partner in complete
liquidation of its interest in the
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partnership. The Treasury Department
and the IRS request comments on
whether a current distribution of money
or other property by the partnership to
a continuing partner as consideration
for an interest in the partnership should
also trigger an addback and, if so, how
to determine the appropriate amount of
the addback. Additionally, the final
regulations clarify that each partner is
considered to have disposed of its
partnership interest within the meaning
of § 1.163(j)–6(h)(3) if the partnership
terminates under section 708(b)(1).
The proportionate rule adopted in the
final regulations applies the equitable
apportionment principles of § 1.61–6
(referenced in Revenue Ruling 84–53) to
determine the amount of excess
business interest expense attributable to
the partner’s interest sold. In Example 1
of § 1.61–6, basis is apportioned among
properties based on the fair market
value of the property and is treated as
equitably apportioned. Similarly, in
Situations 1 and 3 of Revenue Ruling
84–53, the IRS ruled that a selling
partner’s basis in the transferred portion
of the interest generally equals an
amount that bears the same relation to
the partner’s basis in the partner’s entire
interest as the fair market value of the
transferred portion of the interest bears
to the fair market value of the entire
interest (the pro rata approach to
equitable apportionment). However, if a
partnership has liabilities, special
adjustments must be made to take into
account the effect of the liabilities on
the basis of the partner’s interest.
Accordingly, the final regulations adopt
the pro rata approach to equitable
apportionment and generally provide
that the adjusted basis of the
partnership interest being disposed of is
increased immediately before the
disposition by the amount of the excess
business interest expense that is
proportionate to the interest disposed of
in the transaction.
The Treasury Department and the IRS
also received comments recommending
the final regulations treat a sale of all or
substantially all of a partnership’s assets
as a deemed disposition of each
partner’s interest in the partnership
within the meaning of section
163(j)(4)(B)(iii)(II). Because the statute
requires a disposition of a partnership
interest to trigger the basis adjustment
described in section 163(j)(4)(B)(iii)(II),
the final regulations do not adopt this
recommendation.
3. Intercompany Transfer of a
Partnership Interest
For a discussion of comments
received on intercompany transfers of
partnership interests, see part V(D) of
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this Summary of Comments and
Explanation of Revisions section.
C. Debt-Financed Distributions
The treatment of interest expense
associated with debt incurred by a
partnership or S corporation to finance
distributions to owners (debt-financed
distributions) is being addressed in the
Concurrent NPRM. Therefore, these
issues are not addressed in the final
regulations.
D. Trading Partnerships
The preamble to the proposed
regulations stated that the business
interest expense of certain passthrough
entities, including S corporations, that
are engaged in trades or businesses that
are per se non-passive activities and in
which one or more owners of the
entities do not materially participate
within the meaning of section 469, as
described in section 163(d)(5)(A)(ii) and
as illustrated in Revenue Ruling 2008–
12, 2008–1 C.B. 520 (March 10, 2008),
will be subject to section 163(j) at the
entity level (even if the interest expense
is also subject to limitation under
section 163(d) at the individual partner
level). With respect to partnerships, to
the extent that such business interest
expense is limited under section
163(j)(4) and becomes a carryover item
of partners who do not materially
participate with respect to such trades
or businesses, those items will be
treated as items of investment interest
expense in the hands of those owners
for purposes of section 163(d) once
those carryover items are treated as paid
or accrued in a succeeding taxable year.
This rule does not apply to corporate
partners.
The Treasury Department and the IRS
received multiple comments
questioning this interpretation of
section 163(j)(5) and its interaction with
section 163(d)(5)(A)(ii). The interaction
of section 163(j)(5) with section
163(d)(5)(A)(ii) is being addressed in the
Concurrent NPRM. Therefore, this issue
is not addressed in the final regulations.
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
The preamble to the proposed
regulations requested comments
regarding the application of section
163(j) to tiered partnership structures,
and the proposed regulations reserved
on this topic. Specifically, the preamble
requested comments on whether excess
business interest expense should be
allocated through upper-tier
partnerships and how or when an
upper-tier partner’s basis should be
adjusted when a lower-tier partnership
is subject to a section 163(j) limitation.
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This issue is being addressed in the
Concurrent NPRM. Therefore, this issue
is not addressed in the final regulations.
F. Partnership Mergers and Divisions
The proposed regulations reserve on
guidance regarding the application of
section 163(j) to partnership mergers
and divisions, and the Treasury
Department and the IRS requested
comments in the preamble to the
proposed regulations on the effect of
partnership mergers and divisions on
excess business interest expense, excess
taxable income, and excepted trade or
business elections in the context of
section 163(j).
In response to this request, one
commenter recommended that: (i) The
carryforward rule in proposed
§ 1.163(j)–6(g) apply to partners of a
partnership treated as a continuing
partnership in a partnership merger or
division; (ii) the disposition rule of
proposed § 1.163(j)–6(h)(3)(i) apply to
partnership interests that are treated as
liquidated in a partnership merger or
division; and (iii) the final regulations
confirm, perhaps through examples, the
application of the excepted trade or
business election and termination rules
in proposed § 1.163(j)–9 in the context
of a partnership merger or division.
The partnership merger and division
rules under section 708 may treat a
partnership as terminating or
continuing, and the regulations under
§ 1.708–1(c) and (d) provide a construct
for analyzing the tax effects of a
partnership merger or division. The
Treasury Department and the IRS have
determined that, in most situations, a
partnership merger or division can be
analyzed appropriately under the rules
of § 1.708–1(c) and (d). As a result, the
Treasury Department and the IRS are
not providing special rules in the final
regulations to analyze the consequences
of a partnership merger or division in
the context of section 163(j) at this time.
However, the Treasury Department and
the IRS continue to study these issues.
G. Applicability of Section 382 to S
Corporations Regarding Disallowed
Business Interest Expense
Carryforwards
The proposed regulations provide that
sections 381(c)(20) and 382(d)(3) and
(k)(1) apply to S corporations with
respect to disallowed business expense
carryforwards. Proposed § 1.163(j)–
6(l)(5) provides that the amount of any
business interest expense not allowed as
a deduction for any taxable year by
reason of the section 163(j) limitation is
carried forward in the succeeding
taxable year as a disallowed business
interest expense carryforward. Proposed
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§ 1.163(j)–6(l)(1) provides that any
disallowed business interest expense is
not allocated to the S corporation’s
shareholders until such business
interest expense is allowed as a
deduction under section 163(j).
Similarly, under proposed § 1.163(j)–
6(l)(6) and (7), an S corporation
shareholder’s stock basis is reduced, but
not below zero, and an S corporation’s
accumulated adjustments account
(AAA) balance is adjusted, when a
disallowed business interest expense
becomes deductible under section
163(j).
The preamble to the proposed
regulations requested comments
regarding the proper integration of
section 163(j) and section 382 and
subchapter S of the Code (subchapter S).
In addition, the preamble to the
proposed regulations requested
comments regarding the treatment of
disallowed business interest expense
carryforwards as an attribute of the S
corporation subject to the section 382
limitation, as opposed to an attribute of
the shareholders, and regarding the
timing for any adjustments to
shareholder basis and the corporation’s
AAA.
In response, one commenter
recommended that the final regulations
retain the approach as set forth in the
proposed regulations. In particular, the
commenter recommended that section
382 (and the comparable provisions of
section 383) be applied only to those
attributes that are carried forward and
taken into account at the corporate
level. The commenter contended that it
would be appropriate to treat
disallowed business interest expense of
an S corporation as a ‘‘pre-change loss’’
such that the corporation would be a
loss corporation pursuant to section
382(k)(1).
The Treasury Department and the IRS
agree with the commenter. Because
disallowed business interest expense is
treated as an attribute of the S
corporation, the S corporation’s
disallowed business interest expense
carryforwards will be treated as prechange losses subject to a section 382
limitation under section 382(d)(3)
following an S corporation’s ownership
change (within the meaning of section
382(g)).
Accordingly, consistent with the
treatment of C corporations under
section 382, the final regulations
provide that a disallowed business
interest expense carryforward of an S
corporation is treated as pre-change loss
and will be subject to a section 382
limitation only if an S corporation
undergoes an ownership change within
the meaning of section 382(g). For
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example, under the final regulations, a
‘‘qualifying disposition’’ by a
shareholder that results in a 20-percent
ownership change of the S corporation,
on its own, will not cause section 382
to apply to an S corporation upon such
qualifying disposition. See § 1.1368–
1(g)(2)(i)(A). See also § 1.1368–1(g)(2)
(defining the term ‘‘qualifying
disposition’’).
A commenter also recommended that
section 382 not be applied to any item
of deduction, loss, or credit that is
allocated to shareholders on a current
basis and taken into account at the
shareholder level. As expressed in the
preamble to the proposed regulations,
the Treasury Department and the IRS
continue to consider the extent to which
section 382 should apply to S
corporations for purposes other than
section 163(j). The application of
section 382 to S corporations for
purposes of section 163(j) should not be
construed as creating any inference
regarding the application of section 382
to S corporations for other purposes.
The Treasury Department and the IRS
continue to seek comments regarding
the proper integration of these two Code
sections and subchapter S.
H. Separate Application of Section
163(j) Limitation to Short Taxable Years
of S Corporation
An S corporation’s items of income
and loss generally are allocated on a pro
rata, per-day basis to all shareholders
that hold the corporation’s stock during
the corporation’s taxable year. See
section 1377(a)(1). However, subchapter
S provides limited exceptions to that
general allocation rule. For example, in
the event that a shareholder completely
terminates its interest, the S corporation
and affected shareholders can elect to
treat its taxable year ‘‘as if the taxable
year consisted of 2 taxable years the first
of which ends on the date of the
termination’’ (each, a hypothetical short
taxable year). Section 1377(a)(2)(A). In
addition, an S corporation may make
such an election if a shareholder has
made a qualifying disposition. See
§ 1.1368–1(g)(2). With regard to each of
these instances, the S corporation may
elect to ‘‘close the books’’ even though
the corporation will file one Federal
income tax return for the taxable year
covering both separate taxable periods.
Subchapter S also specifies instances
in which an S corporation may elect, or
is required, to file a Federal income tax
return for a short taxable year (actual
short taxable year). For example, an S
corporation may elect to determine
taxable income or loss based on a
closing-of-the-books method with
respect to an S termination year. See
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section 1362(e)(3) (providing an election
to have items assigned to each short
taxable year under normal Federal
income tax accounting rules). However,
if a sale or exchange of at least 50
percent of the S corporation’s stock
occurs during that S termination year,
the S corporation must utilize the
closing-of-the-books method. See
section 1362(e)(6)(D). See also section
1362(e)(6)(C) (requiring the use of the
closing-of-the-books method with
respect to any item resulting from the
application of section 338).
Based on a request from a commenter,
the Treasury Department and the IRS
have considered whether the section
163(j) limitation should apply
separately with respect to each
hypothetical or actual short taxable
year. Specifically, the commenter
recommended that, if an S corporation
(1) has an actual short taxable year, or
(2) determines its taxable income or loss
as if its taxable year consisted of
separate taxable years (that is,
hypothetical short taxable years), the
final regulations should clarify that a
separate section 163(j) limitation should
be calculated for, and applied to, each
actual or hypothetical short taxable
year. To support that recommendation,
the commenter emphasized ‘‘sound
policy reasons’’ for ensuring that owners
of the corporation during the first short
taxable period are not affected by the
fortunes of the corporation during the
second short period, and vice versa.
The Treasury Department and the IRS
agree that a separate section 163(j)
limitation should be calculated for, and
applied to, each actual or hypothetical
short taxable year. Section 163(j)(1)
limits the amount of business interest
expense allowed as a deduction ‘‘for any
taxable year.’’ Accordingly, the Treasury
Department and the IRS have
determined that a separate section 163(j)
limitation should apply to each actual
short taxable year. See § 1.1362–3(c)(3)
(setting forth the general rule that ‘‘the
S and C short years are treated as two
separate years for purposes of all
provisions of the Internal Revenue
Code’’). In addition, subchapter S and
the regulations in this part under
subchapter S explicitly treat
hypothetical short taxable years as
separate taxable years. See section
1377(a)(2)(A) (providing that an S
corporation can treat its taxable year ‘‘as
if the taxable year consisted of 2 taxable
years’’) and § 1.1368–1(g)(1) (providing
that the ‘‘section applies as if the taxable
year consisted of separate taxable
years’’). As a result, the Treasury
Department and the IRS also have
determined that a separate section 163(j)
limitation should apply to each
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hypothetical short taxable year and
sections 1.1362–3(c), 1.1368–1(g)(2),
and 1.1377–1(b)(3) have been amended
accordingly.
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I. Partnership or S Corporation Not
Subject to Section 163(j)
Under proposed § 1.163(j)–6(m)(1), if
a partner or S corporation shareholder is
allocated business interest expense from
an exempt entity, that allocated
business interest expense will be subject
to the partner’s or S corporation
shareholder’s section 163(j) limitations.
Commenters recommended that
proposed § 1.163(j)–6(m)(1) be modified
so that business interest expense
incurred by a partnership that is an
exempt entity is not subject to section
163(j) at the partner level. Commenters
argued that proposed § 1.163(j)–6(m)(1)
was inconsistent with section
163(j)(4)(A), which requires the testing
of partnership-level business interest
expense at the partnership level, not the
partner level. The Treasury Department
and the IRS agree, and have determined
that the same argument naturally should
apply to S corporations and their
shareholders. See section 163(j)(4)(D) (in
relevant part, providing that rules
similar to section 163(j)(4)(A) shall
apply with respect to any S corporation
and its shareholders). Accordingly, the
final regulations provide that business
interest expense of an exempt
partnership, or exempt S corporation,
pursuant to section 163(j)(3) does not
retain its character as business interest
expense and, as a result, is not subject
to the section 163(j) limitation at the
partner or S corporation shareholder
level.
One commenter requested
clarification as to whether proposed
§ 1.163(j)–6(m)(3) applies only to
exempt entities or also could apply to
trades or businesses that become not
subject to the requirements of section
163(j) by reason of engaging in excepted
trades or businesses. The final
regulations clarify that § 1.163(j)–
6(m)(3) does not apply when a
partnership engages in excepted trades
or businesses. Accordingly, if a partner
is allocated excess business interest
expense from a partnership and, in a
succeeding taxable year, such
partnership engages in excepted trades
or businesses, then the partner shall not
treat any of its excess business interest
expense that was previously allocated
from such partnership as business
interest expense paid or accrued by the
partner in such succeeding taxable year
by reason of the partnership engaging in
excepted trades or businesses. Rather,
such excess business interest expense
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shall remain as excess business interest
expense until such time as it is treated
as business interest expense paid or
accrued by the partner pursuant to
§ 1.163(j)–6(g)(2) or by reason of the
partnership becoming an exempt entity.
The final regulations provide a similar
clarification for S corporations in
§ 1.163(j)–6(m)(4).
J. Trusts
For purposes of determining ATI for
trusts, one commenter noted that the
definition of ATI does not contain an
addback for deductible trust
distributions. Trusts and decedents’
estates taxable under section 641 are
permitted to deduct under sections 651
and 661 certain distributions made to
beneficiaries. The commenter suggested
that section 163(j) should apply before
a trust takes a deduction for
distributions to beneficiaries, and that,
if a deductible trust or estate
distribution is added back to the trust’s
ATI and thus is taken into account in
determining the amount of interest
expense allowable to the trust under
section 163(j), such trust or estate
distribution should be excluded from
the recipient beneficiaries’ calculation
of ATI. Thus, under the commenter’s
approach, a beneficiary of a trust or a
decedent’s estate would not be able to
utilize a trust distribution to deduct
additional business interest expense at
the beneficiary level.
The Treasury Department and the IRS
agree with this comment. Proposed
Regulation § 1.163(j)–2(f) is consistent
with this result. However, in order to
clarify that trusts and decedents’ estates
taxable under section 641 compute ATI
without regard to deductions under
sections 651 and 661, the final
regulations explicitly provide for this
positive ATI adjustment. Additionally,
the Treasury Department and the IRS
have determined that a similar rule
should apply for charitable deductions
of a trust or a decedent’s estate under
section 642(c).
K. Qualified Expenditures
The ATI of a partnership is generally
determined in accordance with
proposed § 1.163(j)–1(b)(1). Partnership
ATI is therefore reduced by deductions
claimed under sections 173 (relating to
circulation expenditures), 174(a)
(relating to research and experimental
expenditures), 263(c) (relating to
intangible drilling and development
expenditures), 616(a) (relating to mine
development expenditures), and 617(a)
(relating to mining exploration
expenditures) (collectively, ‘‘qualified
expenditures’’). As a result, deductions
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for qualified expenditures will reduce a
partnership’s section 163(j) limitation
pursuant to proposed § 1.163(j)–2(b).
Deductions for those items also will
reduce the amount of excess taxable
income that may be allocated to the
partners and thus reduce the amount by
which partner-level ATI may be
increased under proposed § 1.163(j)–
6(e)(1).
A partner may elect to capitalize its
distributive share of any qualified
expenditures of a partnership under
section 59(e)(4)(C) or may be required to
capitalize a portion of its distributive
share of certain qualified expenditures
of a partnership under section 291(b).
As a result, the taxable income reported
by a partner in a taxable year
attributable to the ownership of a
partnership interest may exceed the
amount of taxable income reported to
the partner on a Schedule K–1.
Commenters recommended that a
distributive share of partnership
deductions capitalized by a partner
under section 59(e) or section 291(b)
increase the ATI of the partner because
qualified expenditures reduce both
partnership ATI and excess taxable
income but may not reduce the taxable
income of a partner. Commenters
suggested two different approaches for
achieving this result: (1) Adjust the
excess taxable income of the
partnership, resulting in an increase to
partner ATI; and (2) increase the ATI of
the partner directly, without making any
adjustments to partnership excess
taxable income. The interaction of
qualified expenditures with section
163(j)(4) is being addressed in the
Concurrent NPRM. Therefore, this issue
is not addressed in the final regulations.
L. CARES Act Partnership Rules
As discussed in the Background
section to this preamble, section
163(j)(10), as amended by the CARES
Act, provides a special rule for excess
business interest expense allocated to a
partner in a taxable year beginning in
2019 (50 percent EBIE Rule). See section
163(j)(10)(a)(ii). The 50 percent EBIE
rule is addressed in proposed § 1.163(j)–
6(g)(4) of the Concurrent NPRM. The
application of the 2019 ATI rule, as
provided in section 163(j)(10)(B), in the
partnership context is also addressed in
proposed § 1.163(j)–6(g)(4) of the
Concurrent NPRM. Therefore, the 50
percent EBIE rule and the application of
the 2019 ATI rule to partnerships are
not addressed in the final regulations.
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VIII. Comments on and Changes to
Proposed § 1.163(j)–7: Application of
the Section 163(j) Limitation to Foreign
Corporations and United States
Shareholders
Section 1.163(j)–7 provides general
rules regarding the application of the
section 163(j) limitation to foreign
corporations and U.S. shareholders. The
following discussion addresses
comments relating to proposed
§ 1.163(j)–7.
The proposed regulations generally
apply section 163(j) and the section
163(j) regulations to determine the
deductibility of an applicable CFC’s
business interest expense in the same
manner as these provisions apply to
determine the deductibility of a
domestic C corporation’s business
interest expense. See proposed
§ 1.163(j)–7(b)(2). The proposed
regulations define an applicable CFC as
a CFC in which at least one U.S.
shareholder owns stock, within the
meaning of section 958(a). However, in
certain cases, the proposed regulations
limit the amount of an applicable CFC’s
business interest expense subject to the
section 163(j) limitation and modify the
computation of an applicable CFC’s
ATI, respectively. Thus, under the
proposed regulations, an applicable CFC
with business interest expense applies
section 163(j) to determine the extent to
which that expense is deductible for
purposes of computing subpart F
income as defined under section 952,
tested income as defined under section
951A(c)(2)(A), and income that is
effectively connected with the conduct
of a U.S. trade or business (ECI), as
applicable. The proposed regulations
provide additional guidance for an
applicable CFC (and other foreign
persons) with ECI in proposed
§ 1.163(j)-8, as discussed in part IX of
this Summary of Comments and
Explanation of Revisions section.
The Treasury Department and the IRS
requested comments in the preamble to
the proposed regulations regarding
whether it would be appropriate to
provide additional modifications to the
application of section 163(j) to
applicable CFCs and whether there are
particular circumstances in which it
may be appropriate to exempt an
applicable CFC from the application of
section 163(j).
Some commenters recommended that
section 163(j) generally should not
apply to applicable CFCs. Other
commenters suggested that section
163(j) should apply to applicable CFCs
only to the extent that they have ECI or,
if an income tax treaty applies, business
profits attributable to a United States
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permanent establishment, or to the
extent that debt was introduced to an
applicable CFC with a principal purpose
of avoiding U.S. income taxes. Some
commenters argued that the Treasury
Department and the IRS lack the
authority to apply section 163(j) to
applicable CFCs because section 163(j)
applies to taxpayers and, they argue,
applicable CFCs are not taxpayers.
Furthermore, some commenters argued
that old section 163(j) did not apply to
applicable CFCs and that Congress
expressed no intent to change that.
Some commenters also argued that
applying section 163(j) to applicable
CFCs creates significant complexity and
an administrative burden. Furthermore,
some commenters suggested that
applying section 163(j) to applicable
CFCs may have a limited effect on tax
revenue or that applying section 163(j)
to applicable CFCs could, in some cases,
result in a net tax benefit to U.S.
shareholders.
The Treasury Department and the IRS
have determined that, under current
law, section 163(j) applies to applicable
CFCs and other foreign corporations
whose income is relevant for U.S. tax
purposes. As a general matter,
application of U.S. tax principles to a
foreign corporation for purposes of
determining its income for U.S. tax
purposes is within the authority of the
Treasury Department and the IRS. For
example, a U.S. shareholder of an
applicable CFC takes into account its
pro rata share of the subpart F income
and net tested income of an applicable
CFC. Accordingly, in order to determine
the U.S. shareholder’s pro rata share, the
income of the applicable CFC must be
determined. Section 1.952–2(a)(1)
provides that, ‘‘[e]xcept as provided in
subparagraph (2) of this paragraph
[relating to insurance gross income], the
gross income of a foreign corporation for
any taxable year shall, subject to the
special rules of paragraph (c) of this
section, be determined by treating such
foreign corporation as a domestic
corporation taxable under section 11
and by applying the principles of
section 61 and the regulations
thereunder.’’ Neither § 1.952–2(a)(2) nor
(c) implicates section 163(j).
Accordingly, pursuant to § 1.952–2, a
foreign corporation is treated as a
domestic corporation for U.S. tax
purposes when calculating its taxable
income, including by application of
section 163(j).
The exclusion of CFCs from the
application of old section 163(j) under
the 1991 Proposed Regulations is not
determinative as to whether applicable
CFCs and other foreign corporations
should be excluded from the application
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56725
of section 163(j). Although both old
section 163(j) and section 163(j) limit
deductions for business interest
expense, the policies of each provision
are significantly different. Old section
163(j) was a narrower provision that
limited a corporation’s ability to use
interest expense deductions to move
earnings out of the United States tax
base. Section 163(j) focuses on limiting
the potential tax benefit of
overleveraged businesses. Because
Congress wholly repealed and replaced
old section 163(j), the provisions of old
section 163(j) and the 1991 Proposed
Regulations are not determinative as to
the application of section 163(j).
Furthermore, nothing in the Code or
legislative history indicates that
Congress intended to exclude applicable
CFCs or other foreign corporations from
the application of section 163(j).
Congress expressly provided that
section 163(j) should not apply to
certain small businesses or to certain
excepted trades or businesses. Congress
did not exempt applicable CFCs or other
foreign corporations from the
application of section 163(j).
Accordingly, the final regulations
clarify that section 163(j) applies to
foreign corporations whose income is
relevant for U.S. tax purposes, other
than by reason of section 881 or 882
(relevant foreign corporations). Section
1.163(j)–7(b). Furthermore, no
comments were received on the
application of § 1.952–2 or section 882
for purposes of determining the income,
including ECI, of an applicable CFC or
on the reduction of an applicable CFC’s
taxable income by the amount of any
dividend received from a related person
for purposes of determining ATI. In
addition to clarifying that these rules
apply to all relevant foreign
corporations, the final regulations
otherwise adopt these rules unchanged.
§ 1.163(j)–7(g)(1).
The Treasury Department and the IRS
acknowledge that the application of
section 163(j) to applicable CFCs and
other relevant foreign corporations, like
many other tax provisions, will increase
the complexity of determining the
taxable income of a relevant foreign
corporation. Similarly, section 163(j)
may have a significant effect on the
amount of taxable income of some
relevant foreign corporations and have
limited or no effect on the amount of
taxable income of others. The Treasury
Department and the IRS do not view the
complexity of a provision of the Code or
its net effect on tax revenue as
determinative as to whether the
provision applies to CFCs. Nonetheless,
the Treasury Department and the IRS
have determined that it is appropriate to
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reduce the compliance and
administrative burdens of applying
section 163(j) to certain applicable
CFCs.
Accordingly, the Treasury Department
and the IRS have developed new rules,
taking into account comments received,
that substantially modify the rules
contained in proposed § 1.163(j)–7. The
Treasury Department and the IRS
anticipate that, in many cases, these
modifications will significantly reduce
the compliance and administrative
burdens of applying section 163(j) to
applicable CFCs. However, because the
operation of these new rules is
sufficiently different from the operation
of the rules in proposed § 1.163(j)–7, the
Treasury Department and the IRS have
determined that these rules should be
proposed in order to provide taxpayers
the opportunity to comment before their
finalization. These rules and a
discussion of their operation are
contained in the Concurrent NPRM.
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IX. Comments on and Changes to
Section 1.163(j)–8: Application of the
Section 163(j) Limitation to Foreign
Persons With Effectively Connected
Taxable Income.
Proposed § 1.163(j)–8 provides rules
for applying section 163(j) to a
nonresident alien individual or foreign
corporation with ECI. Although no
comments were received on proposed
§ 1.163(j)–8, the Treasury Department
and the IRS continue to study methods
of determining the amount of deductible
business interest expense and
disallowed business interest expense
carryforwards that are allocable to ECI.
Accordingly, the final regulations
reserve on the application of the
business interest expense deduction
limitation to foreign persons with ECI.
In the Concurrent NPRM, the
Treasury Department and the IRS are
proposing rules for determining the
amount of deductible business interest
expense and disallowed business
interest expense carryforward of a
nonresident alien, foreign corporation,
or partnership that is properly allocable
to ECI. The Treasury Department and
the IRS request comments on
appropriate methods of making this
determination. These comments should
consider the appropriate method for
determining the extent to which
business interest expense determined
under § 1.882–5 should be treated as
attributable to a partnership and subject
to the section 163(j) limitation at the
partnership level.
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X. Comments on and Changes to
Proposed § 1.163(j)–9: Elections for
Excepted Trades or Businesses; Safe
Harbor for Certain REITs
Section 1.163(j)–9 provides general
rules and procedures for making an
election for a trade or business to be an
electing real property trade or business
under section 163(j)(7)(B) and an
election for a trade or business to be an
electing farming business under section
163(j)(7)(C). The following discussion
addresses some of the provisions in
§ 1.163(j)–9 and the comments received.
A. Protective Elections
Section 163(j)(3) provides that the
section 163(j) limitation does not apply
to taxpayers that meet the gross receipts
test of section 448(c). The small
business exemption applies
automatically if the requirements are
met; thus, no election is necessary to
ensure that the section 163(j) limitation
does not apply. However, for real
property trades or businesses under
section 163(j)(7)(B), and for farming
businesses under section 163(j)(7)(C),
the section 163(j) limitation does not
apply only if the taxpayer is eligible for
and makes an election.
The preamble to the proposed
regulations provides that a taxpayer that
qualifies for the small business
exemption is not eligible to make an
election for a trade or business to be an
electing real property trade or business
or an electing farming business, in part
because the taxpayer is already not
subject to the section 163(j) limitation,
and in part because an electing real
property trade or business or an electing
farming business is required to use ADS
for certain types of property under
section 163(j)(10) and cannot claim the
additional first-year depreciation
deduction under section 168(k) for those
types of property. The Treasury
Department and the IRS were concerned
that certain small business taxpayers
might make the election without
realizing that the election could have
adverse effects on their deduction for
depreciation expense and their method
of accounting for depreciation.
Commenters suggested that, in some
situations, making an annual gross
receipts determination, to determine
whether a taxpayer should make an
election or is already exempt from the
limitation, could be burdensome. For
example, a taxpayer that has to request
the average annual gross receipts of
numerous unrelated entities under
section 448 aggregation principles in
order to make the gross receipts
determination may choose to forgo
making that determination if the
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taxpayer knows that its trade or
business qualifies to be an electing real
property trade or business or an electing
farming business. These commenters
requested that taxpayers be allowed to
make such an election without regard to
whether the gross receipts test of section
448(c) has been tested or is met,
notwithstanding the potentially adverse
depreciation expense implications.
The Treasury Department and the IRS
agree with the commenters.
Accordingly, the final regulations
provide that taxpayers may make an
election for a trade or business to be an
electing real property trade or business
or an electing farming business,
provided that they qualify to make such
elections, even if the gross receipts test
under section 448(c) may be satisfied by
the electing trades or businesses in the
taxable year in which the election is
made. As is the case for all other
electing real property trades or
businesses and electing farming
businesses, the elections are irrevocable
and affect depreciation as provided in
section 163(j)(11). However, this rule
also benefits taxpayers subject to section
163(j) that are owners of small
businesses because treating these small
businesses as engaged in an excepted
trade or business may result in the
allocation of more owner interest
expense to excepted trades or
businesses under § 1.163(j)–10(c).
Commenters also requested a
protective election for taxpayers
engaged in rental real estate activities if
it is unclear whether the activities rise
to the level of a trade or business under
section 162. The protective election is
necessary, according to some
commenters, because the definition of
an ‘‘electing real property trade or
business’’ in section 163(j)(7)(B) and
proposed § 1.163(j)–1(b)(14) allows a
trade or business described in section
469(c)(7)(C) to make the election, and a
real property trade or business as
defined in section 469(c)(7)(C) can
include rental real estate that does not
rise to the level of a section 162 trade
or business.
Generally, interest expense associated
with an activity that does not rise to the
level of a section 162 trade or business
is not subject to the section 163(j)
limitation. The section 163(j) limitation
applies to taxpayers with business
interest, which is defined under section
163(j)(5) as any interest properly
allocable to a trade or business.
Proposed § 1.163(j)–1(b)(38) defines a
‘‘trade or business’’ as a trade or
business under section 162. In contrast,
an electing real property trade or
business must be described in section
469(c)(7)(C). Section 1.469–9(b)(1)
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provides that, for purposes of section
469(c)(7), the term ‘‘trade or business’’
is defined as ‘‘any trade or business
determined by treating the types of
activities in § 1.469–4(b)(1) as if they
involved the conduct of a trade or
business; and any interest in rental real
estate, including any interest in rental
real estate that gives rise to deductions
under section 212.’’
Thus, section 469(c)(7)(C) includes all
rental real estate (as defined in § 1.469–
9(b)(3)) and adopts a broader definition
of a ‘‘trade or business’’ than section
162. Under this broader definition,
taxpayers with rental real estate may be
able to qualify as ‘‘real estate
professionals’’ through work performed
in their rental real estate, even if the
rental real estate activities otherwise do
not rise to the level of a section 162
trade or business.
For example, for purposes of section
469(c)(7)(C), a taxpayer who owns real
property and rents to tenants under a
triple net lease arrangement will be
treated as engaged in a real property
trade or business even though the
renting under the terms of a triple net
lease arrangement may not rise to the
level of a section 162 trade or business.
The triple net lease arrangement is
included in the broader definition of a
trade or business under § 1.469–9(b)(1)
because the arrangement represents an
interest in rental real estate.
Accordingly, renting real property
under a triple net lease arrangement
generally will fall within the definition
of a ‘‘rental real property trade or
business’’ in section 469(c)(7)(C) and
proposed § 1.469–9(b)(2). As a result,
the taxpayer with such a rental
arrangement should be able to make an
election to treat this activity as an
electing real property trade or business,
if the taxpayer so chooses, even though
the renting of real property under a
triple net lease arrangement might not
be a section 162 trade or business. This
result is simply a consequence of
Congress cross-referencing the broader
section 469 definition of a ‘‘real
property trade or business’’ for purposes
of section 163(j).
Thus, the commenters stated that,
although taxpayers who are certain they
are not engaged in a section 162 trade
or business do not need to make an
election out of the section 163(j)
limitation because they are not subject
to this limitation, taxpayers engaged in
rental real estate activities who are not
certain whether their rental real estate
activities rise to the level of a section
162 trade or business should be given
the ability to obtain certainty by making
a protective election to treat their rental
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real estate activities as an electing real
property trade or business.
The Treasury Department and the IRS
agree with the recommendation for a
protective election under these
circumstances. Thus, the final
regulations provide that an election to
treat rental real estate activities as an
electing real property trade or business
is available regardless of whether the
taxpayer making the election is engaged
in a trade or business within the
meaning of section 162. Under the
protective election, a taxpayer engaged
in activities described in section
469(c)(7)(C) and § 1.469–9(b)(2), as
required in proposed § 1.163(j)–
1(b)(14)(i), but unsure whether its
activities rise to the level of a section
162 trade or business, may make an
election for a trade or business to be an
electing real property trade or business.
As with all other electing real
property trades or businesses, once the
election is made, all other consequences
of the election outlined in § 1.163(j)–9
apply, such as the irrevocability of the
election and the required use of the
alternative depreciation system for
certain assets.
B. One-Time Late Election or
Withdrawal of Election Procedures
Commenters requested a one-time
automatic extension of time for certain
taxpayers to file an election under
section 163(j)(7)(B) or section
163(j)(7)(C) due to uncertainty about the
effect of a decision to make or not make
such an election and about which
taxpayers are eligible to make such an
election prior to the publication of the
final regulations. Additionally,
commenters requested a one-time
opportunity to withdraw an election
made under section 163(j)(7)(B) or
section 163(j)(7)(C) prior to the
publication of the final regulations. The
Treasury Department and the IRS agree
with the commenters’ concerns. Thus,
in order to address the commenters’
concerns, and to provide immediate
transition guidance under section 163(j)
for taxpayers affected by the various
amendments to the Code made by the
CARES Act (including, for example, the
technical corrections to section 168(e) of
the Code relating to the classification of
qualified improvement property),
Revenue Procedure 2020–22 was issued
to provide an automatic extension of
time to make, or an opportunity to
withdraw, an election for taxable years
beginning in 2018, 2019, or 2020. The
revenue procedure also provides the
time and manner of making or revoking
the three elections provided by the
CARES Act under section 163(j)(10) for
taxable years beginning in 2019 or 2020.
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C. The Anti-Abuse Rule Under Proposed
§ 1.163(j)–9(h)
Numerous comments were received
concerning the anti-abuse rule in
proposed § 1.163(j)–9(h)(1) (proposed
–9(h) anti-abuse rule). The proposed
–9(h) anti-abuse rule prohibits an
otherwise qualifying real property trade
or business from making an election
under section 163(j)(7)(B) if at least 80
percent of the business’s real property,
determined by fair market value, is
leased to a trade or business under
common control (that is, 50 percent of
the direct and indirect ownership of
both businesses is held by related
parties within the meaning of sections
267(b) and 707(b)) with the real
property trade or business. Proposed
§ 1.163(j)–9(h)(2) provides an exception
to the proposed –9(h) anti-abuse rule for
REITs that lease qualified lodging
facilities (defined in section
856(d)(9)(D)) and qualified health care
properties (defined in section
856(e)(6)(D)) (REIT exception).
The preamble to the proposed
regulations explains that it would be
inappropriate to allow an election under
section 163(j)(7)(B) to be an excepted
real property trade or business for a
trade or business that leases
substantially all of its real property to
the owner of the real property trade or
business, or to a related party of the
owner: ‘‘To permit such an election
would encourage a taxpayer to enter
into non-economic structures where the
real estate components of non-real estate
businesses are separated from the rest of
such businesses in order to artificially
reduce the application of section 163(j)
by leasing the real property to the
taxpayer or a related party of the
taxpayer and electing for this
‘‘business’’ to be an excepted real
property trade or business. As a result,
these proposed regulations would also
contain an anti-abuse rule.’’ The
preamble further explains the reasoning
for the REIT exception by stating that,
because REITs that lease qualified
lodging facilities and qualified
healthcare properties are generally
permitted (pursuant to section
856(d)(8)(B)) to lease these properties to
a taxable REIT subsidiary (TRS), this
anti-abuse rule does not apply to these
types of REITs. The Treasury
Department and the IRS requested
comments in the preamble to the
proposed regulations on whether other
exceptions to the anti-abuse rule (such
as, for example, an exception for certain
fact patterns where real property that is
leased from a related party is ultimately
sub-leased to a third party) would be
appropriate.
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Commenters suggested eliminating or
modifying the proposed –9(h) anti-abuse
rule because of the concern that, as
currently written, this rule applies to
non-abusive lease arrangements
between commonly controlled trades or
businesses. Specifically, commenters
raised concerns about the applicability
of the proposed –9(h) anti-abuse rule to
specific types of business structures
where the real property is owned by one
legal entity (referred to as property
company, or PropCo) and leased to a
separate but commonly controlled legal
entity that operates and manages a
business (referred to as operating
company, or OpCo). According to
commenters, this PropCo/OpCo
structure has valid business protection,
lending, and regulatory purposes in
certain industries. Commenters also
claimed that this structure was in
existence for many years prior to the
enactment of the section 163(j)
limitation and was not created in an
attempt to circumvent application of the
section 163(j) limitation.
For example, the PropCo/OpCo
structure is used by some hotels in the
following manner: PropCo generally
owns the real property subject to
significant debt, services such debt, and
leases the real property to OpCo, which
operates a real property trade or
business by licensing the property to
unrelated third parties (guests). This
structure is used to limit legal liability,
manage state and local tax burdens, plan
for family wealth transfers, and for other
business objectives. One commenter
recommended a ‘‘look-through’’
exception to the proposed –9(h) antiabuse rule where the real property is
ultimately leased (or licensed) to
unrelated third parties in a PropCo/
OpCo structure. This exception would
allow a real property trade or business
owning real property, or PropCo, to
make an election to be an electing real
property trade or business if it leases
real property to a commonly controlled
real property trade or business, or OpCo,
if OpCo subleases (or licenses) the real
property to unrelated third parties.
Similarly, commenters noted that the
property ownership, mortgage, and
resulting interest expense for trades or
businesses described as nursing homes,
continuing care retirement
communities, independent living
facilities, assisted living facilities,
memory care facilities, and skilled
nursing facilities (collectively,
‘‘residential living facilities’’) is often
contained in one legal entity, or PropCo,
and the operation and management of
the residential living facility is
contained in another, commonly
controlled legal entity, or OpCo.
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Commenters explained that the
Department of Housing and Urban
Development, which is a major lender
in the residential living industry, and
many other lenders often require the use
of single-asset or separate legal entities
for lending purposes.
To prevent the application of the
proposed –9(h) anti-abuse rule to a
PropCo that leases real property to a
residential living facility, some
commenters suggested that the antiabuse rule should not apply to a trade
or business that leases real property to
a residential living facility (1) regardless
of whether the lessor and lessee are
under common control, or (2) if both the
lessor trade or business and the
commonly controlled lessee
independently qualify as electing real
property trades or businesses.
Commenters noted that the proposed
–9(h) anti-abuse rule should not apply
to situations where the entities, if
combined or aggregated and without
taking the lease into account, would
each qualify as real property trades or
businesses. Without modification to the
proposed –9(h) anti-abuse rule, the
PropCo in a PropCo/OpCo structure
would be prohibited from making a real
property trade or business election even
though all of its lease income is derived
from a real property trade or business.
Commenters suggested that proposed
§ 1.163(j)–9(h)(2), which provides an
exception for REITs, should apply to
similarly situated taxpayers that are
privately owned but use a commonly
controlled entity in a PropCo/OpCo
structure rather than a REIT.
Other suggestions made by
commenters include (1) eliminating the
proposed –9(h) anti-abuse rule and
instead relying on the more general
proposed § 1.163(j)–2(h) anti-avoidance
rule to disregard or recharacterize the
types of non-economic structures
targeted by the proposed –9(h) antiabuse rule, (2) clarifying that the
proposed –9(h) anti-abuse rule would
apply only if there is a ‘‘principal
purpose of tax avoidance,’’ (3) providing
exceptions to the proposed –9(h) antiabuse rule if the taxpayer demonstrates
a substantial economic purpose for the
PropCo/OpCo structures unrelated to
avoiding section 163(j), or if the PropCo/
OpCo structure was in place prior to
enactment of the TCJA, and (4)
expanding the REIT exception to
include all real property trades or
businesses that lease to residential
living facilities.
The operation of two separate, but
commonly controlled, legal entities is
also common in the cattle and beef
industry—one entity owns all of the
land and the buildings used by the
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operating entity, whereas the operating
entity owns inventory (cattle or crops)
and equipment and operates the farm,
ranch, or feed yard. Commenters
recommended providing an exception
from the proposed –9(h) anti-abuse rule
for farming businesses or, alternatively,
clarifying that the allocation rules under
proposed § 1.163(j)–10 do not apply to
separate out the real property to real
property businesses included under the
proposed –9(h) anti-abuse rule.
The Treasury Department and the IRS
agree with commenters that certain
exceptions should be added to the
proposed –9(h) anti-abuse rule. The
final regulations provide two additional
exceptions to the anti-abuse rule. Under
the first exception, if at least 90 percent
of a lessor’s real property, determined
by fair market rental value, is leased to
a related party that operates an excepted
trade or business and/or to unrelated
parties, the lessor is eligible to make an
election to be an electing real property
trade or business for its entire trade or
business (de minimis exception). The de
minimis exception accommodates
taxpayers that, by law or for valid
business reasons, divide their real
property holding and leasing activities
from their operating trade or business
that qualifies as an excepted trade or
business, while still maintaining an
anti-abuse rule to prevent non-economic
business structures designed to
circumvent the section 163(j) limitation.
See § 1.163(j)–9(j).
The second exception is a lookthrough rule that modifies the proposed
–9(h) anti-abuse rule by allowing
taxpayers to make an election for a
certain portion of their real property
trade or business (look-through
exception). Under the look-through
exception, if a lessor trade or business
leases to a trade or business under
common control (lessee), the lessor is
eligible to make an election to be an
electing real property trade or business
to the extent that the lessor leases to an
unrelated party or to an electing trade or
business under common control with
the lessor or lessee, and to the extent
that the lessee trade or business under
common control subleases (or licenses)
to unrelated third parties and/or related
parties that operate an excepted trade or
business. Accordingly, the lessor can
make an election for the portion of its
trade or business that is equivalent to
the portion of the real property that is
ultimately leased to unrelated parties
and/or related parties that operate an
excepted trade or business. A lessor that
makes an election under the lookthrough exception must allocate the
basis of assets used in its trades or
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businesses under the rules provided in
§ 1.163(j)–10(c)(3)(iii)(D).
D. Residential Living Facilities and
Notice With Proposed Revenue
Procedure
The PropCo/OpCo structure,
discussed previously in part X(C) of this
Summary of Comments and Explanation
of Revisions section, is used extensively
by certain residential living facilities
that provide residential housing along
with supplemental assistive, nursing,
and other routine medical services. The
commonly controlled lessees in the
PropCo/OpCo structure expressed
concern about whether the residential
living facility trades or businesses
qualify as real property trades or
businesses under section 469 and
§ 1.469–9(b)(2), and are thus eligible to
make an election under section
163(j)(7)(B), because of the
supplemental services that they provide.
Accordingly, Notice 2020—[INSERT
NOTICE #], 2020—[INSERT CB/IRB
GUIDANCE NUMBERS], released
concurrently with these final
regulations, provides notice of a
proposed revenue procedure detailing a
proposed safe harbor under which a
taxpayer engaged in a trade or business
that manages or operates a residential
living facility and that also provides
supplemental assistive, nursing, and
other routine medical services may elect
to treat such trade or business as a real
property trade or business within the
meaning of section 469(c)(7)(C), solely
for purposes of qualifying as an electing
real property trade or business under
section 163(j)(7)(B). Thus, if a lessor
leases real property to a commonly
controlled lessee that operates a
residential living facility, which
qualifies as and makes an election to be
an excepted trade or business under the
proposed safe harbor in Notice 2020—
[INSERT NOTICE #], the lessor may
qualify to use the de minimis exception
or the look-through exception.
The Treasury Department and the IRS
request comments in Notice 2020—
[INSERT NOTICE #] on the proposed
revenue procedure. Interested parties
are invited to submit comments on the
proposed revenue procedure by
[INSERT DATE 90 DAYS AFTER
PUBLICATION of Notice 2020—
[INSERT NOTICE #] IN the IRB].
The proposed revenue procedure is
proposed to apply to taxpayers with
taxable years ending after December 31,
2017. Until such time that the proposed
revenue procedure is published in final
form, taxpayers may use the safe harbor
described in the proposed revenue
procedure for purposes of determining
whether a residential living facility, as
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defined in the proposed revenue
procedure, may be treated as a real
property trade or business solely for
purposes of section 163(j).
Future guidance might be needed to
determine whether a particular trade or
business can make an election.
Accordingly, the definitions of electing
real property trade or business in
§ 1.163(j)–1(b)(14) and electing farming
business in § 1.163(j)–1(b)(13) include a
new provision noting that the Secretary
may issue guidance on whether a trade
or business can be an electing real
property trade or business or electing
farming business.
E. Safe Harbor for Certain REITs
Proposed § 1.163(j)–9(g) provides a
special safe harbor for REITs. The safe
harbor provides that, if a REIT holds
real property, interests in partnerships
holding real property, or shares in other
REITs holding real property, the REIT is
eligible to make an election to be an
electing real property trade or business
for all or part of its assets. If a REIT
makes an election to be an electing real
property trade or business, and if the
value of the REIT’s real property
financing assets (as defined in proposed
§ 1.163(j)–9(g)(5) and (6)) at the close of
the taxable year is 10 percent or less of
the value of the REIT’s total assets at the
close of the taxable year, then, under the
safe harbor in the proposed regulations,
all of the REIT’s assets are treated as
assets of an excepted trade or business.
If a REIT makes an election to be an
electing real property trade or business,
and if the value of the REIT’s real
property financing assets at the close of
the taxable year is more than 10 percent
of the value of the REIT’s total assets,
then, under the safe harbor in the
proposed regulations, the REIT’s
business interest income, business
interest expense, and other items of
expense and gross income are allocated
between excepted and non-excepted
trades or businesses under the rules set
forth in proposed § 1.163(j)–10, as
modified by proposed § 1.163(j)–9(g)(4).
The safe harbor also allows REITs to use
§ 1.856–10 for the definition of ‘‘real
property’’ in determining which assets
are assets of an excepted trade or
business. The final regulations generally
adopt the safe harbor for REITs in the
proposed regulations, with
modifications in response to comments
discussed in this part X(E) of the
Summary of Comments and Explanation
of Revisions section.
One commenter recommended that
the Treasury Department and the IRS
revise proposed § 1.163(j)–9(g)(1) to
clarify that a REIT may make the safe
harbor election if the REIT owns an
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56729
interest in one or more partnerships
holding real property or stock in one or
more REITs holding real property. The
commenter indicated that the use of the
plural ‘‘interests in partnerships’’ and
‘‘shares in other REITs’’ could imply
that a REIT cannot make the safe harbor
election if the REIT owns an interest in
a single partnership or shares in a single
REIT. The Treasury Department and the
IRS agree that the regulations should not
preclude a REIT that owns an interest in
a single partnership or shares in a single
REIT from applying the safe harbor.
This commenter also recommended
that the final regulations clarify that the
safe harbor election may be made if the
electing REIT owns a direct interest in
a partnership or lower-tier REIT that
does not directly hold real property, but
that holds an interest in another
partnership or lower-tier REIT that
directly holds real property.
The determination of whether a REIT
is eligible to make the safe harbor
election under the proposed regulations
was intended to mirror the
determination of whether the REIT
holds real property (as defined under
§ 1.856–10) when testing the value of
the REIT’s real estate assets under
section 856(c)(4)(A). If a REIT is a
partner in a partnership that holds real
property (as defined under § 1.856–10),
the REIT is deemed to own its
proportionate share of the partnership’s
real property for purposes of section
856(c)(4). The Treasury Department and
the IRS also recognize that, for purposes
of section 856(c)(4), a REIT is deemed to
own a share of real property from any
partnership interest held through an
upper-tier partnership.
Moreover, under section 856(c)(5)(B),
shares in other REITs qualify as real
estate assets. Although a REIT
(shareholder REIT) that holds shares in
another REIT would not need to
determine whether the other REIT holds
real property for purposes of testing the
value of the shareholder REIT’s real
estate assets under section 856(c)(4), the
proposed regulations allowed the
shareholder REIT to make the safe
harbor election as long as it determines
that the other REIT holds real property.
The Treasury Department and the IRS
recognize that the other REIT in this
situation may not necessarily hold real
property but instead may hold shares in
a lower-tier REIT (which is a real estate
asset in the hands of the other REIT).
Because the shareholder REIT can
hold shares in another REIT that holds
shares in a lower-tier REIT that holds
real property, the Treasury Department
and the IRS have concluded that a
shareholder REIT may make the safe
harbor election if it determines that it
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holds an indirect interest in a REIT that
holds real property. Accordingly, the
final regulations clarify that a REIT may
elect to be an electing real property
trade or business if the REIT holds real
property, interests in one or more
partnerships holding real property
either directly or indirectly through
interests in other partnerships or shares
in other REITs, or shares in one or more
other REITs holding real property either
directly or indirectly through interests
in partnerships or shares in other REITs.
Several commenters also requested
that certain partnerships with a REIT as
a partner be allowed to apply the REIT
safe harbor election at the partnership
level. Commenters noted that many
REITs own interests in partnerships that
directly or indirectly hold real property,
and these partnerships incur the debt
that is secured by the real property and
claim the interest expense deductions.
Commenters recommended that the
REIT safe harbor election be made
available to partnerships if: (1) At least
one partner is a REIT that owns, directly
or indirectly, at least 50 percent of the
partnership’s capital or profits; (2) the
partnership meets the requirements of
section 856(c)(2), (3), and (4) as if the
partnership were a REIT; and (3) the
partnership satisfies the requirements of
proposed § 1.163(j)–9(g)(1) as if the
partnership were a REIT.
The Treasury Department and the IRS
agree that a partnership that is
controlled by a REIT or REITs and that
would meet the REIT gross income and
asset tests in section 856(c)(2), (3), and
(4) (as if the partnership were a REIT)
is sufficiently similar to a REIT for this
purpose. Accordingly, the final
regulations provide that a partnership
may apply the REIT safe harbor election
at the partnership level if one or more
REITs own, directly or indirectly, at
least 50 percent of the partnership’s
capital and profits, the partnership
meets the requirements of section
856(c)(2), (3), and (4) as if the
partnership were a REIT, and the
partnership satisfies the requirements
described in § 1.163(j)–9(h)(1) as if the
partnership were a REIT.
A commenter also recommended that
the REIT exception to the proposed
§ 1.163(j)–9(h) anti-abuse rule be
clarified to apply to any partnership in
which a REIT owns a 50 percent or
greater direct or indirect capital or
profits interest, if the partnership leases
a qualified lodging facility or qualified
health care property to a TRS or a
partnership in which a TRS is a 50
percent or greater direct or indirect
partner. The REIT exception was
intended to allow REITs that lease
qualified lodging facilities and qualified
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healthcare properties pursuant to the
related party rental exception in section
856(d)(8)(B) to make a real property
trade or business election because these
leases are explicitly authorized by the
Code. In response to comments, the
final regulations clarify that the REIT
exception also applies to partnerships
making the REIT safe harbor election
that lease qualified lodging facilities and
qualified healthcare properties.
However, the final regulations do not
specify the related party to which the
REIT must lease the qualified lodging
facility or qualified healthcare property
in order to qualify for the REIT
exception and, therefore, Treasury and
the IRS did not include a provision for
partnerships in which a TRS is a
partner.
A commenter requested clarification
regarding the application of the real
property trade or business election to a
rental real estate partnership and its
REIT partners if the partnership holds
real property and is not engaged in a
trade or business within the meaning of
section 162. Part XVI of this Summary
of Comments and Explanation of
Revision section clarifies that taxpayers
engaged in rental real estate activities
that do not necessarily rise to the level
of a section 162 trade or business
nevertheless are treated as engaged in
real property trades or businesses
within the meaning of section
469(c)(7)(C) (and for purposes of section
163(j) by reference). As such, a
partnership engaged in a rental real
estate activity (regardless of whether
that activity rises to the level of a
section 162 trade or business) will be
permitted to make the election under
section 163(j)(7)(B) with respect to the
rental real estate activity to be an
electing real property trade or business
for purposes of section 163(j), and any
interest expense that is allocable to that
rental real estate activity and that is
allocable to a REIT partner will not be
investment interest (within the meaning
of section 163(d)) that is treated as
interest expense allocable to a trade or
business of a C corporation partner
under § 1.163(j)–4(b)(3).
For purposes of valuing a REIT’s
assets, the proposed regulations provide
that REIT real property financing assets
also include the portion of a shareholder
REIT’s interest in another REIT
attributable to that other REIT’s real
property financing assets. The final
regulations clarify that this rule also
applies in the context of tiered-REIT
structures.
The proposed regulations provide that
no portion of the value of a shareholder
REIT’s shares in another REIT is
included in the value of the shareholder
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REIT’s real property financing assets if
all of the other REIT’s assets are treated
as assets of an excepted trade or
business under proposed § 1.163–
9(g)(2). The proposed regulations
provide that if a shareholder REIT does
not receive from the other REIT the
information necessary to determine
whether and the extent that the assets of
the other REIT are investments in real
property financing assets, then the
shareholder REIT’s shares in the other
REIT are treated as real property
financing assets.
A commenter requested that the final
regulations clarify how a shareholder
REIT determines whether the value of
the other REIT’s real property financing
assets is 10 percent or less of the other
REIT’s total asset value for purposes of
determining whether the electing
shareholder REIT must allocate interest
expense between excepted and nonexcepted businesses. The commenter
recommended that the final regulations
provide an example to clarify this point
or specify that the shareholder REIT
may make this determination based on
all of the facts available to the
shareholder REIT. The commenter
proposed that a shareholder REIT that
makes an incorrect determination in
good faith that the other REIT qualifies
under proposed § 1.163–9(g)(2)
nevertheless be permitted to treat all of
the value of the lower REIT’s shares as
assets other than real property financing
assets.
In response to this comment, the final
regulations allow a shareholder REIT to
use an applicable financial statement
(within the meaning of section 451(b))
of the other REIT to determine whether
and the extent that the assets of the
other REIT are investments in real
property financing assets (rather than
having to receive the information
directly from the other REIT). However,
the final regulations do not permit a
shareholder REIT to treat the shares in
the other REIT as assets other than real
property financing assets when the
shareholder REIT’s determination is
based on information other than an
applicable financial statement or
information received directly from the
other REIT.
In the event that a REIT is required to
allocate its interest expense between
excepted and non-excepted trades or
businesses under § 1.163(j)–10, a
commenter requested clarification
regarding the application of the lookthrough rules to tiered entities. Under
the proposed regulations, if a REIT
holds an interest in a partnership, in
applying the partnership look-through
rule in proposed § 1.163(j)–
10(c)(5)(ii)(A)(2), the REIT also applies
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the definition of real property under
§ 1.856–10 to determine whether the
partnership’s assets are allocable to an
excepted trade or business. In addition,
under the proposed regulations, if a
shareholder REIT holds shares in
another REIT and all of the other REIT’s
assets are not treated as assets of an
excepted trade or business, the
proposed regulations provide that the
shareholder REIT applies the same
partnership look-through rule (as if the
other REIT were a partnership) in
determining the extent to which the
shareholder REIT’s adjusted basis in the
shares of the other REIT is properly
allocable to an excepted trade or
business of the shareholder REIT.
In response to comments, the final
regulations provide that, when applying
the partnership look-through rule in the
case of tiered entities, a REIT applies the
definition of real property in § 1.856–10
to each partnership in the chain to
determine whether the partnership’s
assets are allocable to an excepted trade
or business. Furthermore, because
shares in other REITs qualify as real
estate assets under section 856(c)(5)(B),
the final regulations provide that, when
applying the look-through rule to REITs
within a tiered-entity structure, a
shareholder REIT may apply the
partnership look-through rule in
§ 1.163(j)–10(c)(5)(ii)(A)(2) to all REITs
in the chain.
In response to an informal inquiry,
the final regulations also clarify that a
REIT or a partnership that is eligible but
chooses not to apply the REIT safe
harbor election may still elect, under
§ 1.163(j)–9(b)(1), for one or more of its
trades or businesses to be an electing
real property trade or business,
provided that such trade or business is
otherwise eligible to elect under
§ 1.163(j)–9(b)(1). A REIT or partnership
that makes the election under § 1.163(j)–
9(b)(1) without utilizing the REIT safe
harbor provisions may not rely on any
portion of § 1.163(j)–9(h)(1) through (7).
partner in a partnership that conducts a
real property trade or business should
be allowed to treat its share of the
partnership’s real property trade or
business as an electing real property
trade or business even if the partnership
does not make the election.
The Treasury Department and the IRS
have rejected this comment because an
election under section 163(j)(7)(B) has
certain consequences—for example, the
use of ADS rather than the general
depreciation system for certain types of
property, which results in the inability
of electing real property trades or
businesses to claim the additional firstyear depreciation deduction under
section 168(k) for those types of
property. Therefore, the Treasury
Department and the IRS have
determined that a corporate partner in a
partnership that conducts a real
property trade or business should be
allowed to treat its share of the
partnership’s real property trade or
business as an electing real property
trade or business only if the partnership
makes the election. However, see part
X(A) of this Summary of Comments and
Explanation of Revisions section
regarding taxpayers that are eligible to
make an election to be an electing real
property trade or business but are not
certain whether they are engaged in a
trade or business under section 162.
F. Real Property Trade or Business
Proposed § 1.163(j)–10(a)(1)(i)
provides that the amount of a taxpayer’s
interest expense that is properly
allocable to excepted trades or
businesses is not subject to the section
163(j) limitation, and the amount of a
taxpayer’s other items of income, gain,
deduction, or loss, including interest
income, that is properly allocable to
excepted trades or businesses is
excluded from the calculation of the
taxpayer’s section 163(j) limitation.
Commenters suggested that, for
purposes of allocating interest between
a non-excepted trade or business and an
excepted trade or business, a corporate
A. General Method of Allocation: Asset
Basis
Proposed § 1.163(j)–10(c) sets forth
the general rule for allocating interest
expense and interest income between
excepted and non-excepted trades or
businesses. Under this general rule,
interest expense and interest income is
allocated between excepted and nonexcepted trades or businesses based
upon the relative amounts of the
taxpayer’s adjusted basis in the assets
used in its trades or businesses. As
noted in the preamble to the proposed
regulations, this general method of
allocation reflects the fact that money is
fungible and the view that interest
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XI. Comments on and Changes To
Proposed § 1.163(j)–10: Allocation of
Interest Expense, Interest Income, and
Other Items of Expense and Gross
Income to an Excepted Trade or
Business.
Section 1.163(j)–10 provides rules for
allocating tax items that are properly
allocable to a trade or business between
excepted trades or businesses and nonexcepted trades or businesses for
purposes of section 163(j). The
following discussion addresses
comments relating to proposed
§ 1.163(j)–10.
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expense is attributable to all activities
and property, regardless of any specific
purpose for incurring an obligation on
which interest is paid. Many
commenters expressed support for this
proposed allocation method.
However, some commenters argued
that taxpayers should be permitted to
allocate interest expense and income
between excepted and non-excepted
trades or businesses based on the
earnings or gross income of each
business, for various reasons. For
example, some commenters posited that
asset basis may bear little connection to
a corporation’s borrowing capacity,
whereas earnings or revenue are useful
indicators of a taxpayer’s ability to meet
its debt obligations, and earnings are a
key factor in determining the amount of
debt the taxpayer may borrow and the
interest rate the taxpayer will be
charged. These commenters also noted
that an asset-basis allocation method
could yield inconsistent results across
industries (for example, industries
whose asset mix is heavily skewed
towards self-created intangibles will
have low asset basis) or within similarly
situated industries (if assets are
purchased at different times). One
commenter also suggested that an
earnings-based approach would be
easier for the IRS and taxpayers to
administer because ATI already must be
calculated by each taxpayer that is
subject to a section 163(j) limitation.
Although the foregoing arguments
have merit, adopting an earnings-based
approach would raise many additional
considerations, such as taxpayers’
ability to time income recognition to
affect allocation and create other
distortions (as in the case of a trade or
business that requires capital
investment for a period of years before
earning significant gross income). Thus,
after further consideration, the Treasury
Department and the IRS have decided to
retain the asset-basis allocation
approach contained in proposed
§ 1.163(j)–10(c). However, the Treasury
Department and the IRS continue to
study these comments and may provide
future guidance on this issue.
B. Allocation Between Trades or
Businesses and Non-Trades or
Businesses
Proposed § 1.163(j)–10(a)(2)(i)
coordinates the rules under proposed
§ 1.163(j)–10 with other Federal income
tax rules. For example, proposed
§ 1.163(j)–10(a)(2)(i) provides that,
before a taxpayer may determine the
amount of interest expense, interest
income, or other tax items that is
properly allocable to excepted or nonexcepted trades or businesses, the
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taxpayer first must apply § 1.163–8T to
determine which tax items are allocable
to non-trades or businesses rather than
to trades or businesses. Some
commenters recommended that noncorporate partners be permitted to
allocate tax items between a trade or
business and a non-trade or business
based on an approach that looks to the
earnings of the trade or business and
non-trade or business. The commenters
argued that an earnings-based approach
to determining when debt is properly
allocable between a trade or business
and a non-trade or business is consistent
with determining whether the earnings
of a taxpayer can support the level of
debt incurred.
After further consideration, the
Treasury Department and the IRS have
decided to retain the § 1.163–8T tracing
approach contained in proposed
§ 1.163(j)–10(a)(2)(i). However, the
Treasury Department and the IRS
continue to study these comments and
may provide future guidance on this
issue. Additionally, the Treasury
Department and the IRS are considering
issuing additional guidance related to
the allocation of interest expense by
partnerships or S corporations. See
proposed § 1.163–14 in the Concurrent
NPRM.
Commenters also recommended that
no allocation between business and
nonbusiness interest expense be
required when a partnership is wholly
owned by corporate partners because a
corporation can have only business
interest income and expense and cannot
have investment interest income and
expense (see proposed § 1.163(j)–
4(b)(3)(i)). The Treasury Department and
the IRS have rejected this comment
because the recommended approach is
inconsistent with the entity approach
taken with respect to partnerships in
section 163(j)(4). Moreover, a separate
rule for partnerships that are wholly
owned by corporate partners is subject
to manipulation because the partnership
could alter the rules to which it is
subject simply by admitting a noncorporate partner with a small economic
interest in the partnership.
C. Consolidated Groups
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1. Overview
As provided in proposed § 1.163(j)–
10(a)(4)(i), the computations required by
section 163(j) and the section 163(j)
regulations generally are made for a
consolidated group on a consolidated
basis. Thus, for purposes of applying the
allocation rules of proposed § 1.163(j)–
10, all members of a consolidated group
are treated as a single corporation. For
example, the group (rather than a
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particular member) is treated as engaged
in excepted or non-excepted trades or
businesses. Moreover, intercompany
transactions (as defined in § 1.1502–
13(b)(1)(i)) are disregarded for purposes
of these allocation rules, and property is
not treated as used in a trade or business
to the extent the use of such property in
that trade or business derives from an
intercompany transaction. Additionally,
stock of a member that is owned by
another member of the same
consolidated group is not treated as an
asset for purposes of § 1.163(j)–10, and
the transfer of any amount of member
stock to a non-member is treated by the
group as a transfer of the member’s
assets proportionate to the amount of
member stock transferred.
After a consolidated group has
determined the percentage of the
group’s interest expense allocable to
excepted trades or businesses for the
taxable year, this exempt percentage is
applied to the interest paid or accrued
by each member during the taxable year
to any lender that is not a group
member. Thus, except to the extent
proposed § 1.163(j)–10(d) (providing
rules for direct allocation in certain
limited circumstances) applies, the
same percentage of interest paid or
accrued by each member to a lender that
is not a member is treated as allocable
to excepted trades or businesses,
regardless of whether any particular
member actually engaged in an excepted
trade or business.
2. Intercompany Transactions
Commenters observed that ignoring
all intercompany transactions and
intercompany obligations for purposes
of proposed § 1.163(j)–10 is theoretically
simple and generally furthers the singleentity approach adopted elsewhere in
the proposed regulations. However, a
commenter recommended that
taxpayers be permitted to take into
account basis from certain
intercompany transactions, so long as
adequate safeguards are put in place
against abuse (for example, to prevent
taxpayers from using intercompany
transactions to increase the consolidated
group’s ATI or to shift asset basis to
excepted trades or businesses), in order
to reduce the administrative burden of
tracking asset basis separately for
purposes of section 163(j). The
commenter also recommended that the
Treasury Department and the IRS
reconsider whether, in certain
circumstances, items from
intercompany transactions (other than
business interest expense and business
interest income) should affect the
amount of the consolidated group’s ATI.
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The Treasury Department and the IRS
acknowledge that the approach in
proposed § 1.163(j)–10(a)(4)(i) creates an
administrative burden for members of
consolidated groups. However, this
approach is consistent with § 1.1502–13,
the stated purpose of which is to
prevent intercompany transactions from
creating, accelerating, avoiding, or
deferring consolidated taxable income
or consolidated tax liability (see
§ 1.1502–13(a)(1)). Allowing tax items
from intercompany transactions to affect
the calculation of a consolidated group’s
tentative taxable income and ATI would
be inconsistent with the single-entity
principles of § 1.1502–13(a). Moreover,
taxpayers already must track asset basis
information for purposes of § 1.1502–13.
Additionally, giving effect to
intercompany transactions for purposes
of section 163(j) would create other
administrative burdens for consolidated
group members. See the discussion in
part V(B) of this Summary of Comments
and Explanation of Revisions section.
Thus, the final regulations continue to
disregard intercompany transactions for
purposes of the allocation rules in
proposed § 1.163(j)–10.
3. Use of Property Derives From an
Intercompany Transaction
A commenter observed that the
meaning of the phrase ‘‘property is not
treated as used in a trade or business to
the extent the use of such property
derives from an intercompany
transaction’’ is unclear. For example,
one member of a consolidated group (S)
leases property to another member of
the group (B), which uses the property
in its trade or business. B’s lease with
S entitles B to use the property. Should
B’s use of the property in its trade or
business be disregarded for purposes of
proposed § 1.163(j)–10 because such use
‘‘derives from an intercompany
transaction’’?
The Treasury Department and the IRS
did not intend for B’s use of the
property in the foregoing scenario to be
disregarded for purposes of the
allocation rules in proposed § 1.163(j)–
10. If S and B were treated as
disregarded entities owned by the same
corporation, the lease would be ignored,
and the leased property would be
treated as an asset used in B’s trade or
business. The final regulations clarify
proposed § 1.163(j)–10(a)(4)(i) to better
reflect this intended result.
The commenter also requested
confirmation that the same allocation
principle applies to third-party costs
incurred by members of the group (in
other words, that such costs are
allocated based on the use of assets in
excepted or non-excepted trades or
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businesses). However, proposed
§ 1.163(j)–10(b)(5) already provides
special rules for the allocation of
expenses other than interest expenses.
Thus, the final regulations do not adopt
this recommendation.
4. Purchase of Member Stock From a
Nonmember
A commenter recommended that a
purchase by one consolidated group
member (S) of stock of another member
(or of an entity that becomes a member
as a result of the purchase) (in either
case, T) from a non-member (X) be
treated as a purchase of a proportionate
amount of T’s assets for purposes of
proposed § 1.163(j)–10. Although the
proposed regulations treat the transfer of
the stock of a member to a non-member
as a transfer of a proportionate amount
of the member’s assets, the proposed
regulations do not expressly address the
acquisition of the stock of a member (or
of a corporation that becomes a member
as a result of the acquisition). The
commenter noted that, if such
acquisitions are not treated as asset
purchases, the amount of adjusted basis
allocated to an excepted or nonexcepted trade or business may differ
significantly depending on whether S
and T file a consolidated return.
For example, T (which is engaged
solely in an excepted trade or business)
has assets with a fair market value of
$100x and $0 adjusted basis, and $0
liabilities. S (which is engaged solely in
a non-excepted trade or business) has
$100x adjusted basis in its assets. S
purchases 100 percent of T’s stock from
X for $100x, and S and T do not file a
consolidated tax return. As a result, S’s
stock in T is treated as an asset (under
proposed § 1.163(j)–10(c)(5)(ii)(B)) with
a basis of $100x. In contrast, if S and T
were to file a consolidated return, S’s
stock in T would not be treated as an
asset under proposed § 1.163(j)–10(a)(4).
Moreover, it is unclear how much
adjusted basis the group could take into
account for purposes of the allocation
rules. Would the group’s adjusted basis
in T’s assets equal T’s basis in its assets
immediately before the acquisition
(here, $0)? Or would all or some portion
of the amount paid by S to acquire T’s
stock be taken into account? The
commenter argued that S should have
the same amount of adjusted basis in T’s
assets regardless of whether S and T file
a consolidated return, and that there is
no legislative history revealing
congressional intent to treat members of
a consolidated group and nonconsolidated corporations differently in
this regard. Thus, according to the
commenter, S should be able to take
into account the amount paid for its T
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stock for purposes of the allocation rules
in proposed § 1.163(j)–10.
Although Congress did not expressly
address this issue, Congress did make
clear that the section 163(j) limitation
applies at the consolidated group level
(see H. Rept. 115–466, at 386 (2017)).
Moreover, section 1502 provides broad
authority for the Secretary of the
Treasury to prescribe regulations to
determine the tax liability of a
consolidated group in a manner that
clearly reflects the income tax liability
of the group and that prevents the
avoidance of tax liability. Consistent
with legislative intent regarding section
163(j) and with the broad grant of
authority under section 1502, the
proposed regulations treat a
consolidated group as a single
corporation for purposes of the
allocation rules of § 1.163(j)–10, and
they disregard the stock of members for
purposes of this section.
Additionally, the Treasury
Department and the IRS have questions
and concerns about treating the
acquisition of stock of a member (or of
an entity that becomes a member) as an
asset sale. How would the purchase
price be added to the group’s basis in
the member’s assets, and how would the
additional basis added to these assets be
depreciated? Would this approach deem
the transaction to be an asset acquisition
for all Federal income tax purposes or
just for purposes of section 163(j), and
what complications would arise from
treating the transaction as an asset
purchase for purposes of section 163(j)
but as a stock purchase for other
purposes?
Due to concerns about these and other
issues, the final regulations do not adopt
the commenter’s recommendation.
However, the Treasury Department and
the IRS continue to study the issue
raised by the commenter and may
address the issue in future guidance.
5. Inclusion of Income From Excepted
Trades or Businesses in Consolidated
ATI
A commenter noted that, because
every member of a consolidated group is
treated as engaged in every trade or
business of the group for purposes of
proposed § 1.163(j)–10, a member
engaged solely in an excepted regulated
utility trade or business that incurs
interest expense related to its business
activities will be subject to the section
163(j) limitation if other group members
are engaged in non-excepted trades or
businesses. The commenter suggested
that this outcome is contrary to the
policy rationale for the exception for
regulated utility trades or businesses.
The commenter further noted that the
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gross income of the excepted trade or
business is not included in the group’s
ATI calculation, and that this outcome
could produce anomalous results. The
commenter thus recommended that a
proportionate share of the gross income
of the excepted trade or business be
included as an adjustment to
consolidated ATI.
The Treasury Department and the IRS
do not agree that the results under
proposed § 1.163(j)–10(a)(4) are
inconsistent with congressional intent
or lead to anomalous results. As noted
in part XI(C)(4) of this Summary of
Comments and Explanation of Revisions
section, Congress expressly stated that
the section 163(j) limitation applies at
the consolidated group level. Thus, the
treatment of a consolidated group as a
single corporation, and the treatment of
every member as engaged in every trade
or business of the group, is consistent
with congressional intent. Moreover, if
the section 163(j) limitation were
inapplicable to group members engaged
in excepted trades or businesses,
consolidated groups could readily avoid
the section 163(j) limitation by
concentrating their external borrowing
in such members. Furthermore,
although a portion of the interest
expense of a member engaged solely in
an excepted trade or business will be
subject to the section 163(j) limitation if
the group is otherwise engaged in nonexcepted trades or businesses, a portion
of the interest expense of a member
engaged solely in a non-excepted trade
or business will not be subject to the
section 163(j) limitation if the group is
otherwise engaged in excepted trades or
businesses—and all of that member’s
income will factor into the group’s ATI
calculation. Finally, as the commenter
acknowledged, section 163(j)(8)(A)(i)
specifically excludes from the
determination of ATI any item of
income, gain, deduction, or loss that is
allocable to an excepted trade or
business.
For the foregoing reasons, the
Treasury Department and the IRS have
determined that no changes to the final
regulations are needed with respect to
this comment.
6. Engaging in Excepted or NonExcepted Trades or Businesses as a
‘‘Special Status’’
One commenter suggested that the
Treasury Department and the IRS
consider whether engaging in an
excepted trade or business should be
treated as a ‘‘special status’’ under
§ 1.1502–13(c)(5) for purposes of
applying the intercompany transaction
rules of § 1.1502–13.
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The intercompany transaction rules
apply for purposes of redetermining and
allocating attributes under § 1.1502–
13(c)(1)(i) in order to reach a ‘‘single
entity’’ answer under the matching rule
of § 1.1502–13(c). For example, one
member of a consolidated group is a
dealer in securities under section 475
(dealer) and sells a security to a second
member that is not a dealer; that second
member then sells the security to a
nonmember in a later year. The
matching rule can apply to ensure that
the taxable items of the two members
harmonize with regard to timing and
character in order to reach the same
overall tax treatment that would be
given to a single corporation whose two
operating divisions engaged in those
transactions. See § 1.1502–13(c)(7)(i),
Example 11.
However, if one member has ‘‘special
status’’ under § 1.1502–13(c)(5) but the
other does not, then attributes of the
item would not be redetermined under
the matching rule. For example, if S (a
bank to which section 582(c) applies)
and B (a nonbank) are members of a
consolidated group, and if S sells debt
securities at a gain to B, the character of
S’s intercompany gain is ordinary (as
required under section 582(c)), but the
character of B’s corresponding item is
determined under § 1.1502–13(c)(1)(i)
without the application of section
582(c). See § 1.1502–13(c)(5).
The ‘‘special status’’ rules of § 1.1502–
13(c)(5) are applicable to entities, such
as banks or insurance companies, that
are subject to a separate set of Federal
income tax rules. Although there are
special tax rules for farming, real estate,
and utilities, an entity engaged in such
trades or businesses also may be
engaged in other trades or businesses to
which such special tax rules would not
apply. Further, the entity’s farming, real
estate, or utility trade or business need
not be its primary trade or business.
Moreover, the treatment of excepted
trades or businesses as a special status
effectively would result in additional
tracing of specific items for purposes of
§ 1.1502–13. As noted in the preamble
to the proposed regulations, the
Treasury Department and the IRS have
decided not to apply a tracing regime to
allocate interest expense and income
between excepted and non-excepted
trades or businesses. Thus, the final
regulations do not treat engaging in an
excepted trade or business as a special
status.
D. Quarterly Asset Testing
Under proposed § 1.163(j)–10(c)(6), a
taxpayer must determine the adjusted
basis in its assets on a quarterly basis
and average those amounts to determine
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the relative amounts of asset basis for its
excepted and non-excepted trades or
businesses for a taxable year. In the
preamble to the proposed regulations,
the Treasury Department and the IRS
requested comments on the frequency of
asset basis determinations required
under proposed § 1.163(j)–10(c).
In response, commenters stated that
this quarterly determination
requirement is administratively
burdensome, and that such a burden is
unwarranted because, in many
circumstances, measuring asset basis
less frequently would produce similar
results. Thus, commenters
recommended that taxpayers be
permitted to allocate asset basis for a
taxable year based on the average of
adjusted asset basis at the beginning and
end of the year. As a result, the
‘‘determination date’’ would be the last
day of the taxpayer’s taxable year, and
the ‘‘determination period’’ would begin
on the first day of the taxpayer’s taxable
year and end on the last day of the year.
Several commenters recommended
that this approach be modeled on the
interest valuation provisions in § 1.861–
9T(g)(2)(i). Under these rules, taxpayers
generally must compute the value of
assets based on an average of asset
values at the beginning and end of the
year. However, if a ‘‘substantial
distortion’’ of asset values would result
from this approach (for example, if there
is a major acquisition or disposition),
the taxpayer must use a different
method of asset valuation that more
clearly reflects the average value of
assets.
Other commenters suggested that
their proposed approach could be
limited to cases in which there is no
more than a de minimis change in asset
basis between the beginning and end of
the taxable year. For example, this
approach could be available for a
taxable year only if the taxpayer
demonstrates that its total adjusted basis
(as measured in accordance with the
rules in proposed § 1.163(j)–10(c)(5)) at
the end of the year in its assets used in
its excepted trades or businesses, as a
percentage of the taxpayer’s total
adjusted basis at the end of such year in
all of its assets used in a trade or
business, does not differ by more than
10 percent from such percentage at the
beginning of the year.
The Treasury Department and the IRS
acknowledge that determining asset
basis on a quarterly basis would impose
an administrative burden. The Treasury
Department and the IRS also agree with
commenters that a safeguard is needed
to account for episodic events, such as
acquisitions, dispositions, or changes in
business, that could affect average
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values. Thus, the final regulations
permit a taxpayer to compute asset basis
in its excepted and non-excepted trades
or businesses by averaging asset basis at
the beginning and end of the year, so
long as the taxpayer falls under a 20
percent de minimis threshold.
E. De Minimis Rules
1. Overview
The proposed regulations provide a
number of de minimis rules to simplify
the application of § 1.163(j)–10. For
example, proposed § 1.163(j)–
10(c)(3)(iii)(C)(3) provides that a utility
trade or business is treated entirely as
an excepted regulated utility trade or
business if more than 90 percent of the
items described in proposed § 1.163(j)–
1(b)(15) are furnished or sold at rates
qualifying for the excepted regulated
utility trade or business exception.
Proposed § 1.163(j)–10(c)(3)(iii)(B)(2)
provides that, if 90 percent or more of
the basis in an asset would be allocated
under proposed § 1.163(j)–10(c)(3) to
either excepted or non-excepted trades
or businesses, then the entire basis in
the asset is allocated to either excepted
or non-excepted trades or businesses,
respectively. In turn, proposed
§ 1.163(j)–10(c)(1)(ii) provides that, if 90
percent or more of a taxpayer’s basis in
its assets is allocated under proposed
§ 1.163(j)–10(c) to either excepted or
non-excepted trades or businesses, then
all of the taxpayer’s interest expense
and interest income are allocated to
either excepted or non-excepted trades
or businesses, respectively.
2. Order in Which the De Minimis Rules
Apply
A commenter recommended that
these de minimis rules be applied in the
order in which they are listed in the
foregoing paragraph. In other words, a
taxpayer first should determine the
extent to which its utility businesses are
excepted regulated utility trades or
businesses. The taxpayer then should
determine the extent to which the basis
of any assets used in both excepted and
non-excepted trades or businesses
should be wholly allocated to either
excepted or non-excepted trades or
businesses. Only then should the
taxpayer determine whether all of its
interest expense and interest income
should be wholly allocated to either
excepted or non-excepted trades or
businesses. The Treasury Department
and the IRS agree that the order
recommended by the commenter is the
most reasonable application of these de
minimis rules, and the final regulations
adopt language confirming this
ordering.
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3. Mandatory Application of De
Minimis Rules
Commenters also requested that the
final regulations continue to mandate
the application of the foregoing de
minimis rules rather than make such de
minimis rules elective. The commenters
expressed concern that creating an
election to use the de minimis rules in
§ 1.163(j)–10(c)(1) and (3) would create
uncertainty for taxpayers, and they
argued that mandatory application of
the de minimis rules would simplify the
rules for taxpayers. The Treasury
Department and the IRS agree that
mandatory application of the de
minimis rules simplifies the application
of § 1.163(j)–10 and eases the burdens of
compliance and administration.
Therefore, the final regulations continue
to mandate the application of the de
minimis rules in § 1.163(j)–10(c)(1) and
(3).
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4. De Minimis Threshold for Electric
Cooperatives
A commenter requested that the de
minimis threshold for utilities in
proposed § 1.163(j)–10(c)(3)(iii)(C)(3) be
lowered from 90 percent to 85 percent
for electric cooperatives. The
commenter argued that a different
threshold is appropriate for electric
cooperatives because, under section
501(c)(12), 85 percent or more of an
electric cooperative’s income (with
adjustments) must consist of amounts
collected from members for the sole
purpose of meeting losses and expenses
in order for the cooperative to be
exempt from Federal income tax.
The Treasury Department and the IRS
have determined that the final
regulations should provide the same de
minimis threshold for electric
cooperatives as for other utility trades or
businesses. The 85 percent threshold
under section 501(c)(12) measures a
cooperative’s income, with adjustments
that are specific to section 501.
Moreover, an electric cooperative is not
required to qualify for tax exemption
under section 501(c)(12) to be engaged
in an excepted regulated utility trade or
business. Therefore, the Treasury
Department and the IRS have
determined that the nexus between
section 501(c)(12) and proposed
§ 1.163(j)–10 is insufficient to justify
lowering the utility de minimis
threshold to 85 percent for electric
cooperatives, and the final regulations
do not incorporate the commenter’s
suggestion.
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5. Standardization of 90 Percent De
Minimis Tests
The terminology used in the 90
percent de minimis tests in proposed
§ 1.163(j)–10 is not consistent. For
example, proposed § 1.163(j)–
10(c)(3)(iii)(C)(3) uses a ‘‘more than 90
percent’’ standard, whereas proposed
§ 1.163(j)–10(c)(3)(iii)(B)(2) uses a ‘‘90
percent or more’’ standard. For the sake
of consistency, and in order to minimize
confusion, the final regulations
standardize the language used in these
tests.
6. Overlapping De Minimis Tests
In addition to the de minimis tests
previously described in this part XI(E)
of the Summary of Comments and
Explanation of Revisions section,
proposed § 1.163(j)–10(c)(3)(iii)(B)(1)
also contains another de minimis rule.
Under this rule, if at least 90 percent of
gross income generated by an asset
during a determination period is with
respect to either excepted or nonexcepted trades or businesses, then the
entire basis in the asset is allocated to
either excepted or non-excepted trades
or businesses, respectively.
The Treasury Department and the IRS
have determined that this rule not only
overlaps with, but also may yield results
inconsistent with, the de minimis rule
in § 1.163(j)–10(c)(3)(iii)(B)(2). Thus, the
final regulations eliminate the de
minimis rule in proposed § 1.163(j)–
10(c)(3)(iii)(B)(1).
F. Assets Used in More Than One Trade
or Business
1. Overview
Proposed § 1.163(j)–10(c)(3) contains
special rules for allocating basis in
assets used in more than one trade or
business. In general, if an asset is used
in more than one trade or business
during a determination period, the
taxpayer’s adjusted basis in the asset
must be allocated to each trade or
business using one of three permissible
methodologies, depending on which
methodology most reasonably reflects
the use of the asset in each trade or
business during that determination
period. These three methodologies are:
(i) The relative amounts of gross income
that an asset generates, has generated, or
may reasonably be expected to generate,
within the meaning of § 1.861–9T(g)(3),
with respect to the trades or businesses;
(ii) if the asset is land or an inherently
permanent structure, the relative
amounts of physical space used by the
trades or businesses; and (iii) if the
trades or businesses generate the same
unit of output, the relative amounts of
output of those trades or businesses.
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However, taxpayers must use the
relative output methodology to allocate
the basis of assets used in both excepted
and non-excepted utility trades or
businesses.
As described in part XI(E)(1) of this
Summary of Comments and Explanation
of Revisions section, a taxpayer’s
allocation of basis in assets used in
more than one trade or business is
subject to several de minimis rules (see
proposed § 1.163(j)–10(c)(3)(iii)).
2. Consistency Requirement
A commenter requested clarification
that the consistency requirement in
proposed § 1.163(j)–10(c)(3)(iii)(A) does
not require a taxpayer to use a single
methodology for different categories of
assets, because a methodology that is
reasonable for one type of asset (for
example, office buildings) may not be
reasonable for another (for example,
intangibles). The Treasury Department
and the IRS agree with this comment,
and the final regulations have been
clarified accordingly.
3. Changing a Taxpayer’s Allocation
Methodology
The Treasury Department and the IRS
have determined that requiring
taxpayers to obtain consent from the
Commissioner to change their allocation
methodology would impose an undue
burden. Thus, the final regulations
permit a taxpayer to change its
allocation methodology after a period of
five taxable years without obtaining
consent from the Commissioner. A
taxpayer that seeks to change its
allocation methodology more frequently
must obtain consent from the
Commissioner.
The Treasury Department and the IRS
also have determined that an allocation
methodology is not a method of
accounting because there is no
guarantee that a taxpayer will be able to
deduct a disallowed business interest
expense carryforward in future taxable
years (as a result, there could be a
permanent disallowance). See the
discussion in part III(A) of this
Summary of Comments and Explanation
of Revisions section.
4. Mandatory Use of Relative Output for
Utility Trades or Businesses
A commenter requested that the final
regulations allow electric cooperatives
to use methodologies other than relative
output to allocate the basis of assets
used in both excepted and non-excepted
utility trades or businesses. The
commenter noted that alternative
methods, such as allocations based on
dollars of sales (or sales less the cost of
sales), have been allowed by the IRS in
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the context of allocating expenses
between patronage and non-patronage
sales. The commenter also stated that
economic realities facing electric
cooperatives operating on a not-forprofit basis would not be accurately
reflected by a relative output
methodology.
The Treasury Department and the IRS
have concluded that relative output
most reasonably reflects the use of
assets in excepted and non-excepted
utility trades or businesses because
§ 1.163(j)–1(b)(15)(i)(A) divides utility
businesses into excepted regulated
utility trades or businesses and nonexcepted utility businesses on the same
basis. To the extent that items described
in § 1.163(j)–1(b)(15)(i)(A) are sold at
rates described in § 1.163(j)–
1(b)(15)(i)(B), and to the extent that the
trade or business is an electing regulated
utility trade or business under
§ 1.163(j)–1(b)(15)(iii), a utility trade or
business is an excepted trade or
business. The Treasury Department and
the IRS do not agree that the final
regulations should apply one
methodology for differentiating
excepted and non-excepted utility
trades or businesses under § 1.163(j)–1
and a different methodology to
determine the allocation of an asset’s
basis between such businesses.
Therefore, the final regulations do not
incorporate the commenter’s suggestion.
Another commenter recommended
that the rule mandating the use of
relative output for the allocation of asset
basis under proposed § 1.163(j)–
10(c)(3)(iii)(C)(2) not be used either to
allocate assets used exclusively in
excepted or non-excepted utility trades
or businesses or to apply the de minimis
test of proposed § 1.163(j)–10(c)(1)(ii).
The special rule in proposed
§ 1.163(j)–10(c)(3)(iii)(C)(2) mandates
the use of relative output only for the
purpose of allocating the basis of assets
used in both excepted and non-excepted
utility trades or businesses. Therefore,
the rule does not mandate the use of
relative output to allocate the basis of an
asset that is used solely in either an
excepted regulated utility trade or
business or a non-excepted utility trade
or business, except to the extent the de
minimis rule in proposed § 1.163(j)–
10(c)(3)(iii)(C)(3) treats a taxpayer’s
entire trade or business as either an
excepted trade or business or a nonexcepted trade or business. The
language proposed by the commenter
still subjects assets to the de minimis
rule in proposed § 1.163(j)–
10(c)(3)(iii)(C)(3). Because the proposed
regulations achieve the result requested
by the commenter, the final regulations
do not adopt the recommended change.
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The de minimis rule in proposed
§ 1.163(j)–10(c)(1)(ii) applies only after
the basis of assets has been allocated
between excepted and non-excepted
trades or businesses. This de minimis
rule treats all of a taxpayer’s trades or
businesses as either excepted or nonexcepted trades or businesses based on
such allocation. Because the rule of
proposed § 1.163(j)–10(c)(1)(ii) does not
apply the methodologies listed in
proposed § 1.163(j)–10(c)(3), including
the relative output methodology, no
change to the proposed regulations is
necessary to achieve the result
requested by the commenter with
respect to proposed § 1.163(j)–
10(c)(1)(ii).
G. Exclusions From Basis Calculations
For purposes of allocating interest
expense and interest income under the
asset-basis allocation method in
proposed § 1.163(j)–10(c), a taxpayer’s
basis in certain types of assets generally
is not taken into account. These assets
include cash and cash equivalents (see
proposed § 1.163(j)–10(c)(5)(iii)). As
noted in the preamble to the proposed
regulations, this rule is intended to
discourage taxpayers from moving cash
to excepted trades or businesses to
increase the amount of asset basis
therein. In the preamble to the proposed
regulations, the Treasury Department
and the IRS requested comments on this
special rule, including whether any
exceptions should apply (such as for
working capital).
In response, commenters
recommended that working capital be
included in the basis allocation
determination, along with collateral that
secures derivatives that hedge business
assets and liabilities within the meaning
of § 1.1221–2.
The Treasury Department and the IRS
have concluded that the inclusion of
working capital in the basis allocation
determination could lead to frequent
disputes between taxpayers and the IRS
over the amount of cash that comprises
‘‘working capital’’ and the allocation of
such amount between and among a
taxpayer’s excepted and non-excepted
trades or businesses. Thus, the final
regulations do not adopt this
recommendation.
The Treasury Department and the IRS
also have concluded that the inclusion
of collateral that secures derivatives that
hedge business assets and liabilities
within the meaning of § 1.1221–2 could
lead to frequent disputes between
taxpayers and the IRS for reasons
similar to those for working capital. For
example, it is not always clear which
business asset or liability is being
hedged, especially in the case of an
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aggregate hedging transaction. In
addition, taxpayers could use this rule
as a planning opportunity for purposes
of allocating the collateral to excepted
trades or businesses. Thus, the final
regulations also do not adopt this
recommendation.
H. Look-Through Rules
1. Ownership Thresholds; Direct and
Indirect Ownership Interests
Proposed § 1.163(j)–10(c)(5)(ii)
provides, in part, that if a taxpayer owns
an interest in a partnership or stock in
a corporation that is not a member of the
taxpayer’s consolidated group, the
partnership interest or stock is treated as
an asset of the taxpayer for purposes of
the allocation rules of proposed
§ 1.163(j)–10.
For purposes of allocating a partner’s
basis in its partnership interest between
excepted and non-excepted trades or
businesses under proposed § 1.163(j)–
10, the partner generally may look
through to its share of the partnership’s
basis in the partnership’s assets (with
certain modifications and limitations)
regardless of the extent of the partner’s
ownership interest in the partnership.
However, the partner must apply this
look-through rule if its direct and
indirect interest in the partnership is
greater than or equal to 80 percent.
Similar rules apply to shareholders of S
corporations. See proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(i) and (c)(5)(ii)(B)(3)(ii).
For purposes of allocating a
shareholder’s stock basis between
excepted and non-excepted trades or
businesses, a shareholder of a domestic
non-consolidated C corporation or a
CFC also must look through to the assets
of the corporation if the shareholder’s
direct and indirect interest therein
satisfies the ownership requirements of
section 1504(a)(2). Shareholders of
domestic non-consolidated C
corporations and CFCs may not look
through their stock in such corporations
if they do not satisfy this ownership
threshold. See proposed § 1.163(j)–
10(c)(5)(ii)(B)(2)(i) and (c)(7)(i)(A).
If a shareholder receives a dividend
that is not investment income, and if the
shareholder looks through to the assets
of the payor corporation under proposed
§ 1.163(j)–10(c)(5)(ii) for the taxable
year, the shareholder also must look
through to the activities of the payor
corporation to allocate the dividend
between the shareholder’s excepted and
non-excepted trades or businesses. See
proposed § 1.163(j)–10(b)(3) and
(c)(7)(i)(B).
Commenters recommended that
taxpayers be afforded greater flexibility
to look through their stock in domestic
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non-consolidated C corporations and
CFCs. For example, one commenter
suggested that the look-through
threshold for CFCs be lowered to 50
percent (analogous to the look-through
threshold for related CFCs in section
954(c)(6)). Another commenter
recommended that a taxpayer be
allowed to look through its stock in a
domestic non-consolidated C
corporation if the taxpayer owns at least
80 percent of such stock by value,
regardless of whether the taxpayer also
owns 80 percent of such stock by vote.
Yet another commenter recommended
that a taxpayer be allowed to look
through its stock in a domestic nonconsolidated C corporation (or be
allowed to allocate its entire basis in
such stock to an excepted trade or
business) if (i) the taxpayer and the C
corporation are engaged in the same
excepted trade or business, and (ii) the
taxpayer either (A) owns at least 50
percent of the stock of the C
corporation, or (B) owns at least 20
percent of the stock of the C corporation
and exercises a significant degree of
control over the corporation’s trade or
business. Another commenter
recommended that the ownership
threshold for looking through domestic
non-consolidated C corporations and
CFCs be eliminated entirely so that
interest expense paid or accrued on debt
incurred to finance the acquisition of a
real estate business is exempt from the
section 163(j) limitation (if the business
qualifies for and makes an election
under proposed § 1.163(j)–9), regardless
of whether that business is held directly
or through a subsidiary.
The Treasury Department and the IRS
have determined that a de minimis
ownership threshold is appropriate for
domestic non-consolidated C
corporations and CFCs because, unlike
a partnership, a corporation generally is
respected as an entity separate from its
owner(s) for tax purposes. See, for
example, Moline Properties v.
Commissioner, 319 U.S. 436 (1943). The
look-through rule for non-consolidated
C corporations provides a limited
exception to this general rule. Moreover,
unlike S corporations, domestic C
corporations are not taxed as flowthrough entities. Thus, the final
regulations retain an 80 percent
ownership threshold for looking
through a domestic non-consolidated C
corporation or a CFC.
However, the final regulations permit
a taxpayer to look through its stock in
a domestic non-consolidated C
corporation or a CFC if the taxpayer
owns at least 80 percent of such stock
by value, regardless of whether the
taxpayer also owns at least 80 percent
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of such stock by vote. Corresponding
changes have been made to the lookthrough rule for dividends.
Additionally, the final regulations
permit a shareholder that meets the
ownership requirements for looking
through the stock of a domestic nonconsolidated C corporation (determined
without applying the constructive
ownership rules of section 318(a)) to
look through to such shareholder’s pro
rata share of the C corporation’s basis in
its assets for purposes of § 1.163(j)–10(c)
(asset basis look-through approach). If a
shareholder applies the asset basis lookthrough approach, it must do so for all
domestic non-consolidated C
corporations for which the shareholder
is eligible to use this approach, and it
must continue to use the asset basis
look-through approach in all future
taxable years in which the shareholder
is eligible to use this approach.
Commenters also asked for
clarification as to the meaning of an
‘‘indirect’’ interest for purposes of these
look-through rules. For example,
commenters asked what the term
‘‘indirect’’ means in the context of the
look-through rule for dividends.
Commenters further noted that, because
section 1504(a)(2) does not contain
constructive ownership rules, there is
uncertainty as to when a shareholder’s
indirect ownership in a corporation is
counted for purposes of the ownership
requirement in the look-through rule.
Commenters also requested specific
constructive ownership rules, as well as
examples to illustrate the application of
the ‘‘direct or indirect’’ ownership
threshold.
The Treasury Department and the IRS
have determined that, for purposes of
applying the ownership thresholds in
§ 1.163(j)–10(c)(5)(ii)(B)(2)(i),
(c)(5)(ii)(B)(3)(ii), and (c)(7)(i)(A) to
shareholders of domestic nonconsolidated C corporations, CFCs, and
S corporations, as applicable, the
constructive ownership rules of section
318(a) should apply. For example,
assume A, B, and C are all nonconsolidated C corporations; A wholly
and directly owns B; A and B each
directly own 50 percent of C; A and B
both conduct a non-excepted trade or
business; and C conducts an excepted
trade or business. Under section
318(a)(2)(C), A is considered to own the
stock owned by B. As a result, A is
considered to own 100 percent of the
stock of C, and the look-through rule of
proposed § 1.163(j)–10(c)(5)(ii)(B)(2)(i)
and (c)(7)(i)(A) applies to A’s stock in C.
Thus, although the Treasury Department
and the IRS have determined that the
ownership threshold for nonconsolidated C corporations should
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56737
remain at 80 percent, the constructive
ownership rules of section 318 will
broaden the availability of the lookthrough rules to shareholders of such
corporations.
In contrast, the Treasury Department
and the IRS have determined that the
constructive ownership rules of section
318(a) should not apply for purposes of
applying the ownership threshold in
proposed § 1.163(j)–10(b)(3) and
(c)(7)(i)(B) to the receipt of dividends
from domestic C corporations and CFCs
because dividends are not paid to
indirect shareholders. To avoid
confusion in this regard, the final
regulations remove the word ‘‘indirect’’
from the ownership threshold for the
dividend look-through rule.
2. Application of Look-Through Rules to
Partnerships
i. In General
For purposes of proposed § 1.163(j)–
10(c), a partnership interest is treated as
an asset of the partner. Pursuant to
proposed § 1.163(j)–10(c)(5)(ii)(A)(1),
the partner’s adjusted basis in its
partnership interest is reduced, but not
below zero, by the partner’s share of
partnership liabilities as determined
under section 752 (section 752 basis
reduction rule). Pursuant to proposed
§ 1.163(j)–10(c)(5)(ii)(A)(2)(iii), a partner
other than a C corporation or tax-exempt
corporation must further reduce its
adjusted basis in its partnership interest
by its share of the tax basis of
partnership assets that is not properly
allocable to a trade or business
(investment asset basis reduction rule).
As noted in part XI(H)(1) of this
Summary of Comments and Explanation
of Revisions section, a partner may
determine what portion of its adjusted
tax basis in a partnership interest is
attributable to an excepted or nonexcepted trade or business by reference
to its share of the partnership’s basis in
the partnership’s assets (look-through
rule). Under proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(i), a partner generally
may choose whether to apply the lookthrough rule without regard to its
ownership percentage, with two
exceptions. First, if a partner’s direct or
indirect interest in a partnership is
greater than or equal to 80 percent of the
partnership’s capital or profits, the
partner must apply the look-through
rule. Second, if the partnership is
eligible for the small business
exemption under section 163(j)(3) and
proposed § 1.163(j)–2(d)(1), a partner
may not apply the look-through rule.
Proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(ii) provides that if, after
applying the investment asset basis
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reduction rule, at least 90 percent of a
partner’s share of a partnership’s basis
in its assets (including adjustments
under sections 734(b) and 743(b)) is
allocable to either excepted or nonexcepted trades or businesses, the
partner’s entire basis in its partnership
interest is treated as allocable to such
excepted or non-excepted trades or
businesses.
Pursuant to proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(iv), if a partner, other
than a C corporation or a tax-exempt
corporation, does not apply the lookthrough rule, the partner generally will
treat its basis in the partnership interest
as either an asset held for investment or
a non-excepted trade or business asset
as determined under section 163(d).
ii. Coordination of Look-Through Rule
and Basis Determination Rules
Outside of the partnership context,
proposed § 1.163(j)–10(c)(5)(i) provides
rules regarding the computation of
adjusted basis for purposes of allocating
business interest expense between
excepted and non-excepted trades or
businesses (collectively, the ‘‘basis
determination rules’’). For example,
proposed § 1.163(j)–10(c)(5)(i)(A)
generally provides that the adjusted
basis of non-depreciable property other
than land is the adjusted basis of the
asset used for determining gain or loss
from the sale or other disposition of that
asset as provided in § 1.1011–1, and
proposed § 1.163(j)–10(c)(5)(i)(C)
generally provides that the adjusted
basis of land and inherently permanent
structures is its unadjusted basis. For
purposes of applying the look-through
rule, the Treasury Department and the
IRS intended the basis determination
rules to require adjustments to the
partnership’s basis in its assets and the
partner’s basis in its partnership interest
to the extent of the partner’s share of
any adjustments to the basis of the
partnership’s assets. Accordingly, the
final regulations explicitly provide that
such is the case.
Multiple commenters noted that the
proposed regulations do not specify
whether a partner that does not apply
the look-through rule should use the
adjusted tax basis in its partnership
interest or should adjust its tax basis to
reflect what its basis would be if the
partnership applied the basis
determination rules to its assets.
Because all partnerships are not subject
to section 163(j) and cannot provide all
partners with the information necessary
to adjust the tax basis of their
partnership interests consistent with the
basis determination rules, the Treasury
Department and the IRS have
determined that the basis determination
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rules should not apply to the basis of a
partnership interest if a partner does not
apply the look-through rule.
iii. Applying the Look-Through Rule
and Determining Share of Partnership
Basis
Proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(i) provides that, for
purposes of the look-through rule, a
partner’s share of a partnership’s assets
is determined using a reasonable
method, taking into account special
allocations under section 704(b),
adjustments under sections 734(b) and
743(b), and direct adjustments relating
to assets subject to qualified
nonrecourse indebtedness under
proposed § 1.163(j)–10(d)(4).
Commenters argued that this language
does not provide adequate guidance
regarding how a partner should
determine its share of the tax basis of a
specific partnership asset when
applying the look-through rule. The
commenters stated that, by indicating
that sections 743(b) and 704(b) should
be taken into account, the proposed
regulations imply that a partner’s share
of the partnership’s basis in an asset is
determined by reference to the future
depreciation deductions that a partner
would be allocated with regard to such
asset or the amount of basis to be taken
into account by that partner in
determining its allocable share of gain
or loss on the partnership’s disposition
of the asset. The commenters also
requested that final regulations address
whether and how allocations under
section 704(c) affect a partner’s share of
the partnership’s basis in its assets.
After further consideration, the Treasury
Department and the IRS have decided to
retain the rule in proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(i).
iv. Investment Asset Basis Reduction
Rule
Under proposed § 1.163(j)–
10(c)(5)(ii)(A)(2)(iii), for purposes of
applying the investment asset basis
reduction rule, a partner’s share of a
partnership’s assets is determined under
a reasonable method, taking into
account special allocations under
section 704(b). A commenter
recommended clarifying whether the
investment asset basis reduction should
be made in accordance with a partner’s
share of the partnership’s actual
adjusted basis in an asset or in
accordance with the partner’s share of
the partnership’s basis in an asset as
determined pursuant to the basis
determination rules. The commenter
further recommended that the approach
adopted on this issue should be
consistent with the approach adopted
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for purposes of determining a partner’s
adjusted basis in its partnership interest.
The Treasury Department and the IRS
agree that these two rules should be
applied consistently. After further
consideration, the Treasury Department
and the IRS have decided to retain the
rule that allows a partner’s share of a
partnership’s investment assets to be
determined using a reasonable method,
taking into account special allocations
under section 704(b). However, if a
partner elects to apply the look-through
rule, then the partner also must apply
the basis determination rules. If a
partner elects not to apply, or is
precluded from applying, the lookthrough rule, then the approach the
partner uses for purposes of the
investment asset basis reduction rule
must be consistent with the approach
the partner uses to determine the
partner’s adjusted basis in its
partnership interest.
v. Coordination of Section 752 Basis
Reduction Rule and Investment Asset
Basis Reduction Rule
Multiple commenters noted that the
combined effect of the section 752 basis
reduction rule and the investment asset
basis reduction rule could require a
partner, other than a C corporation or a
tax-exempt corporation, in a partnership
that holds investment assets funded by
partnership liabilities to reduce the
adjusted tax basis of its partnership
interest twice—once for the
partnership’s basis in its investment
assets, and a second time for the
liabilities that funded their purchase.
The Treasury Department and the IRS
have determined that this result would
be inappropriate. Accordingly, the final
regulations amend the investment asset
basis reduction rule by providing that,
with respect to a partner other than a C
corporation or tax-exempt corporation,
the partner’s adjusted basis in its
partnership interest is decreased by the
partner’s share of the excess of (a) the
partnership’s asset basis with respect to
those assets over (b) the partnership’s
debt that is traced to such assets in
accordance with § 1.163–8T. In order to
neutralize the effect of any cost recovery
deductions associated with a
partnership’s investment assets funded
by partnership liabilities (for example,
non-trade or business property held for
the production of income), the final
regulations also amend the investment
asset basis reduction rule by providing
that, with respect to a partner other than
a C corporation or tax-exempt
corporation, the partner’s adjusted basis
in its partnership interest is increased
by the partner’s share of the excess of (a)
the partnership’s debt that is traced to
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such assets in accordance with § 1.163–
8T over (b) the partnership’s asset basis
with respect to those assets.
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vi. Allocating Basis in a Partnership
Interest Between Excepted and NonExcepted Trades or Businesses
A commenter requested explicit
confirmation that, under the lookthrough rule, a partner allocates the
basis of its partnership interest between
excepted and non-excepted trades or
businesses in the same proportion as the
partner’s share of the partnership’s
adjusted tax basis in its trade or
business assets is allocated between
excepted and non-excepted trades or
businesses. The final regulations
explicitly state that this is the rule.
Commenters also stated that the
proposed regulations do not address
how a partner should allocate business
interest expense and business interest
income under proposed § 1.163(j)–10(c)
to the extent the partner (i) has zero
basis in all partnership interests for
purposes of section 163(j), and (ii) owns
no other trade or business assets. The
Treasury Department and the IRS have
determined that these facts would be
rare, particularly given the adjustments
to partnership basis provided for in
§ 1.163(j)–10. Therefore, the final
regulations do not include a rule
addressing this fact pattern. However,
the Treasury Department and the IRS
request comments on how frequently
this fact pattern would occur and how
best to address such a situation.
3. Additional Limitation on Application
of Look-Through Rules to C
Corporations
A commenter noted that the lookthrough rules may be distortive if an
individual (A) that is directly engaged
in a trade or business also owns stock
in a C corporation (with its own trade
or business) that satisfies the section
1504(a)(2) ownership requirements. A’s
interest expense that is attributable to
A’s investment in the C corporation
under § 1.163–8T retains its character as
investment interest expense. Moreover,
if A also has business interest expense,
the allocation of that expense between
excepted and non-excepted trades or
businesses would appear to take into
account A’s investment in the C
corporation on a look-through basis as
well. Thus, A’s shares in the C
corporation may be double-counted
insofar as they affect the character of
both the directly attributable investment
interest expense and the unrelated
business interest expense.
To address the possible distortive
effects of the look-through rules when
applied to stock of a non-consolidated C
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corporation that is held as an
investment, the final regulations
provide that the look-through rule in
§ 1.163(j)–10(c)(5)(ii)(B)(2)(i) is available
only if dividends paid on the stock
would not be included in the taxpayer’s
investment income under section
163(d)(4)(B). Because corporations
cannot have investment income under
section 163(d)(4)(B), this additional
requirement does not otherwise affect
their ability to look-through the stock of
a non-consolidated C corporation.
4. Dispositions of Stock in NonConsolidated C Corporations
Under proposed § 1.163(j)–10(b)(4)(i),
if a shareholder recognizes gain or loss
upon the disposition of its stock in a
non-consolidated C corporation, if such
stock is not property held for
investment, and if the taxpayer looks
through to the assets of the C
corporation under proposed § 1.163(j)–
10(c)(5)(ii)(B), then the taxpayer must
allocate gain or loss from the stock
disposition to excepted or non-excepted
trades or businesses based upon the
relative amounts of the corporation’s
adjusted basis in the assets used in its
trades or businesses. This rule is
analogous to the look-through rule for
dividends in proposed § 1.163(j)–
10(b)(3).
However, the dividend look-through
rule also provides that, if at least 90
percent of the payor corporation’s
adjusted basis in its assets during the
taxable year is allocable to either
excepted or non-excepted trades or
businesses, then all of the taxpayer’s
dividend income from the payor
corporation for the taxable year is
treated as allocable to excepted or nonexcepted trades or businesses,
respectively. Commenters asked why
the rule regarding the disposition of
non-consolidated C corporation stock is
not subject to a 90 percent de minimis
rule analogous to the rule for dividends.
The Treasury Department and the IRS
have determined that the rule regarding
the disposition of stock in a nonconsolidated C corporation (including a
CFC) should be subject to a 90 percent
de minimis rule. The final regulations
have modified proposed § 1.163(j)–
10(b)(4)(i) accordingly.
5. Application of Look-Through Rules to
Small Businesses
Under proposed § 1.163(j)–
10(c)(5)(ii)(D), a taxpayer may not apply
the look-through rules in proposed
§ 1.163(j)–10(b)(3) and (c)(5)(ii)(A), (B),
and (C) to an entity that is eligible for
the small business exemption. As
described in the preamble to the
proposed regulations, the Treasury
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56739
Department and the IRS determined that
these look-through rules should not be
available in these cases because of the
administrative burden that would be
imposed on small businesses from
collecting and providing information to
their shareholders or partners regarding
inside asset basis when those small
businesses are themselves exempt from
the application of section 163(j). The
preamble to the proposed regulations
also provides that a taxpayer that is
eligible for the small business
exemption may not make an election
under proposed § 1.163(j)–9.
Commenters requested that entities
that qualify for the small business
exemption be allowed to make an
election under proposed § 1.163(j)–9,
and that such an electing entity’s
shareholders or partners be permitted to
apply the look-through rules. Absent
such a rule, shareholders and partners
of a small business entity that conducts
an excepted trade or business could be
worse off than shareholders and
partners of a larger entity (ineligible for
the small business exemption) that
conducts an excepted trade or business.
As noted in part X(A) of this
Summary of Comments and Explanation
of Revisions section, the Treasury
Department and the IRS have
determined that entities eligible for the
small business exemption should be
permitted to make a protective election
under proposed § 1.163(j)–9.
Accordingly, the final regulations also
allow taxpayers to apply the lookthrough rules to entities that qualify for
the small business exemption and that
make a protective election under
proposed § 1.163(j)–9.
6. Application of the Look-Through
Rules to Foreign Utilities
Section 163(j)(7)(A)(iv) does not treat
utilities that are exclusively regulated
by foreign regulators (and not by a State
government, a political subdivision of a
State government, an agency or
instrumentality of the United States, or
the governing or ratemaking body of a
domestic electric cooperative) (foreignregulated utility) as excepted trades or
businesses. As a result, under the
interest allocation rules of proposed
§ 1.163(j)–10(c), a U.S. corporation that
looks through to the assets of a CFC that
operates a foreign-regulated utility must
allocate its entire basis in its CFC stock
to a non-excepted trade or business,
even if all of the CFC’s operating assets
are used in a foreign-regulated utility
business. Moreover, if the U.S.
corporation has significant basis in its
CFC stock, a significant portion of the
U.S. corporation’s business interest
expense will be subject to the section
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163(j) limitation, even if the U.S.
corporation is solely or primarily
engaged in an excepted utility trade or
business.
A commenter noted that, if the U.S.
corporation does not have sufficient
income from non-excepted trades or
businesses, the corporation might never
be able to deduct its disallowed
business interest expense. The
commenter thus recommended that
stock in a CFC engaged in a foreignregulated utility trade or business be
treated as having zero basis for purposes
of the interest allocation rules in
proposed § 1.163(j)–10(c).
The final regulations do not adopt the
commenter’s recommendation.
However, the Treasury Department and
the IRS have determined that, if a
taxpayer applies the look-through rule
to a CFC, the taxpayer may allocate its
basis in its CFC stock to an excepted
trade or business to the extent the CFC
is engaged in either (i) an excepted trade
or business, or (ii) a foreign-regulated
utility trade or business that would be
treated as an excepted trade or business
if the utility meets certain requirements
related to regulation by a foreign
government. The final regulations have
been modified accordingly. See
§ 1.163(j)–10(c)(5)(ii)(C)(2).
I. Deemed Asset Sale
Proposed § 1.163(j)–10(c)(5)(iv)
provides that, solely for purposes of
determining the amount of basis
allocable to excepted and non-excepted
trades or businesses under proposed
§ 1.163(j)–10(c), an election under
section 336, 338, or 754, as applicable,
is deemed to have been made for any
acquisition of corporate stock or
partnership interests with respect to
which the taxpayer demonstrates to the
satisfaction of the Commissioner that
the taxpayer was eligible to make an
election but was actually or effectively
precluded from doing so by a regulatory
agency with respect to an excepted
regulated utility trade or business. As
explained in the preamble to the
proposed regulations, this deemed asset
sale rule is intended to place taxpayers
that are actually or effectively precluded
from making an election under section
336, section 338, or section 754 on the
same footing for purposes of the basis
allocation rules in proposed § 1.163(j)–
10(c) as taxpayers that are not subject to
such limitations.
Commenters pointed out that, as a
practical matter, a basis step-up election
generally cannot be made if the acquired
entity has a regulatory liability for
deferred taxes on its books because, in
that case, the election may cause
customer bills to increase. In other
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words, deferred tax liabilities typically
lower a utility’s rate base (which is used
to compute the rates charged to
customers). An election under section
336, section 338, or section 754 would
eliminate this deferred tax liability,
thereby increasing the rate base and
potentially increasing the rates charged
to customers. As a result, regulatory
agencies frequently do not approve a
basis step-up election made in
connection with the sale or purchase of
a regulated utility. Commenters argued
that even broaching the possibility of
such a basis step-up could create
concerns for the regulatory agency
regarding a proposed acquisition.
Commenters also queried how taxpayers
that do not raise this issue with the
regulatory agency can ‘‘demonstrate’’
that they were ‘‘effectively precluded’’
by the agency from making the election.
In short, commenters claimed that the
‘‘demonstration’’ requirement in
proposed § 1.163(j)–10(c)(5)(iv) would
be impractical, result in unnecessary
requests to regulatory agencies, lead to
controversy, create uncertainty, and
limit the effectiveness of this provision.
To address the foregoing concerns, the
final regulations provide that a taxpayer
that acquired or acquires an interest in
a regulated entity should be deemed to
have made an election to step up the tax
basis of the assets of the acquired entity
if the taxpayer can demonstrate that (a)
the acquisition qualified for an election
under section 336, 338, or 754, and (b)
immediately before the acquisition, the
acquired entity had a regulatory liability
for deferred taxes on its books with
respect to property predominantly used
in an excepted regulated utility trade or
business.
J. Carryforwards of Disallowed
Disqualified Interest
Proposed § 1.163(j)–1(b)(10) defines
the term ‘‘disallowed disqualified
interest’’ to mean interest expense,
including carryforwards, for which a
deduction was disallowed under old
section 163(j) in the taxpayer’s last
taxable year beginning before January 1,
2018, and that was carried forward
under old section 163(j). Under the
proposed regulations, disallowed
disqualified interest that is properly
allocable to a non-excepted trade or
business is subject to the section 163(j)
limitation as a disallowed business
interest expense carryforward. See
proposed §§ 1.163(j)–2(c)(1) and
1.163(j)–11(b)(1). In the preamble to the
proposed regulations, the Treasury
Department and the IRS requested
comments as to how the allocation rules
in proposed § 1.163(j)–10 should apply
to disallowed disqualified interest.
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Commenters recommended several
possible approaches to allocating
disallowed disqualified interest between
excepted and non-excepted trades or
businesses. Under one approach
(historical approach), a taxpayer would
apply the allocation rules of proposed
§ 1.163(j)–10 to disallowed disqualified
interest in the taxable year in which
such interest expense was incurred.
Although this approach would be
consistent with the allocation rules for
other business interest expense, it likely
would be administratively burdensome
for many taxpayers because such
interest expense may have been
incurred years (if not decades) ago.
Under another approach (effective
date approach), a taxpayer would apply
the allocation rules of proposed
§ 1.163(j)–10 to disallowed disqualified
interest in the taxpayer’s first taxable
year beginning after December 31, 2017,
as if the disallowed disqualified interest
expense were incurred in that year.
Although this approach would be less
administratively burdensome than the
historical approach, it might not
accurately represent the taxpayer’s
circumstances in the year(s) in which
the disallowed disqualified interest
actually was incurred.
Under a third approach, taxpayers
would be permitted to use any
reasonable method to allocate
disallowed disqualified interest between
excepted and non-excepted trades or
businesses, provided the method is
applied consistently to disallowed
disqualified interest that arose in the
same taxable year. This approach also
might include the effective date
approach as a safe harbor. However, this
approach could prove to be
administratively burdensome for the
IRS.
To reduce the administrative burden
for both taxpayers and the IRS, the final
regulations permit taxpayers to use
either the historical approach or the
effective date approach.
A commenter also pointed out that
proposed § 1.163(j)–11(b)(1) could be
construed as permitting only disallowed
disqualified interest that is properly
allocable to a non-excepted trade or
business to be carried forward to the
taxpayer’s first taxable year beginning
after December 31, 2017. The
commenter requested confirmation that
disallowed disqualified interest that is
properly allocable to an excepted trade
or business also is carried forward. The
final regulations confirm this point. See
§ 1.163(j)–11(c)(1).
K. Anti-Abuse Rule
Proposed § 1.163(j)–10(c)(8) provides
an anti-abuse rule to discourage
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taxpayers from manipulating the
allocation of business interest expense
and business interest income between
non-excepted and excepted trades or
businesses. Pursuant to this provision, if
a principal purpose for the acquisition,
disposition, or change in use of an asset
was to artificially shift the amount of
basis allocable to excepted or nonexcepted trades or businesses on a
determination date, the additional basis
or change in use is not taken into
account for purposes of § 1.163(j)–10.
A commenter expressed support for
this rule but suggested that the final
regulations eliminate the ‘‘principal
purpose’’ standard and rely instead on
a rule based on asset acquisitions,
dispositions, or changes in use that do
not have ‘‘a substantial business
purpose.’’
The Treasury Department and the IRS
have determined that using ‘‘a
substantial business purpose’’ as the
threshold for applying the anti-abuse
rule would limit the effectiveness of this
rule because taxpayers generally would
be able to provide an ostensible
business purpose for the acquisition,
disposition, or transfer of an asset. Thus,
the anti-abuse rule in the final
regulations retains the ‘‘principal
purpose’’ standard.
L. Direct Allocation
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1. Overview
As previously noted, proposed
§ 1.163(j)–10(c) generally requires
interest expense and interest income to
be allocated between excepted and nonexcepted trades or businesses according
to the relative amounts of basis in the
assets used in such trades or businesses.
However, proposed § 1.163(j)–10(d)
contains several exceptions to this
general rule.
First, a taxpayer with qualified
nonrecourse indebtedness is required to
directly allocate interest expense from
such indebtedness to the taxpayer’s
assets in the manner and to the extent
provided in § 1.861–10T(b) (see
proposed § 1.163(j)–10(d)(1)). Section
1.861–10T(b) defines the term
‘‘qualified nonrecourse indebtedness’’ to
mean any borrowing (other than
borrowings excluded by § 1.861–
10T(b)(4)) that satisfies certain
requirements, including the
requirements that (i) the creditor can
look only to the identified property (or
any lease or other interest therein) as
security for payment of the principal
and interest on the loan, and (ii) the
cash flow from the property is
reasonably expected to be sufficient to
fulfill the terms and conditions of the
loan agreement. For these purposes, the
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term ‘‘cash flow from the property’’ does
not include revenue if a significant
portion thereof is derived from activities
such as sales or the use of other
property. Thus, revenue derived from
the sale or lease of inventory or similar
property, including plant or equipment
used in the manufacture and sale or
lease, or purchase and sale or lease, of
such inventory or similar property, does
not constitute cash flow from the
property. See § 1.861–10T(b)(3)(i).
Second, a taxpayer that is engaged in
the trade or business of banking,
insurance, financing, or a similar
business is required to directly allocate
interest expense and interest income
from such business to the taxpayer’s
assets used in that business (see
proposed § 1.163(j)–10(d)(2)).
Additionally, for purposes of the
general allocation rule in proposed
§ 1.163(j)–10(c), taxpayers are required
to reduce their asset basis by the entire
amount of the basis in the assets to
which interest expense is directly
allocated pursuant to proposed
§ 1.163(j)–10(d)(1) or (2). See proposed
§ 1.163(j)–10(d)(4).
2. Expansion of the Direct Allocation
Rule
Some commenters recommended that
the direct allocation rule in proposed
§ 1.163(j)–10(d) be applied in
circumstances other than those set forth
in proposed § 1.163(j)–10(d)(1) and (2).
For example, a commenter queried
whether a borrowing could be
considered qualified nonrecourse
indebtedness for purposes of proposed
§ 1.163(j)–10(d) even if the loan
document doesn’t require the creditor to
look exclusively to an asset as security
for payment of principal and interest on
a loan (as required by § 1.861–
10T(b)(2)(iii)). Other commenters asked
that direct allocation be applied to debt
directly incurred by an excepted
regulated utility trade or business.
These commenters argued that, because
such debt must be approved by a
regulatory agency and relates directly to
the underlying needs of that trade or
business, such debt should be viewed as
‘‘properly allocable’’ to that trade or
business. Moreover, they claimed that
the definition of ‘‘qualified nonrecourse
indebtedness’’ in § 1.861–10T(b) is too
narrow to include either debt directly
incurred by an excepted regulated
utility trade or business or debt incurred
to purchase stock of a corporation or
interests in a partnership primarily
engaged in an excepted regulated utility
trade or business.
In contrast, other commenters
supported the decision to limit the
availability of tracing to the limited
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56741
circumstances in proposed § 1.163(j)–
10(d).
As noted in part XI(L)(1) of this
Summary of Comments and Explanation
of Revisions section, a borrowing is not
considered qualified nonrecourse
indebtedness under § 1.861–10T(b)
unless the creditor can look only to the
identified property (or any interest
therein) as security for the loan. By
definition, the creditor on a nonrecourse loan may not seek to recover
the borrower’s other assets; in other
words, the creditor has no further
recourse. The Treasury Department and
the IRS decline to expand the exception
in proposed § 1.163(j)–10(d)(1) to
include unsecured debt because, by
definition, such debt is supported by all
of the assets of the borrower.
The Treasury Department and the IRS
also have determined that the definition
of qualified nonrecourse indebtedness
should not be expanded to encompass
indebtedness incurred to acquire stock
or partnership interests in an entity
primarily engaged in an excepted trade
or business because such an approach is
akin to tracing. As noted in the
preamble to the proposed regulations,
money is fungible, and the Treasury
Department and the IRS have
determined that a tracing regime would
be inappropriate, with limited
exceptions. The Treasury Department
and the IRS have determined that the
definition of qualified nonrecourse
indebtedness should not be expanded to
encompass all indebtedness directly
incurred by regulated utility trades or
businesses, for similar reasons.
However, the Treasury Department
and the IRS appreciate that it is difficult
for utility trades or businesses to avail
themselves of the direct allocation rule
in proposed § 1.163(j)–10(d)(1) given the
definition of qualified nonrecourse debt
in § 1.861–10T(b). In particular, the
Treasury Department and the IRS
understand that the exclusion of
inventory revenue from the calculation
of ‘‘cash flow from the property’’
effectively precludes many utilities from
using direct allocation under proposed
§ 1.163(j)–10(d)(1). Thus, solely for
purposes of the allocation rules in
proposed § 1.163(j)–10, the final
regulations create an exception to the
definition of qualified nonrecourse
indebtedness in § 1.861–10T(b) to allow
for the inclusion of revenue from the
sale or lease of inventory for utility
trades or businesses.
Another commenter recommended
that, for taxpayers engaged in excepted
regulated utility trades or businesses,
the basis in certain grants and
contributions in aid of construction
should be directly allocated to non-
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excepted trades or businesses if the
costs have not been taken into account
by a regulatory body in determining the
cost of the utility’s service for
ratemaking purposes. As discussed in
part II of this Summary of Comments
and Explanation of Revisions section,
the final regulations do not require the
rates for the sale or furnishing of utility
items to be established or approved on
a cost of service and rate of return basis
in order for a utility trade or business
to qualify as an excepted regulated
utility trade or business. Without such
a requirement, the Treasury Department
and the IRS do not find a significant
nexus between a regulatory body’s
determination of a utility trade or
business’s cost of service and the
allocation of the basis in grants and
contributions in aid of construction.
Therefore, the final regulations do not
adopt the commenter’s
recommendation.
3. Basis Reduction Requirement for
Qualified Nonrecourse Indebtedness
Commenters noted that, as drafted,
the basis reduction requirement in
proposed § 1.163(j)–10(d)(4) would lead
to inappropriate results for assets that
are acquired using both equity financing
and qualified nonrecourse indebtedness
(or using both recourse and nonrecourse
indebtedness) because this requirement
would remove asset basis that was not
financed by qualified nonrecourse
indebtedness.
Commenters also observed that this
requirement could lead to significant
distortions because a small amount of
qualified nonrecourse indebtedness
would cause an entire property to be
removed from a taxpayer’s basis
allocation computation. For example,
assume a taxpayer has (i) $500,000 of
unsecured debt, (ii) property used in an
excepted trade or business with a basis
of $10 million and $100,000 of qualified
nonrecourse indebtedness (Asset A),
and (iii) a non-excepted trade or
business whose assets have a basis of $1
million. Under proposed § 1.163(j)–
10(d)(4), Asset A would be entirely
excluded from the basis allocation
computation in proposed § 1.163(j)–
10(c). As a result, all interest expense on
the $500,000 of unsecured debt would
be subject to the section 163(j)
limitation.
Commenters further noted that
taxpayers could take advantage of this
basis adjustment rule to minimize the
application of section 163(j). In other
words, taxpayers could incur a
relatively small amount of nonrecourse
debt to acquire assets used in nonexcepted trades or businesses, thereby
reducing the amount of asset basis
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allocated to such trades or businesses
for purposes of the general allocation
rule in proposed § 1.163(j)–10(c).
To eliminate these distortions and
inappropriate results, commenters
recommended that basis in the assets
securing qualified nonrecourse
indebtedness be reduced (but not below
zero) for purposes of the general
allocation rule solely by the amount of
such qualified nonrecourse
indebtedness. The Treasury Department
and the IRS agree with this
recommendation, and the final
regulations have been modified
accordingly.
4. Direct Allocation Rule for Financial
Services Businesses
Commenters asked for clarification of
the direct allocation rule for financial
services entities in proposed § 1.163(j)–
10(d)(2). For example, commenters
noted that, because the definition in
§ 1.904–4(e)(2) includes income from
certain services (including investment
advisory services), this rule may apply
to taxpayers that are not doing much
actual financing, and commenters
queried whether the direct allocation
rule should apply to such taxpayers.
Commenters also asked whether
proposed § 1.163(j)–10(d)(2) is intended
to cover all of a bank’s activities or only
part of them and, if the answer is the
latter, whether a bank must bifurcate its
activities for purposes of proposed
§ 1.163(j)–10.
Commenters also questioned the basis
reduction rule in proposed § 1.163(j)–
10(d)(4) for financial services
businesses. Commenters noted that,
unlike the case of qualified nonrecourse
indebtedness, it may not be possible to
trace all interest expense related to a
financial services business to specific
assets. Moreover, requiring a taxpayer to
fully eliminate its basis in the assets of
a financial services business under
proposed § 1.163(j)–10(d)(4) could be
distortive because the taxpayer’s general
debt obligations likely support at least
some portion of the taxpayer’s financial
services business assets.
Given the uncertainty surrounding the
proper scope of the direct allocation
rule for financial services businesses in
proposed § 1.163(j)–10(d)(2) and the
proper application of the basis
reduction rule to such businesses in
proposed § 1.163(j)–10(d)(4), the
Treasury Department and the IRS have
decided to remove proposed § 1.163(j)–
10(d)(2). To ensure that financial
services entities are not unduly affected
by the rule (in proposed § 1.163(j)–
10(c)(5)(iii)) that excludes cash and cash
equivalents from the general asset basis
allocation rule in proposed § 1.163(j)–
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10(c), the final regulations have retained
the exception in proposed § 1.163(j)–
10(c)(5)(iii) for financial services
entities.
XII. Comments on Proposed Changes to
§ 1.382–2: General Rules for Ownership
Change
As described in the preamble to the
proposed regulations, section 382(k)(1)
provides that, for purposes of section
382, the term ‘‘loss corporation’’
includes a corporation entitled to use a
carryforward of disallowed interest
described in section 381(c)(20), which
refers to carryovers of disallowed
business interest described in section
163(j)(2). Section 163(j)(2) permits
business interest expense for which a
deduction is disallowed under section
163(j)(1) to be carried forward to the
succeeding taxable year.
In turn, section 382(d)(3) provides
that the term ‘‘pre-change loss’’ includes
disallowed business interest expense
carryforwards ‘‘under rules similar to
the rules’’ in section 382(d)(1). Section
382(d)(1) treats as a ‘‘pre-change loss’’
both (i) net operating loss carryforwards
to the taxable year in which the change
date occurs (change year), and (ii) the
net operating loss carryforward for the
change year to the extent such loss is
allocable to the pre-change period.
Proposed changes to § 1.382–2
clarified that a ‘‘pre-change loss’’
includes the portion of any disallowed
business interest expense of the old loss
corporation paid or accrued in the
taxable year of the testing date that is
attributable to the pre-change period,
and that a ‘‘loss corporation’’ includes a
corporation that is entitled to use a
carryforward of such a disallowed
business interest expense.
Commenters noted that, viewed in
isolation, section 382(k)(1) would not
appear to apply to a corporation that has
only a current-year disallowed business
interest expense. Some commenters also
claimed that the inclusion of currentyear disallowed business interest
expense in the definition of a ‘‘loss
corporation’’ is inconsistent with the
statutory language of section 382(k)(1).
The Treasury Department and the IRS
have determined that section 382
should apply to current-year disallowed
business interest expense (to the extent
such expense is allocable to the prechange period) because this approach is
consistent with the statutory treatment
of NOLs. See section 382(k)(1)
(providing, in part, that the term ‘‘loss
corporation’’ means a corporation
‘‘having a net operating loss for the
taxable year in which the ownership
change occurs’’). Moreover, as a policy
matter, current-year attributes that relate
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to the period before an ownership
change should be subject to section 382.
The exclusion of these items would
permit trafficking in losses, which is
contrary to the stated policy underlying
section 382 of preventing ‘‘exploit[ation]
by persons other than those who
incurred the loss.’’ H. Rept. 83–1337, at
42 (1954). Thus, no changes to the final
regulations have been made in response
to these comments. However, the final
regulations revise the definition of a
‘‘section 382 disallowed business
interest carryforward’’ (which includes
both disallowed business interest
expense carryforwards and current-year
disallowed business interest expense
allocable to the pre-change period) in
§ 1.382–2(a)(7) to reflect changes to the
allocation rules discussed in part XIII of
this Summary of Comments and
Explanation of Revisions section.
XIII. Comments on Proposed Changes to
§ 1.382–6: Allocation of Income and
Loss to Periods Before and After the
Change Date for Purposes of Section 382
Section 1.382–6 provides rules for the
allocation of income and loss to periods
before and after the change date for
purposes of section 382. Section 1.382–
6(a) generally provides that a loss
corporation must allocate its net
operating loss or taxable income, and its
net capital loss or modified capital gain
net income, for the change year between
the pre-change and post-change periods
by ratably allocating an equal portion to
each day in the year. Section 1.382–6(b),
which contains an exception to this
general rule, permits a loss corporation
to elect to allocate the foregoing items
for the change year between the prechange and post-change periods as if the
loss corporation’s books were closed on
the change date. Such an election does
not terminate the loss corporation’s
taxable year as of the change date (in
other words, the change year is still
treated as a single tax year for Federal
income tax purposes).
The proposed regulations revise
§ 1.382–6 to address the treatment of
business interest expense. More
specifically, the proposed regulations
provide that, regardless of whether a
loss corporation has made a closing-ofthe-books election under § 1.382–6(b),
the amount of the corporation’s
deduction for current-year business
interest expense is calculated based on
ratable allocation for purposes of
calculating the corporation’s taxable
income attributable to the pre-change
period.
Commenters objected to the
mandatory use of ratable allocation for
business interest expense in § 1.382–6.
For example, commenters argued that
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this approach is distortive (and
taxpayer-unfavorable) in situations in
which the loss corporation incurs
minimal interest expense in the prechange period but makes highly
leveraged acquisitions in the postchange period. Another commenter
noted that this approach is distortive
(and taxpayer-favorable) in situations in
which the loss corporation incurs
significant business interest expense in
the pre-change period and allocates a
portion of that expense to the postchange period. To avoid these
distortions and complications,
commenters recommended that a
closing-of-the-books election also be
allowed for business interest expense.
The Treasury Department and the IRS
acknowledge that a ratable allocation
approach may lead to distortions and
administrative burdens in certain
situations. Thus, the final regulations
permit a loss corporation to allocate
current-year business interest expense
between the pre-change and post-change
periods using the closing-of-the-books
method set forth in § 1.382–6(b)(4) if the
loss corporation makes a closing-of-thebooks election under § 1.382–6(b).
Section 1.382–6(b)(4) also provides
correlative rules for the allocation of
disallowed business interest expense
carryforwards to the pre-change and
post-change periods when a closing-ofthe-books election is made. In turn,
section 1.382–6(a)(2) clarifies the
amount of business interest expense,
disallowed business interest expense,
and disallowed business interest
expense carryforwards that are allocable
to the pre-change and post-change
periods if no closing-of-the-books
election is made.
XIV. Comments on and Changes to
Proposed § 1.383–1: Special Limitations
on Certain Capital Losses and Excess
Credits
Section 1.383–1(d) provides ordering
rules for the utilization of pre-change
losses and pre-change credits and for
the absorption of the section 382
limitation and the section 383 credit
limitation. Under proposed changes to
§ 1.383–1(d), a taxpayer’s section 382
limitation would be absorbed by
disallowed business interest expense
carryforwards before being absorbed by
NOLs. As described in the preamble to
the proposed regulations, the Treasury
Department and the IRS prioritized the
use of disallowed business interest
expense carryforwards over NOLs
because ‘‘taxpayers must calculate their
current-year income or loss in order to
determine whether and to what extent
they can use an NOL in that year, and
deductions for business interest
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expense, including carryforwards from
prior taxable years, factor into the
calculation of current-year income or
loss.’’
Although commenters described the
foregoing ordering rule as
understandable and fairly simple to
administer, they noted that pre-2018
NOLs (unlike disallowed business
interest expense carryforwards) have a
limited carryforward period, and that
such NOLs may expire without use as
a result of this ordering rule.
Commenters thus recommended
allowing taxpayers to elect an
alternative ordering rule with respect to
pre-2018 NOLs.
The Treasury Department and the IRS
have decided not to adopt this
recommended approach, for several
reasons. First, as commenters also
noted, such an approach would add
complexity. Second, as stated in the
preamble to the proposed regulations,
deductions for business interest expense
(including disallowed business interest
expense carryforwards) factor into the
determination whether and to what
extent a taxpayer can use an NOL in a
taxable year. Thus, no changes have
been made to proposed § 1.383–1(d) in
the final regulations.
XV. Other Comments About Section 382
A. Application of Section 382(l)(5)
Section 382(l)(5) provides an
exception to the general loss limitation
rule under section 382(a) for an old loss
corporation in Title 11 proceedings or in
similar cases if the historic shareholders
and creditors of such corporation own at
least 50 percent of the stock of the new
loss corporation as a result of being
shareholders or creditors immediately
before the ownership change. If this
exception applies, the corporation’s prechange losses and excess credits that
may be carried over to a post-change
year must be ‘‘computed as if no
deduction was allowable under this
chapter for the interest paid or accrued’’
on debt converted into stock under Title
11 (or in a similar case) during the 3year period preceding the year of the
ownership change (change year) or
during the pre-change period in the
change year. Section 382(l)(5)(B). In
other words, because the old loss
corporation gets the benefit of treating
certain creditors as shareholders for
purposes of determining whether the
corporation has undergone an
ownership change within the meaning
of section 382(g), the corporation must
treat the debt held by such creditors as
equity for Federal income tax purposes.
As a result, the corporation must treat
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the interest payments as non-deductible
distributions on equity.
As provided in proposed § 1.382–2,
section 382 disallowed business interest
carryforwards are pre-change losses.
Because a deduction for such
carryforwards is ‘‘allowable’’ in a future
year, commenters asked whether such
carryforwards must be recomputed
under section 382(l)(5)(B).
The Treasury Department and the IRS
have determined that no clarification of
the rule is necessary. Because section
382 disallowed business interest
carryforwards are pre-change losses, if a
corporation has such a carryforward
from any taxable year ending during the
3-year period preceding the change year
(or during the pre-change period in the
change year), and if section 382(l)(5)
applies to an ownership change, the
corporation must recompute the amount
of such carryforwards as if the business
interest expense that generated such
carryforwards were not interest.
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B. Application of Section 382(e)(3)
A commenter also recommended that
the final regulations address the
application of section 382(e)(3) to
foreign corporations with section 382
disallowed business interest
carryforwards. Section 382(e)(3)
provides that, except as otherwise
provided in regulations, only items
treated as connected with the conduct of
a U.S. trade or business are taken into
account in determining the value of an
old loss corporation that is a foreign
corporation if an ownership change
occurs. Thus, if a foreign corporation is
not engaged in a U.S. trade or business,
that corporation’s section 382 limitation
is zero. As a result, if a foreign
corporation with no U.S. trade or
business undergoes a section 382
ownership change, section 382(e)(3)
appears to limit the corporation’s
section 382 disallowed business interest
carryforwards to $0. The commenter
described this result as onerous and
unintended and recommended that, for
purposes of applying section 382 to
such carryforwards, a foreign
corporation’s value be treated as the
total value of its stock.
The Treasury Department and the IRS
are aware of this issue and other issues
relating to the application of section 382
to CFCs. The Treasury Department and
the IRS continue to study the
application of section 382 to CFCs and
may address this issue in future
guidance. The Treasury Department and
the IRS welcome further comments on
the application of section 382 to CFCs.
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C. Application of Section 382(h)(6)
As noted in the Background section,
the September 2019 section 382
proposed regulations included a rule
expressly providing that section 382
disallowed business interest
carryforwards are not treated as RBILs,
thus precluding a double detriment
under section 382 with respect to such
carryforwards. This conclusion might
have been reached by application of the
general anti-duplication principles
reflected in the current regulations
under section 382. See, for example,
§ 1.382–8(d) (regarding duplicative
reductions in value of loss
corporations). However, because of the
complexity of this area, the Treasury
Department and the IRS included the
clarification to prevent possible
confusion and to provide certainty to
taxpayers that there is no double
detriment with respect to section 382
disallowed business interest
carryforwards. Although no formal
comments were received on this rule
during the comment period for the
September 2019 section 382 proposed
regulations, informal comments from
practitioners active in the field have
been uniformly positive and have
confirmed that this rule is a welcome,
taxpayer-beneficial addition to the
regulations under section 382.
Due to the uncontroversial nature of
this rule, the Treasury Department and
the IRS have determined that
finalization of this portion of the
September 2019 section 382 proposed
regulations is warranted at this time.
The Treasury Department and the IRS
continue to actively study the remainder
of the rules in the September 2019
section 382 proposed regulations.
XVI. Definition of Real Property Trade
or Business
Commenters suggested that the
definition of a ‘‘real property trade or
business’’ should be clarified to include
all rental real estate, even if the rental
real estate does not rise to the level of
a section 162 trade or business. The
Treasury Department and the IRS have
determined that modifications to the
rules in the proposed regulations are not
necessary to make this point clear.
Section 1.469–9(b)(1) provides that the
definition of a ‘‘trade or business’’ (for
purposes of section 469(c)(7)(C))
includes interests in rental real estate
even if the rental real estate gives rise
to deductions under section 212. The
definition of real property trade or
business in § 1.469–9(b)(2) (for purposes
of section 469(c)(7)(C)) necessarily
would encompass or include the
definition of a trade or business as
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provided in § 1.469–9(b)(1).
Accordingly, taxpayers engaged in
rental real estate activities that do not
necessarily rise to the level of a section
162 trade or business nevertheless will
be treated as engaged in real property
trades or businesses for purposes of
section 469(c)(7)(C) (and section 163(j)
by reference), and such taxpayers will
be permitted to make the election for a
trade or business to be an electing real
property trade or business for purposes
of section 163(j).
Commenters also requested
clarification that a trade or business
should not be required to have a direct
nexus or relationship to rental real
estate in order to qualify as a real
property trade or business under section
469(c)(7)(C). The Treasury Department
and the IRS agree that businesses
involving real property construction,
reconstruction, development,
redevelopment, conversion, acquisition,
or brokerage should not necessarily be
required to have a direct nexus or
relationship to rental real estate to be
treated as a real property trade or
business under section 469(c)(7)(C). The
proposed regulations provide
definitions for the terms ‘‘real property
management’’ and ‘‘real property
operations’’ while reserving the
remaining nine terms in section
469(c)(7)(C) as undefined. The statement
in the preamble to the proposed
regulations regarding a nexus or
relationship to rental real estate was
intended as the rationale for the
decision to limit the definition of the
two terms to the management and
operation of rental real estate. Without
these limiting definitions, the Treasury
Department and the IRS were concerned
that these two terms could be read so
broadly as to allow virtually any type of
business to qualify as a real property
trade or business. The other nine terms
in section 469(c)(7)(C) currently remain
undefined, although the Treasury
Department and the IRS intend to issue
additional guidance in the future to
provide definitions for these terms.
The Treasury Department and the IRS
generally agree with the observation that
real property construction,
reconstruction, development,
redevelopment, conversion, acquisition,
or brokerage businesses should not
necessarily be required to have a direct
nexus or relationship to rental real
estate in order to be treated as real
property trades or businesses. However,
the expectation nevertheless remains
that the end products or final objectives
of such businesses should at least have
the potential to be used as rental real
estate or as integral components in
rental real estate activities.
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Several commenters requested
clarification regarding whether
timberlands will qualify as real property
trades or businesses. The Treasury
Department and the IRS have concluded
that unharvested or unsevered timber
clearly fall within the definition of ‘‘real
property’’ as provided in the proposed
regulations. The question is whether the
activity of holding of timberlands falls
within the definition of a ‘‘real property
trade or business.’’ The Treasury
Department and the IRS have concluded
that the maintenance and management
of timberlands generally does not meet
the intended meaning of any of the
eleven terms in section 469(c)(7)(C), and
that the owners of timberlands were not
intended recipients for relief from the
per se passive rule for rental real estate
when section 469(c)(7) originally was
enacted. However, as set forth in the
Concurrent NPRM, such activities might
constitute the development of real estate
within the meaning of section
469(c)(7)(C). See proposed § 1.469–
9(b)(2)(ii)(A) and (B) contained in the
Concurrent NPRM.
One commenter requested an example
illustrating that the management or
operation of a pipeline or transmission
line will meet the definition of a real
property trade or business. In addition,
another commenter requested an
example illustrating that the operation
of a bridge, tunnel, toll road, or airport
qualifies as a real property trade or
business.
Although the Treasury Department
and the IRS generally agree that the
operation of a pipeline, bridge, tunnel,
toll road, or airport may meet the
definition of a real property trade or
business under certain and specific facts
and circumstances, the answers to these
questions will remain dependent on the
facts and circumstances of each case.
The Treasury Department and the IRS
expect that such examples generally
will provide very limited guidance to
most taxpayers because any such
examples likely will be viewed as
inapplicable for taxpayers with any
differing facts and circumstances.
Additionally, one commenter
recommended removing the reference to
the term ‘‘customers’’ from the
definitions of the terms ‘‘real property
management’’ and ‘‘real property
operation’’ because, in certain
situations, the party paying for the use
of the property or for other services may
be a governmental agency providing
services to the general public or for the
public good. The Treasury Department
and the IRS have determined that this
modification is unnecessary because the
term ‘‘customer’’ for this purpose is
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broad enough to include governmental
entities.
One commenter also requested that
the definition of a real property trade or
business be revised to include
broadband, street lighting, telephone
poles, parking meters, and rolling stock.
The Treasury Department and the IRS
decline to revise the definition of real
property trade or business in section
469(c)(7)(C) in this manner because the
maintenance and management of these
types of assets generally do not meet the
intended meaning of any of the eleven
terms in section 469(c)(7)(C), and the
owners of such assets were not intended
recipients for relief from the per se
passive rule for rental real estate when
section 469(c)(7) originally was enacted.
One commenter requested that the
final regulations remove the last
sentence in the definition of each of the
terms ‘‘real property management’’ and
‘‘real property operation.’’ The
commenter stated that these sentences
create confusion regarding whether
incidental services provided along with
rental real estate will cause the business
to fail to qualify as a real property trade
or business. In response to this
comment, the Treasury Department and
the IRS have revised these sentences to
clarify that incidental services, even if
significant, do not disqualify a business
as a real property trade or business.
Statement of Availability of IRS
Documents
The IRS Notices, Revenue Rulings,
and Revenue Procedures cited in this
document are published in the Internal
Revenue Bulletin (or Cumulative
Bulletin) and are available from the
Superintendent of Documents, U.S.
Government Publishing Office,
Washington, DC 20402, or by visiting
the IRS website at https://www.irs.gov.
Special Analyses
I. Regulatory Planning and Review—
Economic Analysis
Executive Orders 13771, 13563 and
12866 direct agencies to assess costs and
benefits of available regulatory
alternatives and, if regulation is
necessary, to select regulatory
approaches that maximize net benefits
(including potential economic,
environmental, public health and safety
effects, distributive impacts, and
equity). Executive Order 13563
emphasizes the importance of
quantifying both costs and benefits, of
reducing costs, of harmonizing rules,
and of promoting flexibility.
The final regulations have been
designated as subject to review under
Executive Order 12866 pursuant to the
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Memorandum of Agreement (April 11,
2018) between the Treasury Department
and the Office of Management and
Budget (OMB) regarding review of tax
regulations. OMB has designated this
final regulation as economically
significant under section 1(c) of the
Memorandum of Agreement.
Accordingly, the final regulations have
been reviewed by OMB’s Office of
Information and Regulatory Affairs. For
purposes of E.O. 13771 this rule is
regulatory.
A. Need for the Final Regulations
The Tax Cuts and Jobs Act (TCJA)
substantially modified the statutory
rules of section 163(j) to limit the
amount of net business interest expense
that can be deducted in the current
taxable year. As a result of those
changes, a number of the relevant terms
and necessary calculations that
taxpayers are required to apply under
the statute can benefit from greater
specificity. The Treasury Department
and the IRS issued proposed regulations
related to section 163(j) on December
28, 2018 (proposed regulations). The
comments to the proposed regulations
demonstrate a variety of opinions on
how to define terms and on how section
163(j) interacts with other sections of
the Code and corresponding regulations.
Based on these considerations, the
final regulations are needed to bring
clarity to instances where the meaning
of the statute was unclear and to
respond to comments received on the
proposed regulations. Among other
benefits, the clarity provided by the
final regulations generally helps ensure
that all taxpayers calculate the business
interest expense limitation in a similar
manner.
B. Background and Overview
The TCJA substantially modified the
statutory rules of section 163(j) to limit
the amount of net business interest
expense that can be deducted in the
current taxable year of any taxpayer,
with limited exceptions. As described in
the preamble to the proposed
regulations (83 FR 67490), section 163(j)
prior to TCJA generally applied to
domestic corporations with interest paid
or accrued to related persons that were
not subject to Federal income tax. With
the enactment of TCJA, the amount
allowed under section 163(j)(1) as a
deduction for business interest expense
is limited to the sum of (1) the
taxpayer’s business interest income for
the taxable year; (2) 30 percent of the
taxpayer’s adjusted taxable income
(ATI) for the taxable year; and (3) the
taxpayer’s floor plan financing interest
expense for the taxable year. As
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described in the Background section
earlier, the Coronavirus Aid, Relief, and
Economic Security Act (CARES Act)
amended section 163(j) to provide
special rules relating to the ATI
limitation for taxable years beginning in
2019 or 2020. The section 163(j)
limitation applies to all taxpayers,
except for certain small businesses with
average annual gross receipts of $25
million or less (adjusted for inflation)
and certain trades or businesses. The
excepted trades or businesses are the
trade or business of providing services
as an employee, electing real property
businesses, electing farming businesses,
and certain regulated utility businesses.
Any amount of business interest not
allowed as a deduction for any taxable
year as a result of the limitation under
section 163(j)(1) is carried forward and
treated as business interest paid or
accrued in the next taxable year under
section 163(j)(2).
Congress modified section 163(j)
under the TCJA, in part, out of concern
that prior law treated debt-financed
investment more favorably than equityfinanced investment. According to
Congress, this debt bias generally
encouraged taxpayers to utilize more
leverage than they would in the absence
of the Code. Limiting the deduction of
business interest is meant to reduce the
relative favorability of debt and hence
encourage a more efficient capital
structure for firms. Congress also
believed it necessary to apply the limit
broadly across different types of
taxpayers so as not to distort the choice
of entity (see H.R. Rep. No. 115–409, at
247 (2017)).
C. Economic Analysis
1. Baseline
The Treasury Department and the IRS
have assessed the economic effects of
the final regulations relative to a noaction baseline reflecting anticipated
Federal income tax-related behavior in
the absence of these final regulations.
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2. Summary of Economic Effects
The final regulations provide
certainty and clarity to taxpayers
regarding terms and calculations that
are contained in section 163(j), which
was substantially modified by TCJA. In
the absence of this clarity, the
likelihood that different taxpayers
would interpret the rules regarding the
deductibility of business interest
expense differently would be
exacerbated. In general, overall
economic performance is enhanced
when businesses face more uniform
signals about tax treatment. Certainty
and clarity over tax treatment also
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reduce compliance costs for taxpayers.
For those situations where taxpayers
would generally adopt similar
interpretations of the statute even in the
absence of guidance, the final
regulations provide value by helping to
ensure that those interpretations are
consistent with the intent and purpose
of the statute. For example, the final
regulations may specify a tax treatment
that few or no taxpayers would adopt in
the absence of specific guidance but that
nonetheless advances Congressional
intent.
The Treasury Department and the IRS
project that the final regulations will
have an annual economic effect greater
than $100 million ($2020). This
determination is based on the
substantial volume of business interest
payments in the economy 2 and the
general responsiveness of business
investment to effective tax rates,3 one
component of which is the deductibility
of interest expense. Based on these two
magnitudes, even modest changes in the
deductibility of interest payments (and
in the certainty of that deductibility)
provided by the final regulations,
relative to the no-action baseline, can be
expected to have annual effects greater
than $100 million. This claim is
particularly likely to hold for the first
set of general 163(j) guidance that is
promulgated following major
legislation, such as TCJA.
The Treasury Department and the IRS
have not undertaken more precise
estimates of the economic effects of
changes in business activity stemming
from these final regulations. The
Treasury Department and the IRS do not
have readily available data or models
that predict with reasonable precision
the decisions that taxpayers would
make under the final regulations versus
alternative regulatory approaches,
including the no-action baseline. Nor do
they have readily available data or
models that would measure with
reasonable precision the loss or gain in
economic surplus resulting from those
business decisions relative to the
decisions that would be made under an
alternative regulatory approach. Such
estimates would be necessary to
quantify the economic effects of the
final regulations versus alternative
approaches.
In the absence of such quantitative
estimates, the Treasury Department and
the IRS have undertaken a qualitative
2 Interest deductions in tax year 2013 for
corporations, partnerships, and sole proprietorships
were approximately $800 billion.
3 See E. Zwick and J. Mahon, ‘‘Tax Policy and
Heterogeneous Investment Behavior,’’ at American
Economic Review 2017, 107(1): 217–48 and articles
cited therein.
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analysis of the economic effects of the
final regulations relative to the noaction baseline and relative to
alternative regulatory approaches. This
analysis is presented in the next two
sections of this Special Analyses.
3. Economic Effects of Provisions
Substantially Revised From the
Proposed Regulations
a. Calculation of ATI
Similar to the proposed regulations,
the final regulations prescribe various
adjustments to the calculation of ATI to
prevent double counting of deductions
and to provide relief for particular types
of taxpayers or taxpayers in particular
circumstances to ensure that all
taxpayers are treated equitably when
calculating ATI. One of these
adjustments prevents the double
counting of depreciation deductions
when a depreciable asset is sold (only
relevant for depreciation deductions in
taxable years beginning after December
31, 2017, and before January 1, 2022).
Other adjustments apply to particular
types of taxpayers, such as regulated
investment companies (RICs), real estate
investment trusts (REITs), or
consolidated groups.
As an alternative, the Treasury
Department and the IRS considered not
providing such adjustments. Without
such adjustments, however, certain
taxpayers may be disadvantaged relative
to otherwise similar taxpayers. For
example, if RICs and REITs included the
dividends paid deduction when
calculating ATI, then these entities
would almost always have ATI of zero
or close to zero. This outcome would
limit the ability of such taxpayers to
ever deduct business interest expense
for Federal income tax purposes even
when their financing profile was similar
to other entities that could deduct
similar net business interest expense.
Based on calculations using the IRS’s
Statistics of Income (SOI) sample of
corporate taxpayers for 2017, the
Treasury Department and the IRS
estimate that approximately $13.5
billion of net business interest expense
is potentially affected by the dividends
paid deduction adjustment to ATI
provided to RICs and REITs in the final
regulations. This net business interest
expense is the amount of interest
expense that is greater than interest
income for RICs and REITs with gross
receipts greater than $25 million.
The final regulations make one
notable change compared to the
proposed regulations regarding the ATI
calculation for taxpayers that
manufacture or produce inventory.
Under the proposed regulations, the
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amount of any depreciation,
amortization, or depletion that is
capitalized into inventory under section
263A during a taxable year beginning
before January 1, 2022 was not added
back to taxable income when calculating
ATI for that taxable year. Under the
final regulations, such amounts are
added back to tentative taxable income,
regardless of the period in which the
capitalized amount is recovered through
cost of goods sold.
Without the final regulations, a
taxpayer with depreciation,
amortization, or depletion expense that
is subject to capitalization would have
lower ATI (and potentially a higher tax
liability due to smaller net interest
deductions) than a similarly situated
taxpayer with depreciation,
amortization, or depletion expense that
is not subject to capitalization. Thus, the
effect of the final regulations for the
calculation of ATI is to prevent
economic distortions by having the net
interest limitation apply more
stringently for certain types of taxpayers
than others. The final regulations
achieve this outcome more effectively
that alternative regulatory approaches,
including the proposed regulations and
the no-action baseline.
Number of Affected Taxpayers. The
Treasury Department and the IRS
estimate that roughly 61,000 entities are
both (i) subject to calculating their
section 163(j) net interest limitation and
(ii) required by the Code to capitalize
any expenses, including depreciation,
amortization, or depletion expenses.
This estimate is an upper bound
estimate of the number of taxpayers
potentially affected by the definition of
ATI prescribed under the regulations
because capitalized depreciation,
amortization, or depletion expenses are
not separately reported and this tax
return item includes other types of
capitalized expenses.
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b. Definition of Interest
The statute limits the amount of
deductible interest expense for a
taxpayer but, as described in the
Explanation of Provisions section of the
proposed regulations, there are no
generally applicable statutory
provisions or regulations addressing
when financial instruments are treated
as debt for Federal income tax purposes
or when a payment is counted as
interest. While there are several places
in the Code and regulations where
interest expense or interest income is
defined, such as in the regulations that
allocate and apportion interest expense
(§ 1.861–9T) and in the Subpart F
regulations (§ 1.954–2), these rules only
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apply to particular taxpayers in
particular situations.
The proposed regulations defined
interest for the purpose of the section
163(j) limitation as (1) amounts
associated with conventional debt
instruments and amounts already
treated as interest for all purposes under
existing statutory provisions or
regulations; (2) additional amounts that
are functionally similar to interest but
not currently labeled as interest under
the Code, or amounts treated as interest
for certain purposes, such as amounts
described in §§ 1.861–9T and 1.954–2;
and (3) any deductible expense or loss
predominantly incurred in
consideration of the time value of
money as part of an anti-avoidance rule.
Thus, the proposed regulations applied
to interest associated with conventional
debt instruments as well as generally to
transactions that are indebtedness in
substance even if not in form.
The Treasury Department and the IRS
proposed this definition of interest,
rather than leaving the term interest
undefined for purposes of section 163(j).
In the absence of this clarity, the
likelihood that different taxpayers
would reach different conclusions over
whether a particular business expense
was deductible business interest
expense would be exacerbated. In
general, overall economic performance
is enhanced when businesses face more
uniform signals about tax treatment.
Another concern about not defining the
term at all is that taxpayer uncertainty
over whether certain transactions are
considered interest could increase
burdens to the IRS and taxpayers
including with respect to disputes and
litigation about whether particular
payments are interest for section 163(j)
purposes.
A further concern, over providing a
narrower definition of interest, is that it
could encourage taxpayers to engage in
transactions that provide financing
while generating deductions
economically similar to interest but that
were not defined as interest for the
purposes of section 163(j). There are
several reasons why curbing such
taxpayer behavior would be beneficial.
First, the ability of taxpayers to engage
in such transactions is correlated with
the size of the trade or business, with
large businesses more likely to benefit
from such avoidance strategies than
small businesses. Second, when the
deciding factor for using such
transactions is the tax benefit of
avoiding a section 163(j) limitation, then
such transactions would impose more
cost or risk on the taxpayer than using
a traditional debt instrument. Engaging
in such transactions is an inefficient use
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of resources. Third, such avoidance
strategies may discourage taxpayers
from shifting to a less leveraged capital
structure, and thus would counteract
the intention of the statute to reduce the
prevalence of highly-leveraged firms
and the probability of systemic financial
distress. Fourth, greater use of financing
outside of conventional debt
instruments may make it more difficult
for financial institutions to determine
the overall level of leverage and credit
risk of firms seeking financing, which
may distort the allocation of capital
across businesses away from firms and
investments with less credit risk.
The final regulations prescribe a
definition of interest that is similar to
the definition of interest in the proposed
regulations although with changes made
in response to comments.4 There are
three general types of changes: (1)
Changes are made to the proposed
regulations that modify, and generally
limit, to what extent certain amounts are
included under the definition of interest
for the purposes of section 163(j). (2)
Several items deemed to be interest for
the purpose of section 163(j) under
proposed § 1.163(j)–1(b)(20)(iii) are not
included in the final regulations. (3) The
anti-avoidance rule in proposed
§ 1.163–1(b)(20)(iv) is modified to
include a principal purpose test and
now also applies to situations where a
taxpayer seeks to artificially increase the
amount of interest income.
To the extent that these changes
narrow the definition of interest that is
subject to the section 163(j) limitation
relative to the proposed regulations,
they are expected to (i) reduce the cost
of financing for taxpayers, an effect that
is expected to increase investment by
these taxpayers, and (ii) increase the
proportion of that financing that might
generally be considered debt-financed.
The first effect occurs because taxpayers
can deduct without limitation costs
from a larger set of financial instruments
under the final regulations, relative to
the proposed regulations. They will
choose these instruments only if the
cost of obtaining funds through those
instruments is lower than what would
have been available under the proposed
regulations. By extension, this change
lowers the overall cost of financing for
taxpayers. A lower cost of financing is
associated with greater investment by
taxpayers, all other things equal. The
second effect occurs because the larger
set of financial instruments for which
taxpayers can deduct expense without
limitation (under the final regulations,
4 The proposed regulations represent the
regulatory alternative to which the final regulations
are compared in the following analysis.
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relative to the proposed regulations)
generally consists of instruments that
have a greater share of debt
characteristics, rather than equity
characteristics. To the extent that
taxpayers use these instruments to a
greater degree under the final
regulations relative to the proposed
regulations, the share of debt-financing
will increase. Congress has generally
expressed the view that excessive debtfinancing may be a less efficient capital
structure for firms. See Senate Budget
Explanation of the Bill at 165.
Because the final regulations define
interest based on the intent and purpose
of the statute and generally treat similar
taxpayers similarly and similar
economic activity similarly, the
Treasury Department and the IRS have
determined that the net result under
these final regulations is a more efficient
allocation of capital across taxpayers
relative to regulatory alternatives,
within the context of the intent and
purpose of the statute.
The Treasury Department and the IRS
have not undertaken quantitative
estimates of the change in the level or
nature of economic activity arising from
the final regulations relative to the
proposed regulations due to limitations
on available data, but to the extent
possible has provided further below an
estimate of the quantity of potentially
affected taxpayers and volume of
transactions. Consider, for example, the
treatment of guaranteed payments for
the use of capital provided by a partner
to a partnership, a financial arrangement
that has both equity and debt
characteristics. The proposed
regulations included guaranteed
payments to capital in the definition of
interest while the final regulations do
not, except to the extent that they are
covered by other provisions of the final
regulations. The Treasury Department
and the IRS have not undertaken
quantitative estimates of this regulatory
decision because we do not have readily
available data or models to measure
with sufficient precision: (i) The volume
and nature of guaranteed payments to
capital and other financial instruments
that taxpayers might use if the final
regulations were in effect; (ii) the
volume and nature of guaranteed
payments and other financial
instruments that taxpayers might have
used if the proposed regulations were in
effect; and (iii) the types of economic
activities that partnerships might
undertake under these two financial
portfolios. Regarding item (iii), the
Treasury Department and the IRS do not
have readily available data or models to
predict how economic activity might
differ under debt-financed versus
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equity-financed investment for the sets
of instruments affected by these final
regulations.
Compliance costs are also expected to
be lower for those transactions that are
not subject to the section 163(j)
limitation under the final regulations
and that would be subject to the
limitation under the proposed
regulations. Generally, this is because
taxpayers would be less likely to need
to calculate the section 163(j) limitation
and less likely to need to track unused
interest deductions that are carried
forward to future tax years. For most
taxpayers, this impact on compliance
costs is expected to be relatively small.
However, for certain taxpayers using
hedging transactions, calculating the
amount of interest associated with the
transactions would be burdensome and
not including such transactions in the
definition of interest lowers compliance
costs to a greater degree. The Treasury
Department and the IRS have not
estimated the reduction in compliance
costs for these taxpayers (under the final
regulations, relative to the proposed
regulations) because we do not have
data or models that are suitable for this
estimation.
The specific changes made with
regard to items (1), (2), and (3) are
discussed in further detail here.
(1) The final regulations change
(relative to the proposed regulations)
how amounts from certain transactions
will be considered interest for the
purposes of section 163(j). There are two
main forms of transactions that are
affected:
Treatment of swaps. The proposed
regulations treated a non-cleared swap
with significant non-periodic payments
as two separate transactions consisting
of an on-market, level payment swap
and a loan (the embedded loan rule).5
The time value component associated
with the embedded loan is recognized
as interest expense to the payor and
interest income to the recipient. The
treatment of cleared swaps was not
specified in the proposed regulations.
The final regulations add two
exceptions to the embedded loan rule.
Specifically, the final regulations add
exceptions for cleared swaps and for
those non-cleared swaps that require the
parties to meet the margin or collateral
requirements of a federal regulator (or
requirements that are substantially
similar to a federal regulator). Relative
to the proposed regulations this
treatment will discourage taxpayers
5 A cleared swap is a collateralized swap that was
cleared by a derivatives clearing organization or by
a clearing agency. A non-cleared swap is a swap
that has not been so cleared.
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from using swaps that are unregulated
and dissimilar to regulated swaps,
because under the final regulations only
such swaps will require the time value
component associated with the
embedded loan to be treated as interest.
One reason for excepting both regulated
and non-regulated collateralized swaps
from the definition of interest is that the
repayment risk of using such
transactions is small, while the noncollateralized swaps are more risky as
individual transactions and would be
likely to contribute to the overall
riskiness of the financial system.
Substitute interest payments. The
proposed regulations provided that
certain substitute interest payments will
be treated as interest for the purposes of
section 163(j).6 The final regulations
modify the treatment of substitute
interest payments by only including
such transactions as interest when the
transaction is not part of the ordinary
course of business of the taxpayer. The
Treasury Department and the IRS have
determined that the ordinary course rule
in the final regulations provides an
appropriate and effective limit on the
treatment of substitute interest as
interest for section 163(j) purposes. This
change has the effect of reducing the
amount of substitute interest payments
that will be deemed interest for the
purpose of section 163(j) relative to the
proposed regulations.
For taxpayers that use substitute
interest payments in the ordinary course
of business, the final regulations may
lower the after-tax cost of such
transactions and such taxpayers are
more likely to use transactions with
substitute interest payments relative to
the proposed regulations. The Treasury
Department and the IRS do not have
readily available data or models to
estimate either (i) the change in
financing arrangements, including both
substitute interest payments and other
financial instruments, that will be used
by taxpayers under this provision of the
final regulations relative to the proposed
regulations, or (ii) the change in the
volume or nature of economic activity
by these taxpayers given these financing
arrangements.
(2) The items removed by the final
regulations from the definition of
interest in the proposed regulations
include debt issuance costs, guaranteed
payments for the use of capital provided
6 A substitute interest payment is a payment,
made to the transferor of a security in a securities
lending transaction or a sale-repurchase transaction,
of an amount equivalent to an interest payment
which the owner of the transferred security is
entitled to receive during the term of the
transaction. This provision applies to substitute
interest payments as described in § 1.861–2(a)(7).
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by a partner to a partnership, and
hedging transactions.7 Under the final
regulations, these items can still be
considered interest under the antiavoidance rule. These items share some
characteristics with interest, but
comments received on the proposed
regulations indicate there is not a
consensus that such items should
always be defined as interest. Removing
these items from the definition of
interest lowers compliance costs for
taxpayers in some cases relative to the
proposed regulations. However, not
including these items in the definition
of interest increases uncertainty
regarding whether amounts from certain
transactions will be treated as interest
under the anti-avoidance rule, and more
disputes are likely to arise between
taxpayers and the IRS.
The final regulations do not include
debt issuance costs, such as legal fees
for document preparation, in the
definition of interest. Debt issuance
costs are usually small relative to total
interest payments in a lending
transaction and often the payments are
made to a third-party who is not the
lender. Hence, there is limited ability
for taxpayers to be able to disguise
interest payments as debt issuance
costs. The primary effect of not
including debt issuance costs in the
definition of interest is to decrease the
after-tax cost of debt financing.
The final regulations do not include
hedging transactions in the definition of
interest. Taxpayers could have multiple
reasons for engaging in hedging
transactions other than just to lower the
amount of interest expense, such as a
reduction in risk. Not including hedging
transactions in the definition of interest
should decrease administration and
compliance costs compared to the
treatment in the proposed regulations
since it can be difficult to separate the
time value component from the
insurance aspects of a hedging
transaction. Under the final regulations,
taxpayers are more likely to use hedging
relative to the proposed regulations due
to the decline in compliance costs and
due to the reduced after-tax cost of
using hedges.
The final regulations do not include
guaranteed payments in the definition
of interest. Guaranteed payments for the
use of capital provided by a partner to
a partnership have both equity and debt
characteristics. The partner who
provided the capital is an owner of the
business, but also receives payments
7 Commitment fees are also not included in the
definition of interest in the final regulations, but
may be addressed as part of another guidance
project on the treatment of fees relating to debt
instruments and other securities in the future.
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that are similar to interest. Removing
guaranteed payments from the
definition of interest lowers the after-tax
cost of such financing for some
taxpayers and may lead these taxpayers
to increase the fraction of financing
through capital with guaranteed
payments relative to other financial
instruments. The Treasury Department
and the IRS do not have readily
available data or models to project the
change in the volume or nature of
businesses’ economic activities that
would arise as a consequence of this
change in the tax treatment of
guaranteed payments to capital, relative
to the proposed regulations.
(3) The final regulations also modify
the anti-avoidance rule found in
proposed § 1.163–1(b)(20)(iv) relative to
the proposed rule. One change is that
the anti-avoidance rule not only applies
to financing transactions used to avoid
the classification of financing expense
as interest expense, but also excludes
transactions that artificially increase the
taxpayer’s interest income from being
included as interest income. The final
regulations also add a principal purpose
condition to the anti-avoidance rule.
That is, the anti-avoidance rule in the
final regulations only applies to
amounts where a principal purpose of
the taxpayer for engaging in a
transaction is to artificially reduce the
amount of net business interest expense,
whether this stems from a decrease in
the amounts reported as interest
expense or an increase in the amounts
reported as interest income. This
symmetric anti-avoidance rule adopted
under the final regulations, applying to
both interest income and interest
expense, increases the number of
transactions to which the rule could
potentially apply compared to the
proposed regulations. However,
including a principal purpose test in the
anti-avoidance rule will decrease how
often the rule would potentially apply
to transactions relative to the proposed
rule.
The anti-avoidance rule is an
important component of the definition
of interest because it is difficult for the
Treasury Department and the IRS to
specifically categorize every type of
transaction already in practice or to
anticipate future innovations in
financial transactions. Relative to
regulatory alternatives, the antiavoidance rule will help limit the ability
of taxpayers to structure transactions in
such a way that would allow deductible
expenses that are economically similar
to interest and frustrate the application
of the statute. In summary, the
definition of interest in the final
regulations provides clarity to taxpayers
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and the IRS regarding which specific
transactions and types of transactions
generate interest subject to the section
163(j) limitation, which should lower
compliance and administrative costs
relative to providing no definition or a
narrower definition of interest. The
Treasury Department and the IRS
further have determined that the
definition of interest specified under the
final regulations will encourage a more
efficient allocation of capital and use of
financing across taxpayers relative to
the no-action baseline, within the
context of the intent and purpose of the
statute.
Number of Affected Taxpayers. The
Treasury Department and the IRS
estimate that the number of partnerships
potentially affected by the change in
treatment to guaranteed payments for
the use of capital provided by a partner
to a partnership is 6,000. This is the
number of partnerships in tax year 2017
with more than $25 million in gross
receipts that also report paying
deductible guaranteed payments. The
amount of total guaranteed payments
reported by these partnerships is
approximately $30 billion. However, it
is not known to what extent these
guaranteed payments are made to
capital or labor, as the tax form for that
tax year did not distinguish between the
two types of guaranteed payments.
Beginning in 2019, Form 1065 will
separately report those two types of
guaranteed payments.
It is not possible to provide a
meaningful estimate of the number of
taxpayers potentially affected by the
final regulations that have deductible
debt issuance costs, substitute interest
payments, or amounts from swaps or
hedging transactions, because those
amounts are not reported separately on
a tax return.
4. Economic Effects of Provisions Not
Substantially Revised From the
Proposed Regulations
a. Calculation of Excess Business
Interest Expense, Excess Business
Interest Income, and Excess Taxable
Income for Partnerships and S
Corporations
The statute applies broadly to
different types of entities, including
passthrough entities, such as
partnerships and S corporations. The
statute specifies that the section 163(j)
limitation applies at the entity level for
a partnership but that items such as
excess business interest expense and
excess taxable income must be allocated
to partners for a variety of reasons
including to compute their own 163(j)
limitation. The statute further specifies
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that the items should be allocated in the
same manner as ‘‘nonseparately stated
taxable income or loss of the
partnership’’; however, this concept had
not previously been defined by statute
or regulations prior to the proposed
regulations. In the absence of guidance,
partnerships would have significant
uncertainty in determining which
partners receive excess items. This
uncertainty could lead one partnership
to undertake an activity that another
partnership might decline to take based
solely on different expectations about
tax treatment of interest income rather
than underlying productivity
differences or economic signals.
The final regulations provide
guidance on how to allocate partnership
excess business interest expense, excess
business interest income, and excess
taxable income to partners. The
allocation method detailed in the final
regulations follows a number of
principles. First, it ensures that the sum
of the excess items at the partner level
is equal to the total at the partnership
level. Second, it ensures that the
partnership does not allocate excess
business interest expense to a partner
that was allocated items that include
ATI and business interest income that
supported the partnership’s deductible
business interest expense (unless the
partner was allocated more interest
expense than its share of deductible
business interest expense). Finally, it
ensures that the partnership allocates
any excess taxable income or excess
business interest income to partners that
are allocated more items comprising
ATI or business interest income than
necessary to support their allocation of
business interest expense.
The final regulations thus provide a
method to ensure that all partnerships
allocate these items consistently and in
a way that matches income and interest
expense, thus promoting economically
efficient investment decisions across
taxpayers and across financing options,
relative to the no-action baseline.
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b. Interest Income Inclusion for Owners
of Partnerships and S Corporations
The final regulations ensure that, for
owners of partnerships and S
corporations, business interest income
is used only once, at the entity level, in
offsetting business interest expenses. It
thereby avoids exacerbating the
incentive to seek out interest income
relative to other forms of less
economically productive income in
order to avoid the section 163(j)
limitation, relative to the no-action
baseline.
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c. Rules Related to Excepted Businesses
For purposes of section 163(j), the
statute states in section 163(j)(7) that the
term ‘‘trade or business’’ does not
include certain regulated utilities, or an
electing real property trade or business
or an electing farming business. The
final regulations clarify whether a trade
or business could elect as a farming
business or a real property trade or
business and thus be excepted from
section 163(j). Specifically, § 1.163(j)–9
provides guidance in applying the rules
for farming and real property trade or
business elections. For an electing real
property trade or business and electing
farming business, the statue specifies
that ‘‘any such election shall be made at
such time and in such manner as the
Secretary shall prescribe, and once
made, shall be irrevocable.’’ Therefore
§ 1.163(j)–9 provides taxpayers with the
time and manner for electing real
property trades or businesses and
electing farming businesses. In addition,
the final regulations define the
conditions under which an election
terminates.
In the absence of specific guidance,
taxpayers may engage in behavior that
counteracts the intent and purpose of
the statute and would not otherwise be
taken except to avoid the irrevocable
nature of the election the statute
specified. The final regulations increase
the likelihood that taxpayers interpret
the ‘irrevocable’ designation similarly
and do not engage in tax-motivated
behavior by appearing to cease
operations in an effort to change an
irrevocable designation.
In addition, § 1.163(j)–9(h) provides a
safe harbor for certain REITs to elect to
be electing real property trades or
businesses. A special rule applies to
REITs for which 10 percent or less of the
value of the REIT’s assets are real
property financing assets. Under this
rule, all of the assets of the REIT are
treated as real property trade or business
assets. The benefit of the safe harbor is
to provide REITs the same tax treatment
and apply the same general rules as
apply to other taxpayers, an
economically efficient approach. The
special rule threshold of 10 percent for
real property financing assets has the
benefit of maintaining consistency with
section 856(c)(4), which uses the same
values for the REIT asset test at the close
of the REIT’s taxable year. Taxpayers
will benefit in reduced compliance time
and cost in applying new rules if the
rules are consistent with other rules that
they must comply with under the Code.
An estimate of the compliance cost
savings that would be due to this crosscode consistency, relative to regulatory
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alternatives, is beyond the capabilities
of the IRS’s compliance model.
In addition, the final regulations
provide a rule that stipulates that if at
least 80 percent of a trade or business’s
real property (by fair market value) is
leased to a trade or business under
common control with the real property
trade or business, the trade or business
cannot make an election to be an
electing real trade or business. In the
absence of such a rule, taxpayers could
restructure their business such that real
estate components of non-real estate
businesses are separated from the rest of
their business to artificially reduce the
application of section 163(j) by leasing
the real property to the taxpayer and
electing this ‘‘business’’ to be an
excepted real property trade or business.
Therefore, the prime benefit of this rule
is to preserve the intent of the statute of
allowing elections in the real property
sector without incentivizing other
sectors of the economy to restructure
their business for the sole intent of
avoiding the section 163(j) limitation.
The Treasury Department and the IRS
received no comments requesting that
the percentage amounts be changed.
Number of Affected Taxpayers. The
Treasury Department and the IRS
project that nearly 3,500 REITs are
potentially affected by the provision in
the final regulations that allows REITs
for which 10 percent or less of the value
of the REIT’s assets are real property
financing assets to elect to treat all of its
assets as allocable to an excepted real
property trade or business. This
estimate is based the number of REITs
in the SOI sample of corporate taxpayers
for 2017 that identify as an Equity REIT.
An Equity REIT is identified by a checkbox on form 1120–REIT where the
choice is Equity REIT or Mortgage REIT.
The Mortgage REIT category should be
chosen by the taxpayer if the primary
source of gross receipts is derived from
mortgage interest and fees. These Equity
REITs reported $1.7 trillion in total
assets.
The Treasury Department and the IRS
project that roughly 2.8 million filers are
potentially affected by provisions of the
final regulations that affect electing real
property trades or businesses or electing
farm businesses. This estimate is based
on a count of all filers with NAICS
codes starting with 111 or 112 (farming),
and 531 (real property) with at least $10
million in gross receipts in taxable year
2017.
d. Allocation Rules Between Excepted
and Non-Excepted Trades or Businesses
The statute is silent over how ATI,
interest income, and expense should be
allocated between excepted and non-
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excepted trades or businesses. Thus, the
Treasury Department and the IRS
decided to provide taxpayers with an
allocation method. Because allocation,
by whatever method, is costly for
taxpayers, the final regulations further
provide that allocation is only required
when the share of the asset tax basis in
both the excepted and the non-excepted
trades or businesses exceeds 10 percent.
In other words, if the share for either
excepted or non-excepted trades or
businesses is 10 percent or less,
allocation is not required. The Treasury
Department and the IRS received no
comments that addressed the 10 percent
threshold provided in this provision.
In terms of the allocation method, the
Treasury Department and the IRS
decided in the final regulations to
require taxpayers to allocate interest
expense and interest income between
related excepted and non-excepted
trades or businesses based on the
relative amounts of the taxpayer’s
adjusted tax basis in the assets used in
its excepted and non-excepted trades or
businesses. As discussed in the
Explanation of Provisions section of the
proposed regulations, this general
method of allocation reflects the fact
that money is fungible and the view that
interest expense is attributable to all
activities and property, regardless of any
specific purpose for incurring an
obligation on which interest is paid.
This asset basis approach is consistent
with the regulations under section 861.
Because this approach is familiar to
taxpayers and consistent with other
parts of the Code, taxpayers benefit in
reduced time and cost spent learning
and applying the rules, relative to
alternative regulatory approaches. An
estimate of the compliance cost savings
that would be due to this familiarity and
cross-code consistency, relative to
regulatory alternatives, is beyond the
capabilities of the IRS’s compliance
model.
The Treasury Department and the IRS
considered several alternatives to this
asset basis approach for allocating
interest income and expense. First, a
tracing approach was considered
whereby taxpayers would be required to
trace disbursements of debt proceeds to
specific expenditures. However, tracing
would impose a significant compliance
burden on taxpayers due to the
complexity of matching interest income
and expense among related companies.
Further, it is not clear how taxpayers
would retroactively apply a tracing
regime to existing debt. In particular,
because C corporations would have had
no reason to trace the proceeds of any
existing indebtedness, imposing a
tracing regime on existing indebtedness
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would require corporations to
reconstruct the use of funds within their
treasury operations at the time such
indebtedness was issued, even if the
issuance occurred many years ago, and
even if the funds were used for a myriad
of purposes across a large number of
entities. Such an approach would
impose substantial compliance costs
and may be impractical or even
impossible for indebtedness issued
years ago.
Moreover, because money is fungible,
a tracing regime would be distortive and
subject to manipulation. Although
taxpayers are impacted from both a
commercial and tax perspective by the
amount of capital raised through the
issuance of equity and indebtedness,
any trade or business conducted by a
taxpayer is generally indifferent to the
source of funds. As a result, if taxpayers
were allowed to use a tracing regime to
allocate indebtedness to excepted trades
or businesses, there would be an
incentive to treat excepted trades or
businesses as funded largely from
indebtedness, and to treat non-excepted
trades or businesses as funded largely
from other types of funding, such as
equity funding, despite the fact that, as
an economic matter, all of a taxpayer’s
trades or businesses are funded based
on the taxpayer’s overall capital
structure.
The Treasury Department and the IRS
rejected a tracing approach because the
complexity of such an approach could
be more difficult for taxpayers and the
IRS to administer and would create too
great an incentive to structure financing
with the sole purpose of avoiding the
application of the statute, relative to the
final regulations. The assumption that a
trade or business is indifferent to its
source of funds may not be appropriate
in cases in which certain indebtedness
is secured by the assets of the trade or
business and cash flow from those
assets is expected to support the
payments required on the indebtedness.
The final regulations provide for a
limited tracing rule in those cases.
The Treasury Department and the IRS
also considered allocating interest
expense based on the relative fair
market value of the assets used in
excepted and non-excepted trades or
businesses. However, determinations of
fair market value frequently are
burdensome for taxpayers, which may
have numerous assets without a readily
established market price. For this
reason, disputes between taxpayers and
the IRS over the fair market value of an
asset are a common and costly
occurrence. In the TCJA, Congress
repealed the use of fair market value in
the apportionment of interest expense
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56751
under section 864 of the Code (see
section 14502(a) of the TCJA) and
claimed that the ability to elect to
allocate interest expense under section
864 on the basis of fair market value of
assets has led to inappropriate results
and needless complexity. See Senate
Budget Explanation of the Bill at 400.
Thus, the Treasury Department and the
IRS have determined that allocating
interest expense based on relative
amounts of asset basis is more
appropriate than a regime based on the
relative fair market value of assets.
The Treasury Department and the IRS
also considered allocating interest
expense to excepted and non-excepted
trades or businesses based on the
relative amounts of gross income
generated by such trades or businesses.
However, gross income is more variable
and volatile than asset basis, in part
because it is based on an annual
measurement. Methods could be
developed to look at multiple years of
gross income through an averaging or
other smoothing methodology, but any
such approach would necessarily create
a number of difficult technical questions
because the income of different trades or
businesses may be subject to differing
business cycles and the taxpayers may
exert control over the timing of income
items, which may lead taxpayers to
make tax-driven business decisions with
no accompanying general economic
benefit. In the TCJA, Congress also
repealed the use of gross income in the
apportionment of interest expense
under section 864 of the Code (see
section 14502(a) of the TCJA). Thus, the
Treasury Department and the IRS have
determined that allocating interest
expense based on relative amounts of
asset basis is more appropriate than a
regime based on the relative amounts of
gross income.
Number of Affected Taxpayers. The
Treasury Department and the IRS
estimate that roughly 83,000 firms had
allocated interest income and expenses
among multiple trades or businesses in
tax year 2015 and thus are potentially
affected by provisions of the final
regulations that affect the annual
allocation statement. This estimate is
based on a count of all Forms 1120,
1120S, and 1065 in tax year 2015 in real
estate, farming, and public utilities
industries that had over $25 million in
gross receipts.
II. Paperwork Reduction Act
The collections of information
contained in the final regulations have
been submitted to the Office of
Management and Budget for review in
accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C.
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3507(d)). An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control
number assigned by the Office of
Management and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and return information are
confidential, as required by section
6103.
A. Collections of Information Imposed
by the Regulations
The collections of information
imposed directly by these regulations
are contained in §§ 1.163(j)–1(b)(15)(iii),
1.163(j)–2(b)(2)(ii), 1.163(j)–2(b)(3),
1.163(j)–9 and 1.163(j)–10.
The collection of information in
§§ 1.163(j)–1(b)(15)(iii) and 1.163(j)–9,
the election statement, is required for
taxpayers to make a one-time election to
treat their regulated utility trade or
business, real property trade or business
or farming trade or business as an
electing excepted regulated utility trade
or business, electing real property trade
or business under section 163(j)(7)(B) or
an electing farming business under
section 163(j)(7)(C). The election to be
an excepted regulated utility trade or
business was not in the proposed
regulations. The scope of taxpayers
eligible to make an election to be an
excepted real property or farming trade
or business has changed from the
proposed regulations. As discussed in
part X of the Summary of Comments
and Explanation of Revisions section,
under the proposed regulations,
taxpayers that met the small business
exemption test under section 448(c)
were not able to make an election for
their trade or business to be an electing
real property trade or business or an
electing farming business because they
were already not subject to the
limitation. Under the final regulations,
those taxpayers are eligible to make a
protective election. Additionally, under
the proposed regulations, it was unclear
whether taxpayers that were unsure of
whether their activity constitutes a trade
or business under section 162 could
make an election. The final regulations
clarify that a taxpayer that is unsure
whether its activity constitutes a trade
or business under section 162 is eligible
to make an election.
The collections of information in
§§ 1.163(j)–2(b)(2)(ii) and 1.163(j)–
2(b)(3) are required to make two
elections relating to changes made to
section 163(j)(10) by the CARES Act.
The election under § 1.163(j)–2(b)(2)(ii)
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is for a taxpayer to use the 30 percent
ATI limitation instead of the 50 percent
ATI limitation when calculating the
taxpayer’s section 163(j) limitation for a
2019 or 2020 taxable year, as provided
in section 163(j)(10)(A)(i) and (iii). The
election under § 1.163(j)–2(b)(2) is for a
taxpayer to use the taxpayer’s ATI for
the last taxable beginning in 2019 as its
ATI for any taxable year beginning in
2020, as provided in section
163(j)(10)(B). Revenue Procedure 2020–
22 describes the time and manner for
making these elections. See also
§ 1.163(j)–2(b)(4).
Taxpayers make the elections by
timely filing a Federal income tax return
or Form 1065, including extensions, an
amended Federal income tax return,
amended Form 1065, or administrative
adjustment request, as applicable. More
specifically, taxpayers complete the
Form 8990, Limitation on Business
Interest Expense under Section 163(j),
using the 30 percent ATI limitation and/
or using the taxpayer’s 2019 ATI, as
applicable. No formal statements are
required to make these elections.
Accordingly, for Paperwork Reduction
Act purposes, the reporting burden
associated with the collections of
information in §§ 1.163(j)–2(b)(2)(ii) and
1.163(j)–2(b)(3) will be reflected in the
IRS Form 8990 Paperwork Reduction
Act Submissions (OMB control number
1545–0123).
The collection of information in
§ 1.163(j)–10, the allocation statement,
is required for taxpayers to demonstrate
how they allocated their interest
expense, interest income, and other
items of income and deduction between
excepted and non-excepted trades or
businesses. The mechanics of the
allocation statement, and the scope of
taxpayers required to file the allocation
statement, have not changed from the
proposed regulations.
Section 1.163(j)–10 in the final
regulations contains another collection
of information, an allocation
methodology change request, requiring
taxpayers to request the Commissioner’s
permission to change a methodology for
allocating the basis in an asset that is
used in multiple trades or businesses if
the request is being made within five
years of any prior change. This
requirement does not create a new
burden because the allocation
methodology change request is made by
following the procedures for requesting
a letter ruling in section 7.01 of Revenue
Procedure 2020–1, 2020–1 IRB 1.
Revenue Procedure 2020–1 was
approved by the Office of Management
and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C.
3507) under control number 1545–0123.
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In 2018, the Treasury Department and
the IRS considered developing a form
election and allocation statement under
§§ 1.163(j)–9 and 1.163(j)–10 for
taxpayers to make the one-time election
and to demonstrate their interest
allocation. To minimize taxpayer
burden, the Treasury Department and
the IRS decided that, for now, taxpayers
should be allowed to use their own
election form and allocation statement.
In the future, if the Treasury Department
and the IRS develop election or
allocation form, the draft versions of the
forms will be posted for comment at
https://apps.irs.gov/app/picklist/list/
draftTaxForms.html.
Certain forms have been modified
with simple questions to signal whether
the taxpayer is subject to section 163(j).
The Treasury Department and the IRS
are considering modifying certain forms
with a checkbox to note that a taxpayer
has made an election for a trade or
business to be an electing real property
trade or business or electing farming
business.
For the allocation methodology
change request in § 1.163(j)–10, the
Treasury Department and the IRS
initially determined that taxpayers
should file a change request any time
there is a change in methodology.
However, a change in allocation
methodology presents a burden for
taxpayers. The disadvantages of
changing an allocation methodology
regularly, including the administrative
and accounting costs associated with
any such change, outweigh the
advantages of changing an allocation
methodology regularly. Accordingly, the
Treasury Department and the IRS do not
anticipate taxpayers using the allocation
methodology change request regularly.
The final regulations require the request
to be made only if a change has not been
made in the past 5 years. To minimize
any compliance burden, the procedures
in Revenue Procedure 2020–1, which
are familiar to taxpayers, apply for the
allocation methodology change request.
B. Burden Estimates
The following burden estimates are
based on the information that is
available to the IRS, and have been
updated from the proposed regulations
to take into account the new election for
certain regulated utility trades or
businesses, the increased scope of
potential filers for the election statement
and to use 2017 Statistics of Income
(SOI) tax data where available.
The most recently available 2017 SOI
tax data indicates that approximately
8,208 filers are possible for the one-time
election to opt out of the section 163(j)
limitation as an electing excepted
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regulated utility trade or business. This
estimate was based on a count of Form
1065, 1065B, 1120 and 1120–S filers
with NAICS codes starting with 2211
(electric power generation, transmission
and distribution), 2212 (natural gas
distribution), and 2213 (water, sewage
and other systems).
The 2017 SOI tax data indicates that
approximately 2,838,981 filers are
possible for the one-time election to opt
out of the section 163(j) limitation as an
electing real property trade or business
or as an electing farming business were
the statute then in effect. This estimate
is based on a count of all filers with
NAICS codes starting with 111 or 112
(farming), and 531 (real property) with
at least $10 million in gross receipts in
taxable year 2017. The increase in
potential filers from the number
provided in the proposed regulations is
due exclusively to the fact that the final
regulations provide that taxpayers that
satisfy the small business exemption are
eligible to file an election.
For the election to use the 30 percent
ATI limitation for a 2019 or 2020
taxable year under § 1.163(j)–2(b)(ii),
while any taxpayer subject to the
section 163(j) limitation is eligible to
make the election, the Treasury
Department and the IRS estimate that
only taxpayers that actively want to
reduce their deductions will make this
election. The application of the base
erosion minimum tax under section 59A
depends, in part, on the amount of a
taxpayer’s deductions. Accordingly, the
Treasury Department and the IRS
estimate that taxpayers that are subject
to both the base erosion minimum tax
under section 59A and section 163(j) are
the potential filers of this election.
Using the 2017 SOI tax data, the
Treasury Department estimate that 3,376
firms will make the election. This
estimate was determined by examining
the number of C corporations with at
least $500,000,000 in gross receipts, that
do not have an NAICS code associated
with a trade or business that is generally
not subject to the section 163(j)
limitation (2211 (electric power
generation, transmission and
distribution), 2212 (natural gas
distribution), 2213 (water, sewage and
other systems), 111 or 112 (farming),
531 (real property)).
For the election to use the taxpayer’s
2019 ATI in 2020 under § 1.163(j)–
2(b)(3), the Treasury Department and
the IRS estimate that 72,608 firms will
make the election. This figure was
determined, using 2017 SOI tax data, by
examining Form 1040, Form 1120, Form
1120S, and Form 1065 filers with more
than $26M in gross receipts, that have
reported interest expense, and do not
have an NAICS code associated with
any trade or business that is generally
not subject to the section 163(j)
limitation.
The Treasury Department and the IRS
continue to estimate the same number of
filers, 82,755, for the annual allocation
statement as was projected in the
proposed regulations. Using the 2015
SOI tax data, the Treasury Department
and the IRS estimate that 82,755 firms
will have allocated interest income and
expenses among multiple trades or
businesses, some of which are excepted
from the section 163(j) limitation and
some that are not. This estimate is a
count of all tax Forms 1120, 1120S, and
1065 in real estate, farming, and public
utilities industries that had over $25
Estimated
number of
respondents
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Likely respondents
Section 1.163(j)–
1(b)(15)(iii) (one-time
election statement (2017
Levels).
Corporations and partnerships with
regulated utility trades or businesses.
Section 1.163(j)–2(b)(ii)
(election to apply the 30
percent ATI percentage).
C corporations with more than
$500 M in gross receipts.
Section 1.163(j)–2(b)(3)
(election to use 2019 ATI
as 2020 ATI).
Individuals, corporations, and partnerships with more than $26 M
in gross receipts and not part of
an excepted trade or business.
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8,028 business
respondents
(including
Forms 1120,
1120–S, and
1065 filers).
3,376 business
respondents
(Form 1120 filers).
72,608 business
respondents
(including
Form 1120,
Form 1120–S,
and Form 1065
filers).
Fmt 4701
Sfmt 4700
56753
million in gross receipts. While the
number of affected taxpayers will
increase with growth in the economy,
the Treasury Department and the IRS
expect that the portion of affected
taxpayers will remain approximately the
same over the foreseeable future.
The time and dollar compliance
burden are derived from the Business
Taxpayers Burden model provided by
the IRS’s Office of Research, Applied
Analytics, and Statistics (RAAS). This
model relates the time and out-of-pocket
costs of business tax preparation,
derived from survey data, to assets and
receipts of affected taxpayers along with
other relevant variables. See ‘‘Tax
Compliance Burden’’ (John Guyton et al,
July 2018) at https://www.irs.gov/pub/
irs-soi/d13315.pdf. A respondent may
require more or less time than the
estimated burden, depending on the
circumstances.
The burden estimates listed in the
below table attempt to capture only
those discretionary changes made in
these proposed regulations, and may not
include burden estimates for forms
associated with the statute. Changes
made by the Act or through new
information collections are captured
separately in forthcoming published
‘‘Supporting Statements’’ for each of
these forms and will be aggregated with
the estimates provided below to
summarize the total burden estimates
for each information collection listed
below. Those total burden estimates will
be available for review and public
comment at https://www.reginfo.gov/
public/Forward?SearchTarget=
PRA&textfield. The Treasury
Department and the IRS request
comment on these estimates.
Estimated
average
annual burden
hours
per respondent
Estimated
total
annual
reporting
burden
(hours)
Estimated
monetized
burden @
$95/hour
($millions)
Estimated
frequency
of
responses
0 to 30 minutes
(estimated average: 15 minutes).
2,007 .......
$190,665 ...
One-time.
See Form 8990 ..
See Form
8990.
See Form
8990.
See Form
8990.
See Form 8990 ..
See Form
8990.
See Form
8990.
See Form
8990.
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Estimated
number of
respondents
Likely respondents
Section 1.163(j)–9 (onetime election statement)
(2017 Levels).
Section 1.163(j)–10 (annual
allocation statement)
(2015 Levels).
Section 1.163(j)–10
(change in allocation
methodology request).
Section 1.163(j)–10 (onetime start-up cost to develop procedures for filing an annual allocation
statement) (2017 Levels).
Three year monetized burden estimate.
Estimated
total
annual
reporting
burden
(hours)
Estimated
monetized
burden @
$95/hour
($millions)
Estimated
frequency
of
responses
Individuals, corporations, and partnerships with real property or
farming trades or businesses
with gross receipts exceeding
$10 million.
Individuals, corporations, and partnerships (1) with more than one
trade or business (at least one
of which is a real property or
farming trade or business), and
(2) public utilities, with gross receipts exceeding the statutory
threshold of $25 million.
Individuals, corporations, and partnerships that want to change
their methodology for allocating
basis among two or more trades
or businesses, and (1) with more
than one trade or business (at
least one of which is a real property or farming trade or business), and (2) public utilities,
with gross receipts exceeding
the statutory threshold of $25
million.
Same as above ..............................
2,838,981 business respondents (all filers).
0 to 30 minutes
(estimated average:15 minutes).
70,746 .....
67.4 ...........
One-time.
82,755 business
respondents
(including
Forms 1120,
1120–S, and
1065 filers).
15 minutes to 2
hours (estimated average: 1 hour).
82,755 .....
7.9 .............
Annually.
See Rev. Proc.
2020–1.
See Rev. Proc.
2020–1.
See Rev.
Proc.
2020–1.
See Rev.
Proc.
2020–1.
On occasion.
82,755 ................
4 hours (start-up
burden).
331,020 ...
31.4 ...........
One-time.
........................................................
............................
............................
.................
40.8 ...........
Three
year
annual
average.
The three-year annual average of the
monetized burden for the information
collection and resulting from
discretionary requirements contained in
this rulemaking is estimated to be 40.9
million ($2017) ([($190, 665) + ($67.4
million + $31.4 million) + ($7.9 million
× 3)]/3). To ensure more accuracy and
consistency across its information
collections, the IRS is currently in the
process of revising the methodology it
uses to estimate burden and costs. Once
this methodology is complete, the IRS
will provide this information to reflect
a more precise estimate of burdens and
costs.
C. Forms
The IRS has developed Form 8990,
‘‘Limitation on Business Interest
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Estimated
average
annual burden
hours
per respondent
Form/revenue procedure
Expense Under Section 163(j),’’ to
facilitate reporting of the limitation. The
form is posted at https://www.irs.gov/
pub/irs-access/f8990_accessible.pdf.
The Form 8990 instructions are posted
at https://www.irs.gov/pub/irs-pdf/
i8990.pdf. The Form 1120 series and the
Form 1065 have been revised to include
a question to alert taxpayers of the need
to file a Form 8990. The instructions to
those and other forms have been revised
to include information about the Form
8990.
As described previously, the reporting
burdens associated with the information
collections in the proposed regulations
are included in the aggregated burden
estimates for OMB control number
1545–0123 (in the case of filers of Form
1120, Form 1065 and Form 8990), 1545–
0074 (in the case of individual filers),
and 1545–0123 (in the case of filers
under Revenue Procedure 2020–1).
The Treasury Department and the IRS
request comment on all aspects of
information collection burdens related
to these regulations, including estimates
for how much time it would take to
comply with the paperwork burdens
described previously for each relevant
form and ways for the IRS to minimize
the paperwork burden. In addition,
when available, drafts of IRS forms are
posted for comment at https://
apps.irs.gov/app/picklist/list/
draftTaxForms.htm.
Type of filer
OMB No(s).
Status
Business (NEW Model) .....
1545–0123 .........................
Published in the Federal Register on 10/8/18. Public
comment period closed on 12/10/18.
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-forforms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
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Form/revenue procedure
56755
Type of filer
OMB No(s).
Status
Individual (NEW Model) ....
1545–0074 .........................
Limited scope submission (1040 only) on 10/11/18 at
OIRA for review. Full ICR submission for all forms in
2019.
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031.
Revenue Procedure 20201
IRS Research estimates ...
1545–0123 .........................
Published in the Internal Revenue Bulletin on January
2, 2020.
Link: https://www.irs.gov/irb/2020-01_IRB.
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III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility
Act (5 U.S.C. chapter 6), it is hereby
certified that the final regulations will
not have a significant economic impact
on a substantial number of small entities
within the meaning of section 601(6) of
the Regulatory Flexibility Act (small
entities). This certification can be made
because the Treasury Department and
the IRS have determined that the
regulations may affect a substantial
number of small entities but have also
concluded that the economic effect on
small entities as a result of these
regulations is not expected to be
significant.
When enacted, the section 163(j)
limitation generally applied to taxpayers
with average annual gross receipts
exceeding $25 million. The gross
receipts threshold for general
applicability of the section 163(j)
limitation increased to $26 million in
2020. The threshold will be adjusted
annually for inflation. However, under
the final regulations, small taxpayers
operating regulated utility trades or
businesses, real property trades or
businesses and farming trades or
businesses are now eligible to
protectively elect out of the election.
Accordingly, the regulations in
§§ 1.163(j)–1 and –9 may apply to small
business filers that operate regulated
utility trades or businesses, real
property trades or businesses or farming
trades or businesses. Those taxpayers
may choose to make a protective
election, such that they are not subject
to the limitation if their average annual
gross receipts for the three prior tax
years eventually exceeds $26 million
(for 2020). Although the exact number
of small entities that will make an
election is unknown, an upper bound
on the number of potentially affected
entities is 10.5 million. This number
was determined by looking at, for the
2017 taxable year, the number of Form
1120, 1120–S, 1120–REIT, 1065, and
individual business filers with more
than $10M in gross receipts that have
NAICS codes commonly associated with
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real property trades or businesses or
farming businesses.
If a taxpayer chooses to make the
election for its trades or businesses, the
taxpayer must attach to its tax return a
statement identifying and describing the
trade or business for which the election
is being made, and must provide other
information as the Commissioner may
require in forms, instructions, or other
published guidance. The election is not
required. The election is potentially
beneficial to businesses with business
interest, but is detrimental to businesses
that have assets for which bonus
depreciation is desired.
The reporting burden is estimated at
0–30 minutes, depending on individual
circumstances, with an estimated
average of 0.25 hours for all affected
entities, regardless of size. The burden
on small entities is expected to be the
same as other entities because the
requirements to make the election apply
equally to all taxpayers. Using the IRS’s
taxpayer compliance cost estimates, the
monetization rate is $95 per hour. Thus,
the average annual burden is $23.75 per
business.
For the section 163(j)(10) elections
under §§ 1.163(j)–2(b)(ii) or 1.163(j)–
2(b)(3), most small business taxpayers
do not need the elections because, as
discussed earlier, they are not subject to
the section 163(j) limitation. For small
taxpayers that are subject to the
limitation, the cost to implement the
elections is low. Pursuant to Revenue
Procedure 2020–22, these taxpayers
simply complete the Form 8990 as if the
election has been made. Accordingly,
the burden of complying with the
elections, if needed, is no different than
for taxpayers that do not make the
elections.
Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking
preceding this regulation was submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for
comment on its effect on small business,
and no comments were received.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded
Mandates Reform Act of 1995 (UMRA)
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requires that agencies assess anticipated
costs and benefits and take certain
actions before issuing a final rule that
includes any Federal mandate that may
result in expenditures in any one year
by a state, local, or tribal government, in
the aggregate, or by the private section,
of $100 million in 1995 dollars, update
annually for inflation. This rule does
not include any Federal mandate that
may result in expenditures by state,
local, or tribal governments, or by the
private section in excess of that
threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled
‘‘Federalism’’) prohibits an agency from
publishing any rule that has federalism
implications if the rule either imposes
substantial, direct compliance costs on
state and local governments, and is not
required by statute, or preempts state
law, unless the agency meets the
consultation and funding requirements
of section 6 of the Executive Order. This
final rule does not have federalism
implications and does not impose
substantial direct compliance costs on
state and local governments or preempt
state law within the meaning of the
Executive Order.
VI. Congressional Review Act
The Administrator of the Office of
Information and Regulatory Affairs of
the Office of Management and Budget
has determined that this is a major rule
for purposes of the Congressional
Review Act (5 U.S.C. 801 et seq.) (CRA).
Under section 801(3) of the CRA, a
major rule takes effect 60 days after the
rule is published in the Federal
Register. Notwithstanding this
requirement, section 808(2) of the CRA
allows agencies to dispense with the
requirements of 801 when the agency
for good cause finds that such procedure
would be impracticable, unnecessary, or
contrary to the public interest and the
rule shall take effect at such time as the
agency promulgating the rule
determines.
The Treasury Department and the IRS
have determined that the rules in this
Treasury decision shall take effect for
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taxable years beginning on or after
November 13, 2020. Pursuant to section
808(2) of the CRA, however, the
Treasury Department and the IRS find,
for good cause, that a 60-day delay in
the effective and the applicability date
for the anti-avoidance rules in
§ 1.163(j)–1(b)(22)(iv) is unnecessary
and contrary to the public interest.
Section 1.163(j)–1(b)(22)(iv) serves an
anti-abuse function and, because
§ 1.163(j)–1(b)(22)(iv) provides a clear
scope of abusive transactions that could
otherwise be executed prior to the
effective date of the section, immediate
application of § 1.163(j)–1(b)(22)(iv) is
necessary as of the publication of this
final regulation.
Drafting Information
The principal authors of these
regulations are Susie Bird, Charles
Gorham, Justin Grill, Zachary King,
Jaime Park, Kathy Reed, Joanna Trebat
and Sophia Wang, Office of the
Associate Chief Counsel (Income Tax
and Accounting); Kevin M. Jacobs,
Russell Jones, John Lovelace, Marie
Milnes-Vasquez, Aglaia Ovtchinnikova,
and Julie Wang, Office of the Associate
Chief Counsel (Corporate); William
Kostak, Anthony McQuillen, and
Adrienne Mikolashek, Office of the
Associate Chief Counsel (Passthroughs
and Special Industries); Azeka
Abramoff, Angela Holland, and Steve
Jensen, Office of the Associate Chief
Counsel (International); William E.
Blanchard, Michael Chin, Steven
Harrison, Andrea Hoffenson, and Diana
Imholtz, Office of the Associate Chief
Counsel (Financial Institutions and
Products). Other personnel from the
Treasury Department and the IRS
participated in their development.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by:
■ 1. Adding entries in numerical order
for §§ 1.163(j)–1 through 1.163(j)–11;
■ 2. Revising the entries for §§ 1.263A–
8 through 1.263A–15;
■ 3. Adding entries in numerical order
for §§ 1.382–1 and 1.383–0;
■ 4. Revising the entry for § 1.383–1;
and
■ 5. Adding entries in numerical order
for §§ 1.860C–2 and 1.1502–90.
The additions and revisions read as
follows:
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*
*
*
*
*
Section 1.163(j)–1 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–2 also issued under 26
U.S.C. 1502.
Section 1.163(j)–3 also issued under 26
U.S.C. 1502.
Section 1.163(j)–4 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–5 also issued under 26
U.S.C. 1502.
Section 1.163(j)–6 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–7 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–8 also issued under 26
U.S.C. 163(j)(8)(B).
Section 1.163(j)–9 also issued under 26
U.S.C. 163(j)(7)(B) and (C) and 26 U.S.C.
1502.
Section 1.163(j)–10 also issued under 26
U.S.C. 163(j)(8)(B) and 26 U.S.C. 1502.
Section 1.163(j)–11 also issued under 26
U.S.C. 1502.
*
*
*
*
*
Sections 1.263A–8 through 1.263A–15 also
issued under 26 U.S.C. 263A(j).
*
*
*
*
*
Section 1.382–1 also issued under 26
U.S.C. 382(m).
*
*
*
*
*
Section 1.383–0 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 383.
Section 1.383–1 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 383.
*
*
*
*
*
Section 1.860C–2 also issued under 26
U.S.C. 860C(b)(1) and 860G(e).
*
*
*
*
*
Section 1.1502–90 also issued under 26
U.S.C. 382(m) and 26 U.S.C. 1502.
*
*
*
*
*
Par. 2. Section 1.163(j)–0 is added to
read as follows:
■
§ 1.163(j)–0
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
■
Authority: 26 U.S.C. 7805, unless
otherwise noted.
Table of contents.
This section lists the table of contents
for §§ 1.163(j)–1 through 1.163(j)–11.
§ 1.163(j)–1 Definitions.
(a) In general.
(b) Definitions.
(1) Adjusted taxable income.
(i) Additions.
(ii) Subtractions.
(iii) Depreciation, amortization, or
depletion capitalized under section
263A.
(iv) Application of § 1.163(j)–
1(b)(1)(ii)(C), (D), and (E).
(A) Sale or other disposition.
(1) In general.
(2) Intercompany transactions.
(3) Deconsolidations.
(B) Deductions by members of a
consolidated group.
(C) Successor assets.
(D) Anti-duplication rule.
(1) In general.
(2) Adjustments following
deconsolidation.
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(v) Other adjustments.
(vi) Additional rules relating to
adjusted taxable income in other
sections.
(vii) ATI cannot be less than zero.
(viii) Examples.
(2) Applicable CFC.
(3) Business interest expense.
(i) In general.
(ii) Special rules.
(4) Business interest income.
(i) In general.
(ii) Special rules.
(5) C corporation.
(6) Cleared swap.
(7) Consolidated group.
(8) Consolidated return year.
(9) Current-year business interest
expense.
(10) Disallowed business interest
expense.
(11) Disallowed business interest
expense carryforward.
(12) Disallowed disqualified interest.
(13) Electing farming business.
(14) Electing real property trade or
business.
(15) Excepted regulated utility trade
or business.
(i) In general.
(A) Automatically excepted regulated
utility trades or businesses.
(B) Electing regulated utility trades or
businesses.
(C) Designated excepted regulated
utility trades or businesses.
(ii) Depreciation and excepted and
non-excepted utility trades or
businesses.
(A) Depreciation.
(B) Allocation of items.
(iii) Election to be an excepted
regulated utility trade or business.
(A) In general.
(B) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(C) Time and manner of making
election.
(1) In general.
(2) Election statement contents.
(3) Consolidated group’s or
partnership’s trade or business.
(4) Termination of election.
(5) Additional guidance.
(16) Excess business interest expense.
(17) Excess taxable income.
(18) Floor plan financing
indebtedness.
(19) Floor plan financing interest
expense.
(20) Group.
(21) Intercompany transaction.
(22) Interest.
(i) In general.
(ii) Swaps with significant
nonperiodic payments.
(A) In general.
(B) Exception for cleared swaps.
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(C) Exception for non-cleared swaps
subject to margin or collateral
requirements.
(iii) Other amounts treated as interest.
(A) Treatment of premium.
(1) Issuer.
(2) Holder.
(B) Treatment of ordinary income or
loss on certain debt instruments.
(C) Substitute interest payments.
(D) Section 1258 gain.
(E) Factoring income.
(F) [Reserved]
(iv) Anti-avoidance rules.
(A) Principal purpose to reduce
interest expense.
(1) Treatment as interest expense.
(2) Corresponding treatment of
amounts as interest income.
(B) Interest income artificially
increased.
(C) Principal purpose.
(D) Coordination with anti-avoidance
rule in § 1.163(j)–2(j).
(v) Examples.
(23) Interest expense.
(24) Interest income.
(25) Member.
(26) Motor vehicle.
(27) Old section 163(j).
(28) Ownership change.
(29) Ownership date.
(30) Real estate investment trust.
(31) Real property.
(32) Regulated investment company.
(33) Relevant foreign corporation.
(34) S corporation.
(35) [Reserved]
(36) Section 163(j) limitation.
(37) Section 163(j) regulations.
(38) Separate return limitation year.
(39) Separate return year.
(40) Separate tentative taxable
income.
(41) Tax-exempt corporation.
(42) Tax-exempt organization.
(43) Tentative taxable income.
(i) In general.
(ii) [Reserved]
(iii) Special rules for defining
tentative taxable income.
(44) Trade or business.
(i) In general.
(ii) Excepted trade or business.
(iii) Non-excepted trade or business.
(45) Unadjusted basis.
(46) United States shareholder.
(c) Applicability date.
(1) In general.
(2) Anti-avoidance rules.
(3) Swaps with significant
nonperiodic payments.
(i) In general.
(ii) Anti-avoidance rule.
§ 1.163(j)–2 Deduction for business
interest expense limited.
(a) Overview.
(b) General rule.
(1) In general.
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(2) 50 percent ATI limitation for
taxable years beginning in 2019 or 2020.
(3) Election to use 2019 ATI in 2020.
(4) Time and manner of making or
revoking the elections.
(c) Disallowed business interest
expense carryforward.
(1) In general.
(2) Coordination with small business
exemption.
(3) Cross-references.
(d) Small business exemption.
(1) Exemption.
(2) Application of the gross receipts
test.
(i) In general.
(ii) Gross receipts of individuals.
(iii) Partners and S corporation
shareholders.
(iv) Tax-exempt organizations.
(e) REMICs.
(f) Trusts.
(i) Calculation of ATI with respect to
certain trusts and estates.
(ii) Calculation of ATI with respect to
certain beneficiaries.
(g) Tax-exempt organizations.
(h) Examples.
(i) [Reserved]
(j) Anti-avoidance rule.
(1) In general.
(2) Examples.
(k) Applicability date.
§ 1.163(j)–3 Relationship of the
section 163(j) limitation to other
provisions affecting interest.
(a) Overview.
(b) Coordination of section 163(j) with
certain other provisions.
(1) In general.
(2) Disallowed interest provisions.
(3) Deferred interest provisions.
(4) At risk rules, passive activity loss
provisions, and limitation on excess
business losses of noncorporate
taxpayers.
(5) Capitalized interest expenses.
(6) Reductions under section 246A.
(7) Section 381.
(8) Section 382.
(c) Examples.
(d) Applicability date.
§ 1.163(j)–4 General rules applicable
to C corporations (including REITs,
RICs, and members of consolidated
groups) and tax-exempt corporations.
(a) Scope.
(b) Characterization of items of
income, gain, deduction, or loss.
(1) Interest expense and interest
income.
(2) Adjusted taxable income.
(3) Investment interest, investment
income, investment expenses, and
certain other tax items of a partnership
with a C corporation partner.
(i) Characterization as expense or
income properly allocable to a trade or
business.
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(ii) Effect of characterization on
partnership.
(iii) Separately stated interest expense
and interest income of a partnership not
treated as excess business interest
expense or excess taxable income of a C
corporation partner.
(iv) Treatment of deemed inclusions
of a domestic partnership that are not
allocable to any trade or business.
(4) Application to RICs and REITs.
(i) In general.
(ii) Tentative taxable income of RICs
and REITs.
(iii) Other adjustments to adjusted
taxable income for RICs and REITs.
(5) Application to tax-exempt
corporations.
(6) Adjusted taxable income of
cooperatives.
(7) Examples.
(c) Effect on earnings and profits.
(1) In general.
(2) Special rule for RICs and REITs.
(3) Special rule for partners that are C
corporations.
(4) Examples.
(d) Special rules for consolidated
groups.
(1) Scope.
(2) Calculation of the section 163(j)
limitation for members of a consolidated
group.
(i) In general.
(ii) Interest.
(iii) Calculation of business interest
expense and business interest income
for a consolidated group.
(iv) Calculation of adjusted taxable
income.
(v) Treatment of intercompany
obligations.
(A) In general.
(B) Repurchase premium.
(3) Investment adjustments.
(4) Examples.
(e) Ownership of partnership interests
by members of a consolidated group.
(1) [Reserved]
(2) Change in status of a member.
(3) Basis adjustments under § 1.1502–
32.
(4) Excess business interest expense
and § 1.1502–36.
(f) Cross-references.
(g) Applicability date.
(1) In general.
(2) [Reserved]
§ 1.163(j)–5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
(a) Scope and definitions.
(1) Scope.
(2) Definitions.
(i) Allocable share of the consolidated
group’s remaining section 163(j)
limitation.
(ii) Consolidated group’s remaining
section 163(j) limitation.
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(iii) Remaining current-year interest
ratio.
(b) Treatment of disallowed business
interest expense carryforwards.
(1) In general.
(2) Deduction of business interest
expense.
(3) Consolidated groups.
(i) In general.
(ii) Deduction of business interest
expense.
(A) General rule.
(B) Section 163(j) limitation equals or
exceeds the current-year business
interest expense and disallowed
business interest expense carryforwards
from prior taxable years.
(C) Current-year business interest
expense and disallowed business
interest expense carryforwards exceed
section 163(j) limitation.
(iii) Departure from group.
(iv) Example: Deduction of interest
expense.
(c) Disallowed business interest
expense carryforwards in transactions to
which section 381(a) applies.
(d) Limitations on disallowed
business interest expense carryforwards
from separate return limitation years.
(1) General rule.
(A) Cumulative section 163(j) SRLY
limitation.
(B) Subgrouping.
(2) Deduction of disallowed business
interest expense carryforwards arising
in a SRLY.
(3) Examples.
(e) Application of section 382.
(1) Pre-change loss.
(2) Loss corporation.
(3) Ordering rules for utilization of
pre-change losses and for absorption of
the section 382 limitation.
(4) Disallowed business interest
expense from the pre-change period in
the year of a testing date.
(5) Recognized built-in loss.
(f) Overlap of SRLY limitation with
section 382.
(g) Additional limitations.
(h) Applicability date.
§ 1.163(j)–6 Application of the
section 163(j) limitation to partnerships
and subchapter S corporations.
(a) Overview.
(b) Definitions.
(1) Section 163(j) items.
(2) Partner basis items.
(3) Remedial items.
(4) Excess business interest income.
(5) Deductible business interest
expense.
(6) Section 163(j) excess items.
(7) Non-excepted assets.
(8) Excepted assets.
(c) Business interest income and
business interest expense of the
partnership.
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(1)–(2) [Reserved]
(3) Character of business interest
expense.
(d) Adjusted taxable income of a
partnership.
(1) Tentative taxable income of a
partnership.
(2) Section 734(b), partner basis items,
and remedial items.
(e) Adjusted taxable income and
business interest income of partners.
(1) Modification of adjusted taxable
income for partners.
(2) Partner basis items and remedial
items.
(3) Disposition of partnership
interests.
(4) Double counting of business
interest income and floor plan financing
interest expense prohibited.
(f) Allocation and determination of
section 163(j) excess items made in the
same manner as nonseparately stated
taxable income or loss of the
partnership.
(1) Overview.
(i) In general.
(ii) Relevance solely for purposes of
section 163(j).
(2) Steps for allocating deductible
business interest expense and section
163(j) excess items.
(i) Partnership-level calculation
required by section 163(j)(4)(A).
(ii) Determination of each partner’s
relevant section 163(j) items.
(iii) Partner-level comparison of
business interest income and business
interest expense.
(iv) Matching partnership and
aggregate partner excess business
interest income.
(v) Remaining business interest
expense determination.
(vi) Determination of final allocable
ATI.
(A) Positive allocable ATI.
(B) Negative allocable ATI.
(C) Final allocable ATI.
(vii) Partner-level comparison of 30
percent of adjusted taxable income and
remaining business interest expense.
(viii) Partner priority right to ATI
capacity excess determination.
(ix) Matching partnership and
aggregate partner excess taxable income.
(x) Matching partnership and
aggregate partner excess business
interest expense.
(xi) Final section 163(j) excess item
and deductible business interest
expense allocation.
(g) Carryforwards.
(1) In general.
(2) Treatment of excess business
interest expense allocated to partners.
(3) Excess taxable income and excess
business interest income ordering rule.
(h) Basis adjustments.
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(1) Section 704(d) ordering.
(2) Excess business interest expense
basis adjustments.
(3) Partner basis adjustment upon
disposition of partnership interest.
(4)–(5) [Reserved]
(i)–(j) [Reserved]
(k) Investment items and certain other
items.
(l) S corporations.
(1) In general.
(i) Corporate level limitation.
(ii) Short taxable periods.
(2) Character of deductible business
interest expense.
(3) Adjusted taxable income of an S
corporation.
(4) Adjusted taxable income and
business interest income of S
corporation shareholders.
(i) Adjusted taxable income of S
corporation shareholders.
(ii) Disposition of S corporation stock.
(iii) Double counting of business
interest income and floor plan financing
interest expense prohibited.
(5) Carryforwards.
(6) Basis adjustments and disallowed
business interest expense carryforwards.
(7) Accumulated adjustment accounts.
(8) Termination of qualified
subchapter S subsidiary election.
(9) Investment items.
(10) Application of section 382.
(m) Partnerships and S corporations
not subject to section 163(j).
(1) Exempt partnerships and S
corporations.
(2) Partnerships and S corporations
engaged in excepted trades or
businesses.
(3) Treatment of excess business
interest expense from partnerships that
are exempt entities in a succeeding
taxable year.
(4) S corporations with disallowed
business interest expense carryforwards
prior to becoming exempt entities.
(n) [Reserved]
(o) Examples.
(p) Applicability date.
§ 1.163(j)–7 Application of the
section 163(j) limitation to foreign
corporations and United States
shareholders.
(a) Overview.
(b) General rule regarding the
application of section 163(j) to relevant
foreign corporations.
(c)–(f) [Reserved]
(g) Rules concerning the computation
of adjusted taxable income of a relevant
foreign corporation.
(1) Tentative taxable income.
(2) Treatment of certain dividends.
(h)–(l) [Reserved]
(m) Applicability date.
§ 1.163(j)–8 [Reserved]
§ 1.163(j)–9 Elections for excepted
trades or businesses; safe harbor for
certain REITs.
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(a) Overview.
(b) Availability of election.
(1) In general.
(2) Special rules.
(i) Exempt small businesses.
(ii) Section 162 trade or business not
required for electing real property trade
or business.
(c) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(3) Depreciation.
(d) Time and manner of making
election.
(1) In general.
(2) Election statement contents.
(3) Consolidated group’s trade or
business.
(4) Partnership’s trade or business.
(e) Termination of election.
(1) In general.
(2) Taxable asset transfer defined.
(3) Related party defined.
(4) Anti-abuse rule.
(f) Additional guidance.
(g) Examples.
(h) Safe harbor for REITs.
(1) In general.
(2) REITs that do not significantly
invest in real property financing assets.
(3) REITs that significantly invest in
real property financing assets.
(4) REIT real property assets, interests
in partnerships, and shares in other
REITs.
(i) Real property assets.
(ii) Partnership interests.
(iii) Shares in other REITs.
(A) In general.
(B) Information necessary.
(iv) Tiered entities.
(5) Value of shares in other REITs.
(i) In general.
(ii) Information necessary.
(iii) Tiered REITs.
(6) Real property financing assets.
(7) Application of safe harbor for
partnerships controlled by REITS.
(8) REITs or partnerships controlled
by REITs that do not apply the safe
harbor.
(i) [Reserved]
(j) Special anti-abuse rule for certain
real property trades or businesses.
(1) In general.
(2) Exceptions.
(i) De minimis exception.
(ii) Look-through exception.
(iii) Inapplicability of exceptions to
consolidated groups.
(iv) Exception for certain REITs.
(3) Allocations.
(4) Examples.
(k) Applicability date.
§ 1.163(j)–10 Allocation of interest
expense, interest income, and other
items of expense and gross income to an
excepted trade or business.
(a) Overview.
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(1) In general.
(i) Purposes.
(ii) Application of section.
(2) Coordination with other rules.
(i) In general.
(ii) Treatment of investment interest,
investment income, investment
expenses, and certain other tax items of
a partnership with a C corporation or
tax-exempt corporation as a partner.
(3) Application of allocation rules to
foreign corporations and foreign
partnerships.
(4) Application of allocation rules to
members of a consolidated group.
(i) In general.
(ii) Application of excepted business
percentage to members of a consolidated
group.
(iii) Basis in assets transferred in an
intercompany transaction.
(5) Tax-exempt organizations.
(6) Application of allocation rules to
disallowed disqualified interest.
(7) Examples.
(b) Allocation of tax items other than
interest expense and interest income.
(1) In general.
(2) Gross income other than dividends
and interest income.
(3) Dividends.
(i) Look-through rule.
(ii) Inapplicability of the look-through
rule.
(4) Gain or loss from the disposition
of non-consolidated C corporation stock,
partnership interests, or S corporation
stock.
(i) Non-consolidated C corporations.
(ii) Partnerships and S corporations.
(5) Expenses, losses, and other
deductions.
(i) Expenses, losses, and other
deductions that are definitely related to
a trade or business.
(ii) Other deductions.
(6) Treatment of investment items and
certain other items of a partnership with
a C corporation partner.
(7) Examples: Allocation of income
and expense.
(c) Allocating interest expense and
interest income that is properly
allocable to a trade or business.
(1) General rule.
(i) In general.
(ii) De minimis exception.
(2) Example.
(3) Asset used in more than one trade
or business.
(i) General rule.
(ii) Permissible methodologies for
allocating asset basis between or among
two or more trades or businesses.
(iii) Special rules.
(A) Consistent allocation
methodologies.
(1) In general.
(2) Consent to change allocation
methodology.
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(B) De minimis exception.
(C) Allocations of excepted regulated
utility trades or businesses.
(1) In general.
(2) Permissible method for allocating
asset basis for utility trades or
businesses.
(3) De minimis rule for excepted
utility trades or businesses.
(4) Example.
(D) Special allocation rule for real
property trades or business subject to
special anti-abuse rule.
(1) In general.
(2) Allocation methodology for real
property.
(3) Example.
(4) Disallowed business interest
expense carryforwards; floor plan
financing interest expense.
(5) Additional rules relating to basis.
(i) Calculation of adjusted basis.
(A) Non-depreciable property other
than land.
(B) Depreciable property other than
inherently permanent structures.
(C) Special rule for land and
inherently permanent structures.
(D) Depreciable or amortizable
intangible property and depreciable
income forecast method property.
(E) Assets not yet used in a trade or
business.
(F) Trusts established to fund specific
liabilities.
(G) Inherently permanent structure.
(ii) Partnership interests; stock in nonconsolidated C corporations.
(A) Partnership interests.
(1) Calculation of asset basis.
(2) Allocation of asset basis.
(i) In general.
(ii) De minimis rule.
(iii) Partnership assets not properly
allocable to a trade or business.
(iv) Inapplicability of partnership
look-through rule.
(B) Stock in domestic nonconsolidated corporations.
(1) In general.
(2) Domestic non-consolidated C
corporations.
(i) Allocation of asset basis.
(ii) De minimis rule.
(iii) Inapplicability of corporate lookthrough rule.
(iv) Use of inside basis for purposes of
C corporation look-through rule.
(3) S corporations.
(i) Calculation of asset basis.
(ii) Allocation of asset basis.
(iii) De minimis rule.
(iv) Inapplicability of S corporation
look-through rule.
(C) Stock in relevant foreign
corporations.
(1) In general.
(2) Special rule for CFC utilities.
(D) Inapplicability of look-through
rule to partnerships or non-consolidated
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C corporations to which the small
business exemption applies.
(E) Tiered entities.
(iii) Cash and cash equivalents and
customer receivables.
(iv) Deemed asset sale.
(v) Other adjustments.
(6) Determination dates;
determination periods; reporting
requirements.
(i) Determination dates and
determination periods.
(A) Quarterly determination periods.
(B) Annual determination periods.
(ii) Application of look-through rules.
(iii) Reporting requirements.
(A) Books and records.
(B) Information statement.
(iv) Failure to file statement.
(7) Ownership threshold for lookthrough rules.
(i) Corporations.
(A) Asset basis.
(B) Dividends.
(ii) Partnerships.
(iii) Inapplicability of look-through
rule.
(8) Anti-abuse rule.
(d) Direct allocations.
(1) In general.
(2) Qualified nonrecourse
indebtedness.
(3) Assets used in more than one trade
or business.
(4) Adjustments to basis of assets to
account for direct allocations.
(5) Example: Direct allocation of
interest expense.
(e) Examples.
(f) Applicability date.
§ 1.163(j)–11 Transition rules.
(a) Overview.
(b) Application of section 163(j)
limitation if a corporation joins a
consolidated group during a taxable
year of the group beginning before
January 1, 2018.
(1) In general.
(2) Example
(c) Treatment of disallowed
disqualified interest.
(1) In general.
(2) Earnings and profits.
(3) Disallowed disqualified interest of
members of an affiliated group.
(i) Scope.
(ii) Allocation of disallowed
disqualified interest to members of the
affiliated group.
(A) In general.
(B) Definitions.
(1) Allocable share of the affiliated
group’s disallowed disqualified interest.
(2) Disallowed disqualified interest
ratio.
(3) Exempt related person interest
expense.
(iii) Treatment of carryforwards.
(4) Application of section 382.
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(i) Ownership change occurring before
November 13, 2020.
(A) Pre-change loss.
(B) Loss corporation.
(ii) Ownership change occurring on or
after November 13, 2020.
(A) Pre-change loss.
(B) Loss corporation.
(5) Treatment of excess limitation
from taxable years beginning before
January 1, 2018.
(6) Example: Members of an affiliated
group.
(d) Applicability date.
■ Par. 3. Sections 1.163(j)–1 through
1.163(j)–11 are added to read as follows:
Sec.
*
*
*
*
*
1.163(j)–1 Definitions.
1.163(j)–2 Deduction for business interest
expense limited.
1.163(j)–3 Relationship of the section 163(j)
limitation to other provisions affecting
interest.
1.163(j)–4 General rules applicable to C
corporations (including REITs, RICs, and
members of consolidated groups) and
tax-exempt corporations.
1.163(j)–5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
1.163(j)–6 Application of the section 163(j)
limitation to partnerships and
subchapter S corporations.
1.163(j)–7 Application of the section 163(j)
limitation to foreign corporations and
United States shareholders.
1.163(j)–8 [Reserved]
1.163(j)–9 Elections for excepted trades or
businesses; safe harbor for certain REITs.
1.163(j)–10 Allocation of interest expense,
interest income, and other items of
expense and gross income to an excepted
trade or business.
1.163(j)–11 Transition rules.
*
*
*
*
*
§ 1.163(j)–1 Definitions.
(a) In general. The definitions
provided in this section apply for
purposes of the section 163(j)
regulations. For purposes of the rules set
forth in §§ 1.163(j)–2 through 1.163(j)–
11, additional definitions for certain
terms are provided in those sections.
(b) Definitions—(1) Adjusted taxable
income. The term adjusted taxable
income (ATI) means the tentative
taxable income of the taxpayer for the
taxable year, with the adjustments in
this paragraph (b)(1).
(i) Additions. The amounts of the
following items that were included in
the computation of the taxpayer’s
tentative taxable income (if any) are
added to tentative taxable income to
determine ATI—
(A) Any business interest expense,
other than disallowed business interest
expense carryforwards;
(B) Any net operating loss deduction
under section 172;
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(C) Any deduction under section
199A;
(D) Subject to paragraph (b)(1)(iii) of
this section, for taxable years beginning
before January 1, 2022, any depreciation
under section 167, section 168, or
section 168 of the Internal Revenue
Code (Code) of 1954 (former section
168);
(E) Subject to paragraph (b)(1)(iii) of
this section, for taxable years beginning
before January 1, 2022, any amortization
of intangibles (for example, under
section 167 or 197) and other amortized
expenditures (for example, under
section 174(b), 195(b)(1)(B), 248, or
1245(a)(2)(C));
(F) Subject to paragraph (b)(1)(iii) of
this section, for taxable years beginning
before January 1, 2022, any depletion
under section 611;
(G) Any deduction for a capital loss
carryback or carryover; and
(H) Any deduction or loss that is not
properly allocable to a non-excepted
trade or business (for rules governing
the allocation of items to an excepted
trade or business, see §§ 1.163(j)–
1(b)(44) and 1.163(j)–10).
(ii) Subtractions. The amounts of the
following items (if any) are subtracted
from the taxpayer’s tentative taxable
income to determine ATI —
(A) Any business interest income that
was included in the computation of the
taxpayer’s tentative taxable income;
(B) Any floor plan financing interest
expense for the taxable year that was
included in the computation of the
taxpayer’s tentative taxable income;
(C) With respect to the sale or other
disposition of property, the greater of
the allowed or allowable depreciation,
amortization, or depletion of the
property, as provided under section
1016(a)(2), for the taxpayer (or, if the
taxpayer is a member of a consolidated
group, the consolidated group) for the
taxable years beginning after December
31, 2017, and before January 1, 2022,
with respect to such property;
(D) With respect to the sale or other
disposition of stock of a member of a
consolidated group by another member,
the investment adjustments under
§ 1.1502–32 with respect to such stock
that are attributable to deductions
described in paragraph (b)(1)(ii)(C) of
this section;
(E) With respect to the sale or other
disposition of an interest in a
partnership, the taxpayer’s distributive
share of deductions described in
paragraph (b)(1)(ii)(C) of this section
with respect to property held by the
partnership at the time of such sale or
other disposition to the extent such
deductions were allowable under
section 704(d);
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(F) Any income or gain that is not
properly allocable to a non-excepted
trade or business (for rules governing
the allocation of items to an excepted
trade or business, see §§ 1.163(j)–
1(b)(44) and 1.163(j)–10)) and that was
included in the computation of the
taxpayer’s tentative taxable income; and
(G) An amount equal to the sum of
any specified deemed inclusions that
were included in the computation of the
taxpayer’s tentative taxable income,
reduced by the portion of the deduction
allowed under section 250(a) by reason
of the specified deemed inclusions. For
this purpose, a specified deemed
inclusion is the inclusion of an amount
by a United States shareholder (as
defined in section 951(b)) in gross
income under section 78, 951(a), or
951A(a) with respect to an applicable
CFC (as defined in § 1.163(j)–1(b)(2))
that is properly allocable to a nonexcepted trade or business.
Furthermore, a specified deemed
inclusion includes any amounts
included in a domestic partnership’s
gross income under section 951(a) or
951A(a) with respect to an applicable
CFC to the extent such amounts are
attributable to investment income of the
partnership and are allocated to a
domestic C corporation that is a direct
(or indirect partner) and treated as
properly allocable to a non-excepted
trade or business of the domestic C
corporation under §§ 1.163(j)–4(b)(3)
and 1.163(j)–10. To determine the
amount of a specified deemed inclusion
described in this paragraph (b)(1)(ii)(G),
the portion of a United States
shareholder’s inclusion under section
951A(a) treated as being with respect to
an applicable CFC is determined under
section 951A(f)(2) and § 1.951A–6(b)(2).
(iii) Depreciation, amortization, or
depletion capitalized under section
263A. For purposes of paragraph
(b)(1)(i) of this section, amounts of
depreciation, amortization, or depletion
that are capitalized under section 263A
during the taxable year are deemed to be
included in the computation of the
taxpayer’s tentative taxable income for
such taxable year, regardless of the
period in which the capitalized amount
is recovered. See Example 3 in
§ 1.163(j)–2(h)(3).
(iv) Application of § 1.163(j)–
1(b)(1)(ii)(C), (D), and (E)—(A) Sale or
other disposition—(1) In general. For
purposes of paragraphs (b)(1)(ii)(C), (D),
and (E) of this section, except as
otherwise provided in this paragraph
(b)(1)(iv)(A), the term sale or other
disposition does not include a transfer
of an asset to an acquiring corporation
in a transaction to which section 381(a)
applies.
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(2) Intercompany transactions. For
purposes of paragraphs (b)(1)(ii)(C) and
(D) of this section, the term sale or other
disposition excludes all intercompany
transactions, within the meaning of
§ 1.1502–13(b)(1)(i).
(3) Deconsolidations.
Notwithstanding any other rule in this
paragraph (b)(1)(iv)(A), any transaction
in which a member leaves a
consolidated group is treated as a sale
or other disposition for purposes of
paragraphs (b)(1)(ii)(C) and (D) of this
section unless the transaction is
described in § 1.1502–13(j)(5)(i)(A).
(B) Deductions by members of a
consolidated group. If paragraph
(b)(1)(ii)(C), (D), or (E) of this section
applies to adjust the tentative taxable
income of a taxpayer, the amount of the
adjustment under paragraph (b)(1)(ii)(C)
of this section equals the greater of the
allowed or allowable depreciation,
amortization, or depletion of the
property, as provided under section
1016(a)(2), for any member of the
consolidated group for the taxable years
beginning after December 31, 2017, and
before January 1, 2022, with respect to
such property.
(C) Successor assets. This paragraph
(b)(1)(iv)(C) applies if deductions
described in paragraph (b)(1)(ii)(C) of
this section are allowed or allowable to
a consolidated group member (S) and
either the depreciable property or S’s
stock is subsequently transferred to
another member (S1) in an
intercompany transaction in which the
transferor receives S1 stock. If this
paragraph (b)(1)(iv)(C) applies, and if
the transferor’s basis in the S1 stock
received in the intercompany
transaction is determined, in whole or
in part, by reference to its basis in the
S stock, the S1 stock received in the
intercompany transaction is treated as a
successor asset to S’s stock for purposes
of paragraph (b)(1)(ii)(D) of this section.
Thus, except as otherwise provided in
paragraph (b)(1)(iv)(D) of this section,
the subsequent disposition of either the
S1 stock or the S stock gives rise to an
adjustment under paragraph (b)(1)(ii)(D)
of this section.
(D) Anti-duplication rule—(1) In
general. The aggregate of the
subtractions from tentative taxable
income of a consolidated group under
paragraphs (b)(1)(ii)(C) and (D) of this
section with respect to an item of
property (including with regard to
dispositions of successor assets
described in paragraph (b)(1)(iv)(C) of
this section) cannot exceed the aggregate
amount of the consolidated group
members’ deductions described in
paragraph (b)(1)(ii)(C) of this section
with respect to such item of property.
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For example, if an adjustment to the
tentative taxable income of a
consolidated group is made under
paragraph (b)(1)(ii)(C) of this section
with respect to the sale or other
disposition of property by a
consolidated group member (S) to an
unrelated person, and if a member of the
group subsequently sells or otherwise
disposes of S’s stock, no further
adjustment to the group’s tentative
taxable income is made under paragraph
(b)(1)(ii)(D) of this section in relation to
the same property with respect to that
stock disposition.
(2) Adjustments following
deconsolidation. Depreciation,
amortization, or depletion deductions
allowed or allowable for a corporation
for a consolidated return year of a group
are disregarded in applying this
paragraph (b)(1)(iv)(D) to any year that
constitutes a separate return year (as
defined in § 1.1502–1(e)) of that
corporation. For example, assume that S
deconsolidates from a group (Group 1)
after holding property for which
depreciation, amortization, or depletion
deductions were allowed or allowable
in Group 1. On the deconsolidation, S
and Group 1 would adjust tentative
taxable income with regard to that
property under paragraphs (b)(1)(ii)(D)
and (b)(1)(iv)(A)(3) of this section. If,
following the deconsolidation, S sells
the property referred to in the previous
sentence, no subtraction from tentative
taxable income is made under paragraph
(b)(1)(ii)(C) of this section during S’s
separate return year with regard to the
amounts included in Group 1 under
paragraphs (b)(1)(ii)(C) and
(b)(1)(iv)(A)(3) of this section.
(v) Other adjustments. ATI is
computed with the other adjustments
provided in §§ 1.163(j)–2 through
1.163(j)–11.
(vi) Additional rules relating to
adjusted taxable income in other
sections. (A) For rules governing the
ATI of C corporations, see §§ 1.163(j)–
4(b)(2) and (3) and 1.163(j)–10(a)(2)(ii).
(B) For rules governing the ATI of
RICs and REITs, see § 1.163(j)–4(b)(4).
(C) For rules governing the ATI of taxexempt corporations, see § 1.163(j)–
4(b)(5).
(D) For rules governing the ATI of
consolidated groups, see § 1.163(j)–
4(d)(2)(iv) and (v).
(E) For rules governing the ATI of
partnerships, see § 1.163(j)–6(d).
(F) For rules governing the ATI of
partners, see §§ 1.163(j)–6(e) and
1.163(j)–6(m)(1) and (2).
(G) For rules governing partnership
basis adjustments affecting ATI, see
§ 1.163(j)–6(h)(2).
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(H) For rules governing the ATI of S
corporations, see § 1.163(j)–6(l)(3).
(I) For rules governing the ATI of S
corporation shareholders, see § 1.163(j)–
6(l)(4).
(J) For rules governing the ATI of
certain beneficiaries of trusts and
estates, see § 1.163(j)–2(f).
(vii) ATI cannot be less than zero. If
the ATI of a taxpayer would be less than
zero, the ATI of the taxpayer is zero.
(viii) Examples. The examples in this
paragraph (b)(1)(viii) illustrate the
application of paragraphs (b)(1)(ii), (iii),
and (iv) of this section. Unless
otherwise indicated, A, B, P, S, and T
are calendar-year domestic C
corporations; P is the parent of a
consolidated group of which S and T are
members; the exemption for certain
small businesses in § 1.163(j)–2(d) does
not apply; no entity is engaged in an
excepted trade or business; no entity has
business interest income or floor plan
financing interest expense; and all
amounts of interest expense are
deductible except for the potential
application of section 163(j).
(A) Example 1—(1) Facts. In 2021, A
purchases a depreciable asset (Asset X)
for $100x and fully depreciates Asset X
under section 168(k). For the 2021
taxable year, A’s ATI (after adding back
A’s depreciation deductions with
respect to Asset X under paragraph
(b)(1)(i)(D) of this section) is $150x. A
incurs $45x of business interest expense
in 2021. In 2024, A sells Asset X to an
unrelated third party.
(2) Analysis. A’s section 163(j)
limitation for 2021 is $45x ($150x × 30
percent). Thus, all $45x of A’s business
interest expense incurred in 2021 is
deductible in that year. However, under
paragraph (b)(1)(ii)(C) of this section, A
must subtract $100x from its tentative
taxable income in computing its ATI for
its 2024 taxable year. A would be
required to subtract $100x from its
tentative taxable income in computing
its ATI for its 2024 taxable year even if
A’s ATI in 2021 was $150x before
adding back A’s depreciation
deductions with respect to Asset X.
(3) Transfer of assets in a
nonrecognition transaction to which
section 381 applies. The facts are the
same as in paragraph (b)(1)(viii)(A)(1) of
this section, except that, rather than sell
Asset X to an unrelated third party in
2024, A merges with and into an
unrelated third party in 2024 in a
transaction described in section
368(a)(1)(A) in which no gain is
recognized. As provided in paragraph
(b)(1)(iv)(A) of this section, the merger
transaction is not treated as a ‘‘sale or
other disposition’’ for purposes of
paragraph (b)(1)(ii)(C) of this section.
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Thus, no adjustment to tentative taxable
income is required in 2024 under
paragraph (b)(1)(ii)(C) of this section.
(4) Transfer of assets in a
nonrecognition transaction to which
section 351 applies. The facts are the
same as in paragraph (b)(1)(viii)(A)(1) of
this section, except that, rather than sell
Asset X to an unrelated third party in
2024, A transfers Asset X to B (A’s
wholly owned subsidiary) in 2024 in a
transaction to which section 351
applies. The section 351 transaction is
treated as a ‘‘sale or other disposition’’
for purposes of paragraph (b)(1)(ii)(C) of
this section. Thus, A must subtract
$100x from its tentative taxable income
in computing its ATI for its 2024 taxable
year.
(B) Example 2—(1) Facts. In 2021, S
purchases a depreciable asset (Asset Y)
for $100x and fully depreciates Asset Y
under section 168(k). P reduces its basis
in its S stock by $100x under § 1.1502–
32 to reflect S’s depreciation
deductions. For the 2021 taxable year,
the P group’s ATI (after adding back S’s
depreciation deductions with respect to
Asset Y under paragraph (b)(1)(i)(D) of
this section) is $150x. The P group
incurs $45x of business interest expense
in 2021. In 2024, P sells all of its S stock
to an unrelated third party.
(2) Analysis. The P group’s section
163(j) limitation for 2021 is $45x ($150x
× 30 percent). Thus, all $45x of the P
group’s business interest expense
incurred in 2021 is deductible in that
year. However, under paragraph
(b)(1)(ii)(D) of this section, the P group
must subtract $100x from its tentative
taxable income in computing its ATI for
its 2024 taxable year. The answer would
be the same if the P group’s ATI in 2021
were $150x before adding back S’s
depreciation deductions with respect to
Asset Y.
(3) Disposition of less than all
member stock. The facts are the same as
in paragraph (b)(1)(viii)(B)(1) of this
section, except that, in 2024, P sells half
of its S stock to an unrelated third party.
Pursuant to paragraph (b)(1)(ii)(D) of
this section, the P group must subtract
$100x from its tentative taxable income
in computing its ATI for its 2024 taxable
year.
(4) Transfer in an intercompany
transaction. The facts are the same as in
paragraph (b)(1)(viii)(B)(1) of this
section, except that, rather than sell S’s
stock to an unrelated third party in
2024, P transfers S’s stock to another
member of the P group in an
intercompany transaction (as defined in
§ 1.1502–13(b)(1)(i)) in 2024. As
provided in paragraph (b)(1)(iv)(A) of
this section, the intercompany
transaction is not treated as a ‘‘sale or
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other disposition’’ for purposes of
paragraph (b)(1)(ii)(D) of this section.
Thus, no adjustment to tentative taxable
income is required in 2024 under
paragraph (b)(1)(ii)(D) of this section.
(5) Disposition of successor assets.
The facts are the same as in paragraph
(b)(1)(viii)(B)(1) of this section, except
that, rather than sell S’s stock to an
unrelated third party in 2024, P
transfers S’s stock to T in 2024 in a
transaction to which section 351 applies
and, in 2025, P sells all of its T stock
to an unrelated third party. Pursuant to
paragraph (b)(1)(iv)(A) of this section,
P’s intercompany transfer of S’s stock to
T is not a ‘‘sale or other disposition’’ for
purposes of paragraph (b)(1)(ii)(D) of
this section. However, pursuant to
paragraph (b)(1)(iv)(C) of this section,
P’s stock in T is treated as a successor
asset for purposes of paragraph
(b)(1)(ii)(D) of this section. Thus, the P
group must subtract $100x from its
tentative taxable income in computing
its ATI for its 2025 taxable year.
(C) Example 3—(1) Facts. In 2021, S
purchases a depreciable asset (Asset Z)
for $100x and fully depreciates Asset Z
under section 168(k). P reduces its basis
in its S stock by $100x under § 1.1502–
32 to reflect S’s depreciation
deductions. For the 2021 taxable year,
the P group’s ATI (after adding back S’s
depreciation deductions with respect to
Asset Z under paragraph (b)(1)(i)(D) of
this section) is $150x. The P group
incurs $45x of business interest expense
in 2021. In 2024, S sells Asset Z to an
unrelated third party. In 2025, P sells all
of its S stock to a member of another
consolidated group.
(2) Analysis. Under paragraph
(b)(1)(ii)(C) of this section, the P group
must subtract $100x from its tentative
taxable income in computing its ATI for
its 2024 taxable year. The answer would
be the same if the P group’s ATI in 2021
were $150x before adding back S’s
depreciation deductions with respect to
Asset Z. P’s sale of all of its S stock in
2025 is a ‘‘sale or other disposition’’ for
purposes of paragraph (b)(1)(ii)(D) of
this section. However, pursuant to
paragraph (b)(1)(iv)(D)(1) of this section,
no further adjustment to the P group’s
tentative taxable income is required in
2025 under paragraph (b)(1)(ii)(D) of
this section.
(3) Disposition of S stock prior to S’s
asset disposition. The facts are the same
as in paragraph (b)(1)(viii)(C)(1) of this
section, except that, in 2024, P sells all
of its S stock to a member of another
consolidated group and, in 2025, S sells
Asset Z to an unrelated third party.
Pursuant to paragraph (b)(1)(ii)(D) of
this section, the P group must subtract
$100x from its tentative taxable income
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in computing its ATI for its 2024 taxable
year. Pursuant to paragraph
(b)(1)(iv)(D)(2) of this section, no
adjustment to the acquiring group’s
tentative taxable income is required in
2025 under paragraph (b)(1)(ii)(C) of this
section.
(4) Transfer of S stock in
nonrecognition transaction. The facts
are the same as in paragraph
(b)(1)(vii)(C)(3) of this section, except
that, rather than sell all of S’s stock to
a member of another consolidated
group, P causes S to merge with and
into a member of another consolidated
group in a transaction described in
section 368(a)(1)(A). As provided in
paragraph (b)(1)(iv)(A) of this section,
the merger transaction is treated as a
‘‘sale or other disposition’’ for purposes
of paragraph (b)(1)(ii)(D) of this section
because S leaves the P group. Thus, the
results are the same as in paragraph
(b)(1)(vii)(C)(3) of this section.
(D) Example 4—(1) Facts. P wholly
owns T, which wholly owns S. In 2021,
S purchases a depreciable asset (Asset
AA) for $100x and fully depreciates
Asset AA under section 168(k). T
reduces its basis in its S stock, and P
reduces its basis in its T stock, by $100x
under § 1.1502–32 to reflect S’s
depreciation deductions. For the 2021
taxable year, the P group’s ATI (after
adding back S’s depreciation deductions
with respect to Asset AA under
paragraph (b)(1)(i)(D) of this section) is
$150x. The P group incurs $45x of
business interest expense in 2021. In
2024, T sells all of its S stock to a
member of another consolidated group.
In 2025, P sells all of its T stock to a
member of another consolidated group.
(2) Analysis. Pursuant to paragraph
(b)(1)(ii)(D) of this section, the P group
must subtract $100x from its tentative
taxable income in computing its ATI for
its 2024 taxable year. Pursuant to
paragraph (b)(1)(iv)(D)(1) of this section,
no adjustment to the P group’s tentative
taxable income is required in 2025
under paragraph (b)(1)(ii)(D) of this
section.
(2) Applicable CFC. The term
applicable CFC means a foreign
corporation described in section 957,
but only if the foreign corporation has
at least one United States shareholder
that owns, within the meaning of
section 958(a), stock of the foreign
corporation.
(3) Business interest expense—(i) In
general. The term business interest
expense means interest expense that is
properly allocable to a non-excepted
trade or business or that is floor plan
financing interest expense. Business
interest expense also includes
disallowed business interest expense
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carryforwards (as defined in paragraph
(b)(11) of this section). However,
business interest expense does not
include amounts of interest expense
carried forward to the taxable year from
a prior taxable year due to the
application of section 465 or section
469, which apply after the application
of section 163(j). For the treatment of
investment interest, see section 163(d);
and for the treatment of personal
interest, see section 163(h).
(ii) Special rules. For special rules for
defining business interest expense in
certain circumstances, see §§ 1.163(j)–
3(b)(2) (regarding disallowed interest
expense), 1.163(j)–4(b) (regarding C
corporations) and 1.163(j)–4(d)(2)(iii)
(regarding consolidated groups),
1.163(j)–1(b)(9) (regarding current-year
business interest expense), and 1.163(j)–
6(c) (regarding partnerships and S
corporations).
(4) Business interest income—(i) In
general. The term business interest
income means interest income
includible in the gross income of a
taxpayer for the taxable year which is
properly allocable to a non-excepted
trade or business. For the treatment of
investment income, see section 163(d).
(ii) Special rules. For special rules
defining business interest income in
certain circumstances, see §§ 1.163(j)–
4(b) (regarding C corporations), 1.163(j)–
4(d)(2)(iii) (regarding consolidated
groups), and 1.163(j)–6(c) (regarding
partnerships and S corporations).
(5) C corporation. The term C
corporation has the meaning provided
in section 1361(a)(2).
(6) Cleared swap. The term cleared
swap means a swap that is cleared by a
derivatives clearing organization, as
such term is defined in section 1a of the
Commodity Exchange Act (7 U.S.C. 1a),
or by a clearing agency, as such term is
defined in section 3 of the Securities
Exchange Act of 1934 (15 U.S.C. 78c),
that is registered as a derivatives
clearing organization under the
Commodity Exchange Act or as a
clearing agency under the Securities
Exchange Act of 1934, respectively, if
the derivatives clearing organization or
clearing agency requires the parties to
the swap to post and collect margin or
collateral.
(7) Consolidated group. The term
consolidated group has the meaning
provided in § 1.1502–1(h).
(8) Consolidated return year. The term
consolidated return year has the
meaning provided in § 1.1502–1(d).
(9) Current-year business interest
expense. The term current-year business
interest expense means business interest
expense that would be deductible in the
current taxable year without regard to
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56763
section 163(j) and that is not a
disallowed business interest expense
carryforward from a prior taxable year.
(10) Disallowed business interest
expense. The term disallowed business
interest expense means the amount of
business interest expense for a taxable
year in excess of the amount allowed as
a deduction for the taxable year under
section 163(j)(1) and § 1.163(j)–2(b). For
purposes of section 163(j) and the
regulations in this part under section
163(j) of the Internal Revenue Code
(Code) disallowed business interest
expense is treated as ‘‘paid or accrued’’
in the taxable year in which the expense
is deductible for Federal income tax
purposes (without regard to section
163(j)) or in the taxable year in which
a deduction for the business interest
expense is permitted under section
163(j), as the context may require.
(11) Disallowed business interest
expense carryforward. The term
disallowed business interest expense
carryforward means any business
interest expense described in § 1.163(j)–
2(c).
(12) Disallowed disqualified interest.
The term disallowed disqualified
interest means interest expense,
including carryforwards, for which a
deduction was disallowed under old
section 163(j) (as defined in paragraph
(b)(27) of this section) in the taxpayer’s
last taxable year beginning before
January 1, 2018, and that was carried
forward pursuant to old section 163(j).
(13) Electing farming business. The
term electing farming business means a
trade or business that makes an election
as provided in § 1.163(j)–9 or other
published guidance and that is—
(i) A farming business, as defined in
section 263A(e)(4) or § 1.263A–4(a)(4);
(ii) Any trade or business of a
specified agricultural or horticultural
cooperative, as defined in section
199A(g)(4); or
(iii) Specifically designated by the
Secretary in guidance published in the
Federal Register or the Internal Revenue
Bulletin (see § 601.601(d) of this
chapter) as a farming business for
purposes of section 163(j).
(14) Electing real property trade or
business. The term electing real
property trade or business means a trade
or business that makes an election as
provided in § 1.163(j)–9 or other
published guidance and that is—
(i) A real property trade or business
described in section 469(c)(7)(C) and
§ 1.469–9(b)(2); or
(ii) A REIT that qualifies for the safe
harbor described in § 1.163(j)–9(h); or
(iii) A trade or business specifically
designated by the Secretary in guidance
published in the Federal Register or the
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Internal Revenue Bulletin (see
§ 601.601(d) of this chapter) as a real
property trade or business for purposes
of section 163(j).
(15) Excepted regulated utility trade
or business—(i) In general. The term
excepted regulated utility trade or
business means:
(A) Automatically excepted regulated
utility trades or businesses. A trade or
business—
(1) That furnishes or sells—
(i) Electrical energy, water, or sewage
disposal services;
(ii) Gas or steam through a local
distribution system; or
(iii) Transportation of gas or steam by
pipeline; but only
(2) To the extent that the rates for the
furnishing or sale of the items in
paragraph (b)(15)(i)(A)(1) of this
section—
(i) Have been established or approved
by a State or political subdivision
thereof, by any agency or
instrumentality of the United States, or
by a public service or public utility
commission or other similar body of any
State or political subdivision thereof
and are determined on a cost of service
and rate of return basis; or
(ii) Have been established or approved
by the governing or ratemaking body of
an electric cooperative; or
(B) Electing regulated utility trades or
businesses. A trade or business that
makes a valid election under paragraph
(b)(15)(iii) of this section; or
(C) Designated excepted regulated
utility trades or businesses. A trade or
business that is specifically designated
by the Secretary in guidance published
in the Federal Register or the Internal
Revenue Bulletin as an excepted
regulated utility trade or business (see
§ 601.601(d) of this chapter) for section
163(j) purposes.
(ii) Depreciation and excepted and
non-excepted utility trades or
businesses.
(A) Depreciation. Taxpayers engaged
in an excepted trade or business
described in paragraph (b)(15)(i) of this
section cannot claim the additional firstyear depreciation deduction under
section 168(k) for any property that is
primarily used in the excepted regulated
utility trade or business.
(B) Allocation of items. If a taxpayer
is engaged in one or more excepted
trades or businesses, as described in
paragraph (b)(15)(i) of this section, and
one or more non-excepted trades or
businesses, the taxpayer must allocate
items between the excepted and nonexcepted utility trades or businesses.
See §§ 1.163(j)–1(b)(44) and 1.163(j)–
10(c)(3)(iii)(C). Some trades or
businesses with de minimis furnishing
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or sales of items described in paragraph
(b)(15)(i)(A)(1) of this section that are
not sold pursuant to rates that are
determined on a cost of service and rate
of return basis or established or
approved by the governing or
ratemaking body of an electric
cooperative, and are not subject to an
election in paragraph (b)(15)(iii), are
treated as excepted trades or businesses.
See § 1.163(j)–10(c)(3)(iii)(C)(3). For
look-through rules applicable to certain
CFCs that furnish or sell items described
in paragraph (b)(15)(i)(A)(1) of this
section that are not sold pursuant to
rates that are determined on a cost of
service and rate of return basis or
established or approved by the
governing or ratemaking body of an
electric cooperative as described in
paragraph (b)(15)(i)(A)(2) of this section,
see § 1.163(j)–10(c)(5)(ii)(C).
(iii) Election to be an excepted
regulated utility trade or business. (A) In
general. A trade or business that is not
an excepted regulated utility trade or
business described in paragraph
(b)(15)(i)(A) or (C) of this section and
that furnishes or sells items described in
paragraph (b)(15)(i)(A)(1) of this section
is eligible to make an election to be an
excepted regulated utility trade or
business to the extent that the rates for
furnishing or selling the items described
in paragraph (b)(15)(i)(A)(1) of this
section have been established or
approved by a regulatory body
described in paragraph (b)(15)(i)(A)(2)(i)
of this section.
(B) Scope and effect of election—(1)
In general. An election under paragraph
(b)(15)(iii) of this section is made with
respect to each eligible trade or business
of the taxpayer and applies only to the
trade or business for which the election
is made. An election under paragraph
(b)(15)(iii) of this section applies to the
taxable year in which the election is
made and to all subsequent taxable
years.
(2) Irrevocability. An election under
paragraph (b)(15)(iii) of this section is
irrevocable.
(C) Time and manner of making
election—(1) In general. Subject to
paragraph (b)(15)(iii)(C)(5) of this
section, a taxpayer makes an election
under paragraph (b)(15)(iii) by attaching
an election statement to the taxpayer’s
timely filed original Federal income tax
return, including extensions. A taxpayer
may make elections for multiple trades
or businesses on a single election
statement.
(2) Election statement contents. The
election statement should be titled
‘‘Section 1.163(j)–1(b)(15)(iii) Election’’
and must contain the following
information for each trade or business:
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(i) The taxpayer’s name;
(ii) The taxpayer’s address;
(iii) The taxpayer’s social security
number (SSN) or employer
identification number (EIN);
(iv) A description of the taxpayer’s
electing trade or business sufficient to
demonstrate qualification for an election
under this section, including the
principal business activity code; and
(v) A statement that the taxpayer is
making an election under section
1.163(j)–1(b)(15)(iii).
(3) Consolidated group’s or
partnership’s trade or business. The
rules in § 1.163(j)–9(d)(3) and (4) apply
with respect to an election under
paragraph (b)(15)(iii) of this section for
a consolidated group’s or partnership’s
trade or business.
(4) Termination of election. The rules
in § 1.163(j)–9(e) apply to determine
when an election under paragraph
(b)(15)(iii) of this section terminates.
(5) Additional guidance. The rules
and procedures regarding the time and
manner of making an election under
paragraph (b)(15)(iii) of this section and
the election statement contents in
paragraph (b)(15)(iii)(C)(2) of this
section may be modified through other
guidance (see §§ 601.601(d) and 601.602
of this chapter). Additional situations in
which an election may terminate under
paragraph (b)(15)(iii)(C)(4) of this
section may be provided through
guidance published in the Federal
Register or in the Internal Revenue
Bulletin (see § 601.601(d) of this
chapter).
(16) Excess business interest expense.
For any partnership, the term excess
business interest expense means the
amount of disallowed business interest
expense of the partnership for a taxable
year under section § 1.163(j)–2(b). With
respect to a partner, see § 1.163(j)–6(g)
and (h).
(17) Excess taxable income. With
respect to any partnership or S
corporation, the term excess taxable
income means the amount which bears
the same ratio to the partnership’s ATI
as—
(i) The excess (if any) of—
(A) The amount determined for the
partnership or S corporation under
section 163(j)(1)(B); over
(B) The amount (if any) by which the
business interest expense of the
partnership, reduced by the floor plan
financing interest expense, exceeds the
business interest income of the
partnership or S corporation; bears to
(ii) The amount determined for the
partnership or S corporation under
section 163(j)(1)(B).
(18) Floor plan financing
indebtedness. The term floor plan
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financing indebtedness means
indebtedness—
(i) Used to finance the acquisition of
motor vehicles held for sale or lease;
and
(ii) Secured by the motor vehicles so
acquired.
(19) Floor plan financing interest
expense. The term floor plan financing
interest expense means interest paid or
accrued on floor plan financing
indebtedness. For purposes of the
section 163(j) regulations, all floor plan
financing interest expense is treated as
business interest expense. See
paragraph (b)(3) of this section.
(20) Group. The term group has the
meaning provided in § 1.1502–1(a).
(21) Intercompany transaction. The
term intercompany transaction has the
meaning provided in § 1.1502–
13(b)(1)(i).
(22) Interest. The term interest means
any amount described in paragraph
(b)(22)(i), (ii), (iii), or (iv) of this section.
(i) In general. Interest is an amount
paid, received, or accrued as
compensation for the use or forbearance
of money under the terms of an
instrument or contractual arrangement,
including a series of transactions, that is
treated as a debt instrument for
purposes of section 1275(a) and
§ 1.1275–1(d), and not treated as stock
under § 1.385–3, or an amount that is
treated as interest under other
provisions of the Code or the Income
Tax Regulations. Thus, interest
includes, but is not limited to, the
following:
(A) Original issue discount (OID), as
adjusted by the holder for any
acquisition premium or amortizable
bond premium;
(B) Qualified stated interest, as
adjusted by the holder for any
amortizable bond premium or by the
issuer for any bond issuance premium;
(C) Acquisition discount;
(D) Amounts treated as taxable OID
under section 1286 (relating to stripped
bonds and stripped coupons);
(E) Accrued market discount on a
market discount bond to the extent
includible in income by the holder
under either section 1276(a) or 1278(b);
(F) OID includible in income by a
holder that has made an election under
§ 1.1272–3 to treat all interest on a debt
instrument as OID;
(G) OID on a synthetic debt
instrument arising from an integrated
transaction under § 1.1275–6;
(H) Repurchase premium to the extent
deductible by the issuer under § 1.163–
7(c) (determined without regard to
section 163(j));
(I) Deferred payments treated as
interest under section 483;
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(J) Amounts treated as interest under
a section 467 rental agreement;
(K) Amounts treated as interest under
section 988;
(L) Forgone interest under section
7872;
(M) De minimis OID taken into
account by the issuer;
(N) Amounts paid or received in
connection with a sale-repurchase
agreement treated as indebtedness
under Federal tax principles; however,
in the case of a sale-repurchase
agreement relating to tax-exempt bonds,
the amount is not tax-exempt interest;
(O) Redeemable ground rent treated as
interest under section 163(c); and
(P) Amounts treated as interest under
section 636.
(ii) Swaps with significant
nonperiodic payments—(A) In general.
Except as provided in paragraphs
(b)(22)(ii)(B) and (C) of this section, a
swap with significant nonperiodic
payments is treated as two separate
transactions consisting of an on-market,
level payment swap and a loan. The
loan must be accounted for by the
parties to the contract independently of
the swap. The time value component
associated with the loan, determined in
accordance with § 1.446–3(f)(2)(iii)(A),
is recognized as interest expense to the
payor and interest income to the
recipient.
(B) Exception for cleared swaps.
Paragraph (b)(22)(ii)(A) of this section
does not apply to a cleared swap (as
defined in paragraph (b)(6) of this
section).
(C) Exception for non-cleared swaps
subject to margin or collateral
requirements. Paragraph (b)(22)(ii)(A) of
this section does not apply to a noncleared swap that requires the parties to
meet the margin or collateral
requirements of a federal regulator or
that provides for margin or collateral
requirements that are substantially
similar to a cleared swap or a noncleared swap subject to the margin or
collateral requirements of a federal
regulator. For purposes of this
paragraph (b)(22)(ii)(C), the term federal
regulator means the Securities and
Exchange Commission (SEC), the
Commodity Futures Trading
Commission (CFTC), or a prudential
regulator, as defined in section 1a(39) of
the Commodity Exchange Act (7 U.S.C.
1a), as amended by section 721 of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010,
Public Law 111–203, 124 Stat. 1376,
Title VII.
(iii) Other amounts treated as
interest—(A) Treatment of premium—
(1) Issuer. If a debt instrument is issued
at a premium within the meaning of
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§ 1.163–13, any ordinary income under
§ 1.163–13(d)(4) is treated as interest
income of the issuer.
(2) Holder. If a taxable debt
instrument is acquired at a premium
within the meaning of § 1.171–1 and the
holder elects to amortize the premium,
any amount deductible as a bond
premium deduction under section
171(a)(1) and § 1.171–2(a)(4)(i)(A) or (C)
is treated as interest expense of the
holder.
(B) Treatment of ordinary income or
loss on certain debt instruments. If an
issuer of a contingent payment debt
instrument subject to § 1.1275–4(b), a
nonfunctional currency contingent
payment debt instrument subject to
§ 1.988–6, or an inflation-indexed debt
instrument subject to § 1.1275–7
recognizes ordinary income on the debt
instrument in accordance with the rules
in § 1.1275–4(b), § 1.988–6(b)(2), or
§ 1.1275–7(f), whichever is applicable,
the ordinary income is treated as
interest income of the issuer. If a holder
of a contingent payment debt
instrument subject to § 1.1275–4(b), a
nonfunctional currency contingent
payment debt instrument subject to
§ 1.988–6, or an inflation-indexed debt
instrument subject to § 1.1275–7
recognizes an ordinary loss on the debt
instrument in accordance with the rules
in § 1.1275–4(b), § 1.988–6(b)(2), or
§ 1.1275–7(f), whichever is applicable,
the ordinary loss is treated as interest
expense of the holder.
(C) Substitute interest payments. A
substitute interest payment described in
§ 1.861–2(a)(7) is treated as interest
expense to the payor only if the
payment relates to a sale-repurchase
agreement or a securities lending
transaction that is not entered into by
the payor in the ordinary course of the
payor’s business. A substitute interest
payment described in § 1.861–2(a)(7) is
treated as interest income to the
recipient only if the payment relates to
a sale-repurchase agreement or a
securities lending transaction that is not
entered into by the recipient in the
ordinary course of the recipient’s
business; however, in the case of a salerepurchase agreement or a securities
lending transaction relating to taxexempt bonds, the recipient of a
substitute payment does not receive taxexempt interest income. This paragraph
(b)(22)(iii)(C) does not apply to an
amount described in paragraph
(b)(22)(i)(N) of this section.
(D) Section 1258 gain. Any gain
treated as ordinary gain under section
1258 is treated as interest income.
(E) Factoring income. The excess of
the amount that a taxpayer collects on
a factored receivable (or realizes upon
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the sale or other disposition of the
factored receivable) over the amount
paid for the factored receivable by the
taxpayer is treated as interest income.
For purposes of this paragraph
(b)(22)(iii)(E), the term factored
receivable includes any account
receivable or other evidence of
indebtedness, whether or not issued at
a discount and whether or not bearing
stated interest, arising out of the
disposition of property or the
performance of services by any person,
if such account receivable or evidence
of indebtedness is acquired by a person
other than the person who disposed of
the property or provided the services
that gave rise to the account receivable
or evidence of indebtedness. This
paragraph (b)(22)(iii)(E) does not apply
to an amount described in paragraph
(b)(22)(i)(C) or (E) of this section.
(F) [Reserved]
(iv) Anti-avoidance rules—(A)
Principal purpose to reduce interest
expense—(1) Treatment as interest
expense. Any expense or loss
economically equivalent to interest is
treated as interest expense if a principal
purpose of structuring the transaction(s)
is to reduce an amount incurred by the
taxpayer that otherwise would have
been described in paragraph (b)(22)(i),
(ii), or (iii) of this section. For this
purpose, the fact that the taxpayer has
a business purpose for obtaining the use
of funds does not affect the
determination of whether the manner in
which the taxpayer structures the
transaction(s) is with a principal
purpose of reducing the taxpayer’s
interest expense. In addition, the fact
that the taxpayer has obtained funds at
a lower pre-tax cost based on the
structure of the transaction(s) does not
affect the determination of whether the
manner in which the taxpayer structures
the transaction(s) is with a principal
purpose of reducing the taxpayer’s
interest expense. For purposes of this
paragraph (b)(22)(iv)(A)(1), any expense
or loss is economically equivalent to
interest to the extent that the expense or
loss is—
(i) Deductible by the taxpayer;
(ii) Incurred by the taxpayer in a
transaction or series of integrated or
related transactions in which the
taxpayer secures the use of funds for a
period of time;
(iii) Substantially incurred in
consideration of the time value of
money; and
(iv) Not described in paragraph
(b)(22)(i), (ii), or (iii) of this section.
(2) Corresponding treatment of
amounts as interest income. If a
taxpayer knows that an expense or loss
is treated by the payor as interest
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expense under paragraph
(b)(22)(iv)(A)(1) of this section, the
taxpayer provides the use of funds for
a period of time in the transaction(s)
subject to paragraph (b)(22)(iv)(A)(1) of
this section, the taxpayer earns income
or gain with respect to the
transaction(s), and such income or gain
is substantially earned in consideration
of the time value of money provided by
the taxpayer, such income or gain is
treated as interest income to the extent
of the expense or loss treated by the
payor as interest expense under
paragraph (b)(22)(iv)(A)(1) of this
section.
(B) Interest income artificially
increased. Notwithstanding paragraphs
(b)(22)(i) through (iii) of this section,
any income realized by a taxpayer in a
transaction or series of integrated or
related transactions is not treated as
interest income of the taxpayer if and to
the extent that a principal purpose for
structuring the transaction(s) is to
artificially increase the taxpayer’s
business interest income. For this
purpose, the fact that the taxpayer has
a business purpose for holding interest
generating assets does not affect the
determination of whether the manner in
which the taxpayer structures the
transaction(s) is with a principal
purpose of artificially increasing the
taxpayer’s business interest income.
(C) Principal purpose. Whether a
transaction or a series of integrated or
related transactions is entered into with
a principal purpose described in
paragraph (b)(22)(iv)(A) or (B) of this
section depends on all the facts and
circumstances related to the
transaction(s), except for those facts
described in paragraph (b)(22)(iv)(A) or
(B) of this section. A purpose may be a
principal purpose even though it is
outweighed by other purposes (taken
together or separately). Factors to be
taken into account in determining
whether one of the taxpayer’s principal
purposes for entering into the
transaction(s) include the taxpayer’s
normal borrowing rate in the taxpayer’s
functional currency, whether the
taxpayer would enter into the
transaction(s) in the ordinary course of
the taxpayer’s trade or business,
whether the parties to the transaction(s)
are related persons (within the meaning
of section 267(b) or section 707(b)),
whether there is a significant and bona
fide business purpose for the structure
of the transaction(s), whether the
transactions are transitory, for example,
due to a circular flow of cash or other
property, and the substance of the
transaction(s).
(D) Coordination with anti-avoidance
rule in § 1.163(j)–2(j). The anti-
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avoidance rules in paragraphs
(b)(22)(iv)(A) through (C) of this section,
rather than the anti-avoidance rules in
§ 1.163(j)–2(j), apply to determine
whether an item is treated as interest
expense or interest income.
(v) Examples. The examples in this
paragraph (b)(22)(v) illustrate the
application of paragraph (b)(22)(iv) of
this section. Unless otherwise indicated,
A, B, C, D, and Bank are domestic C
corporations that are publicly traded;
the exemption for certain small
businesses in § 1.163(j)–2(d) does not
apply; A is not engaged in an excepted
trade or business; and all amounts of
interest expense are deductible except
for the potential application of section
163(j).
(A) Example 1—(1) Facts. A is
engaged in a manufacturing business
and uses the calendar year as its annual
accounting period. A’s functional
currency is the U.S. dollar and A
conducts virtually all of its business in
the U.S. dollar. A has no connection to
Japan or the Japanese yen in the
ordinary course of business. A projects
that it will have business interest
expense of $100x on an existing loan
obligation with a stated principal
amount of $2,000x (Loan 1) and no
business interest income in its taxable
year ending December 31, 2021. In early
2021, A enters into the following
transactions, which A would not have
entered into in the ordinary course of
A’s trade or business:
(i) A enters into a loan obligation in
which A borrows Japanese yen from
Bank in an amount equivalent to
$2,000x with an interest rate of 1
percent (Loan 2) (at the time of the loan,
the U.S. dollar equivalent interest rate
on a loan of $2,000x is 5 percent);
(ii) A enters into a foreign currency
swap transaction (FX Swap) with Bank
with a notional principal amount of
$2,000x under which A receives
Japanese yen at 1 percent multiplied by
the amount of Japanese yen borrowed
from Bank (which for 2021 equals $20x)
and pays U.S. dollars at 5 percent
multiplied by a notional amount of
$2,000x ($100x per year);
(iii) The FX Swap is not integrated
with Loan 2 under § 1.988–5; and
(iv) A enters into a spot transaction
with Bank to convert the proceeds of
Loan 2 into $2,000x U.S. dollars and A
uses the U.S. dollars to repay Loan 1.
(2) Analysis. A principal purpose of A
entering into the transactions with Bank
was to try to reduce the amount
incurred by A that otherwise would be
interest expense; in effect, A sought to
alter A’s cost of borrowing by converting
a substantial portion of its interest
expense deductions on Loan 1 into
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section 165 deductions on the FX Swap
($100x interest expense related to Loan
1 compared to $20x interest expense
related to Loan 2 and $80x section 165
deduction). A’s functional currency is
the U.S. dollar and A conducts virtually
all of its business in the U.S. dollar. A
has no connection to Japan or the
Japanese yen and would not have
entered into the transactions in the
ordinary course of A’s trade or business.
The section 165 deductions related to
the FX Swap were incurred by A in a
series of transactions in which A
secured the use of funds for a period of
time and were substantially incurred in
consideration of the time value of
money. As a result, under paragraph
(b)(22)(iv)(A)(1) of this section, for
purposes of section 163(j), the $80x paid
by A to Bank on the FX Swap is treated
by A as interest expense.
(B) Example 2—(1) Facts. A is
engaged in a manufacturing business
and uses the calendar year as its annual
accounting period. A does not use gold
in its manufacturing business. In 2021,
A expects to borrow $1,000x for six
months. In January 2021, A borrows
from B two ounces of gold at a time
when the spot price for gold is $500x
per ounce. A agrees to return the two
ounces of gold in six months. A sells the
two ounces of gold to C for $1,000x. A
then enters into a contract with D to
purchase two ounces of gold six months
in the future for $1,013x. In exchange
for the use of $1,000x in cash for six
months, A has sustained a loss of $13x
in connection with these related
transactions. A would not have entered
into the gold transactions in the
ordinary course of A’s trade or business.
(2) Analysis. In a series of related
transactions, A has obtained the use of
$1,000x for six months and created a
loss of $13x substantially incurred in
consideration of the time value of
money. A would not have entered into
the gold transactions in the ordinary
course of A’s trade or business. A
entered into the transactions with a
principal purpose of structuring the
transactions to reduce its interest
expense (in effect, A sought to convert
what otherwise would be interest
expense into a loss through the
transactions). As a result, under
paragraph (b)(22)(iv)(A)(1) of this
section, for purposes of section 163(j),
the loss of $13x is treated by A as
interest expense.
(C) Example 3—(1) Facts. A is
engaged in a manufacturing business
and uses the calendar year as its annual
accounting period. A’s functional
currency is the U.S. dollar and A
conducts virtually all of its business in
the U.S. dollar. A has no connection to
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Argentina or the Argentine peso as part
of its ordinary course of business. As of
January 1, 2021, A expects to have
adjusted taxable income (as defined in
paragraph (b)(1) of this section) of $200x
in the taxable year ending December 31,
2021. A also projects that it will have
business interest expense of $70x on an
existing loan in 2021. A has cash
equivalents of $100x on which A
expects to earn $5x of business interest
income. In early 2021, A enters into the
following transactions, which A would
not have entered into in the ordinary
course of A’s trade or business:
(i) A enters into a spot transaction
with Bank to convert the $100x of cash
equivalents into an amount in Argentine
pesos equivalent to $100x and A uses
the Argentine pesos to purchase an
Argentine peso note (Note) issued by a
subsidiary of Bank for the Argentine
peso equivalent of $100x; the Note pays
interest at a 10 percent rate; and
(ii) A enters into a foreign currency
swap transaction (FX Swap) with Bank
with a notional principal amount of
$100x under which A pays Argentine
pesos at 10 percent multiplied by the
amount of Argentine peso principal
amount on the Note (which for 2021
equals $10x) and receives U.S. dollars at
5 percent multiplied by a notional
amount of $100x ($5x per year).
(2) Analysis. A principal purpose of A
entering into the transactions was to
increase the amount of business interest
income received by A; in effect, A
increased its business interest income
by separately accounting for its net
deduction of $5x per year on the FX
Swap. A’s functional currency is the
U.S. dollar and A conducts virtually all
of its business in the U.S. dollar. A has
no connection to Argentina or the
Argentine peso and would not have
entered into the transactions in the
ordinary course of A’s trade or business.
The FX Swap was incurred by A as a
part of a transaction that A entered into
with a principal purpose of artificially
increasing its business interest income.
As a result, under paragraph
(b)(22)(iv)(B) of this section, for
purposes of section 163(j), the $10x
business interest income earned on the
Note by A is reduced by $5x (the net
$5x paid by A on the FX Swap).
(D) Example 4—(1) Facts. A is wholly
owned by FC, a foreign corporation
organized in foreign country X. A uses
the calendar year for its annual
accounting period. FC has a better credit
rating than A. A needs to borrow
$2,000x in the taxable year ending
December 31, 2021, to fund its business
operations. A also projects that, if it
borrows $2,000x on January 1, 2021,
and pays a market rate of interest, it will
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56767
have business interest expense of $100x
in its taxable year ending December 31,
2021. In early 2021, A enters into the
following transactions:
(i) A enters into a loan obligation in
which A borrows $2,000x from Bank
with an interest rate of 3 percent (Loan
1);
(ii) FC and Bank enter into a guarantee
arrangement (Guarantee) under which
FC agrees to guarantee Bank that Bank
will be timely paid all of the amounts
due on Loan 1; and
(iii) A enters into a guarantee fee
agreement with FC (Guarantee Fee
Agreement) under which A agrees to
pay FC $40x in return for FC entering
into the Guarantee, which was not an
agreement that A would have entered
into in the ordinary course of A’s trade
or business.
(2) Analysis. A principal purpose of A
entering into the transactions was to
reduce the amount incurred by A that
otherwise would be interest expense; in
effect, A sought to convert a substantial
portion of its interest expense
deductions on Loan 1 into section 162
deductions on the Guarantee Fee
Agreement ($100x interest expense had
A borrowed without the Guarantee
compared to $60x interest expense
related to Loan 1 and $40x section 162
deduction). A would not have entered
into the Guarantee Fee Agreement in the
ordinary course of A’s trade or business.
The $40x section 162 deductions related
to the Guarantee Fee Agreement were
incurred by A in a series of transactions
in which A secured the use of funds for
a period of time and were substantially
incurred in consideration of the time
value of money. As a result, under
paragraph (b)(22)(iv)(A)(1) of this
section, for purposes of section 163(j),
the $40x paid by A to FC on the
Guarantee Fee Agreement is treated by
A as interest expense.
(E) Example 5—(1) Facts. A, B, and C
are equal partners in ABC partnership.
ABC is considering acquiring an
additional loan from a third-party
lender to expand its business
operations. However, ABC already has
significant debt and interest expense.
For the purpose of reducing the amount
of additional interest expense ABC
would have otherwise incurred by
borrowing, A agrees to make an
additional contribution to ABC for use
in its business operations in exchange
for a guaranteed payment for the use of
capital under section 707(c).
(2) Analysis. The guaranteed payment
is deductible by ABC, incurred by ABC
in a transaction in which ABC secures
the use of funds for a period of time,
substantially incurred in consideration
of the time value of money, and not
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described in paragraph (b)(22)(i), (ii), or
(iii) of this section. As a result, the
guaranteed payment to A is
economically equivalent to the interest
that ABC would have incurred on an
additional loan from a third-party
lender. A principal purpose of A making
a contribution in exchange for a
guaranteed payment for the use of
capital was to reduce the amount
incurred by ABC that otherwise would
be interest expense. As a result, under
paragraph (b)(22)(iv)(A)(1) of this
section, for purposes of section 163(j),
such guaranteed payment is treated as
interest expense of ABC for purposes of
section 163(j). In addition, under
paragraph (b)(22)(iv)(A)(2) of this
section, if A knows that the guaranteed
payment is treated as interest expense of
ABC, because A provides the use of
funds for a period of time in a
transaction subject to paragraph
(b)(22)(iv)(A)(1) of this section, A earns
income or gain with respect to the
transaction, and such income or gain is
substantially earned in consideration of
the time value of money provided by A,
the guaranteed payment is treated as
interest income of A for purposes of
section 163(j).
(23) Interest expense. The term
interest expense means interest that is
paid or accrued, or treated as paid or
accrued, for the taxable year.
(24) Interest income. The term interest
income means interest that is included
in gross income for the taxable year.
(25) Member. The term member has
the meaning provided in § 1.1502–1(b).
(26) Motor vehicle. The term motor
vehicle means a motor vehicle as
defined in section 163(j)(9)(C).
(27) Old section 163(j). The term old
section 163(j) means section 163(j)
immediately prior to its amendment by
Public Law 115–97, 131 Stat. 2054
(2017).
(28) Ownership change. The term
ownership change has the meaning
provided in section 382 and the
regulations in this part under section
382 of the Code.
(29) Ownership date. The term
ownership date has the meaning
provided in section 382 and the
regulations in this part under section
382 of the Code.
(30) Real estate investment trust. The
term real estate investment trust (REIT)
has the meaning provided in section
856.
(31) Real property. The term real
property includes—
(i) Real property as defined in
§ 1.469–9(b)(2); and
(ii) Any direct or indirect right,
including a license or other contractual
right, to share in the appreciation in
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value of, or the gross or net proceeds or
profits generated by, an interest in real
property, including net proceeds or
profits associated with tolls, rents or
other similar fees.
(32) Regulated investment company.
The term regulated investment company
(RIC) has the meaning provided in
section 851.
(33) Relevant foreign corporation. The
term relevant foreign corporation means
any foreign corporation whose
classification is relevant under
§ 301.7701–3(d)(1) for a taxable year,
other than solely pursuant to section
881 or 882.
(34) S corporation. The term S
corporation has the meaning provided
in section 1361(a)(1).
(35) [Reserved]
(36) Section 163(j) limitation. The
term section 163(j) limitation means the
limit on the amount of business interest
expense that a taxpayer may deduct in
a taxable year under section 163(j) and
§ 1.163(j)–2(b).
(37) Section 163(j) regulations. The
term section 163(j) regulations means
this section and §§ 1.163(j)–2 through
1.163(j)–11.
(38) Separate return limitation year.
The term separate return limitation year
(SRLY) has the meaning provided in
§ 1.1502–1(f).
(39) Separate return year. The term
separate return year has the meaning
provided in § 1.1502–1(e).
(40) Separate tentative taxable
income. The term separate tentative
taxable income with respect to a
taxpayer and a taxable year has the
meaning provided in § 1.1502–12, but
for this purpose computed without
regard to the application of the section
163(j) limitation and with the addition
of the adjustments made in paragraph
(b)(43)(ii) of this section and § 1.163(j)–
4(d)(2)(iv).
(41) Tax-exempt corporation. The
term tax-exempt corporation means any
tax-exempt organization that is
organized as a corporation.
(42) Tax-exempt organization. The
term tax-exempt organization means
any entity subject to tax under section
511.
(43) Tentative taxable income—(i) In
general. The term tentative taxable
income, with respect to a taxpayer and
a taxable year, generally is determined
in the same manner as taxable income
under section 63 but for this purpose
computed without regard to the
application of the section 163(j)
limitation. Tentative taxable income is
computed without regard to any
disallowed business interest expense
carryforwards.
(ii) [Reserved]
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(iii) Special rules for defining
tentative taxable income. (A) For special
rules defining the tentative taxable
income of a RIC or REIT, see § 1.163(j)–
4(b)(4)(ii).
(B) For special rules defining the
tentative taxable income of consolidated
groups, see § 1.163(j)–4(d)(2)(iv).
(C) For special rules defining the
tentative taxable income of a
partnership, see § 1.163(j)–6(d)(1).
(D) For special rules defining the
tentative taxable income of an S
corporation, see § 1.163(j)–6(l)(3).
(E) For special rules clarifying that
tentative taxable income takes sections
461(l), 465, and 469 into account, see
§ 1.163(j)–3(b)(4).
(F) For special rules clarifying that
tentative taxable income takes sections
461(l), 465, and 469 into account, see
§ 1.163(j)–3(b)(4).
(G) For special rules clarifying that
tentative taxable income takes sections
461(l), 465, and 469 into account, see
§ 1.163(j)–3(b)(4).
(44) Trade or business—(i) In general.
The term trade or business means a
trade or business within the meaning of
section 162.
(ii) Excepted trade or business. The
term excepted trade or business means
the trade or business of performing
services as an employee, an electing real
property trade or business, an electing
farming business, or an excepted
regulated utility trade or business. For
additional rules related to excepted
trades or businesses, including elections
made under section 163(j)(7)(B) and (C),
see § 1.163(j)–9.
(iii) Non-excepted trade or business.
The term non-excepted trade or
business means any trade or business
that is not an excepted trade or
business.
(45) Unadjusted basis. The term
unadjusted basis means the basis as
determined under section 1012 or other
applicable sections of chapter 1 of
subtitle A of the Code, including
subchapters O (relating to gain or loss
on dispositions of property), C (relating
to corporate distributions and
adjustments), K (relating to partners and
partnerships), and P (relating to capital
gains and losses) of the Code.
Unadjusted basis is determined without
regard to any adjustments described in
section 1016(a)(2) or (3), any
adjustments for tax credits claimed by
the taxpayer (for example, under section
50(c)), or any adjustments for any
portion of the basis that the taxpayer has
elected to treat as an expense (for
example, under section 179, 179B, or
179C).
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(46) United States shareholder. The
term United States shareholder has the
meaning provided in section 951(b).
(c) Applicability date—(1) In general.
Except as provided in paragraphs (c)(2)
and (3) of this section, this section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, and
before November 13, 2020 so long as the
taxpayers and their related parties
consistently apply the rules of the
section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.383–0, 1.383–1, 1.469–9,
1.469–11, 1.704–1, 1.882–5, 1.1362–3,
1.1368–1, 1.1377–1, 1.1502–13, 1.1502–
21, 1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, and 1.383–1), and 1.1504–4,
to that taxable year. Additionally,
taxpayers and their related parties
within the meaning of sections 267(b)
and 707(b)(1), otherwise relying on the
notice of proposed rulemaking that was
published on December 28, 2018, in the
Federal Register (83 FR 67490) in its
entirety under § 1.163(j)–1(c), may
alternatively choose to follow § 1.163(j)–
1(b)(1)(iii), rather than proposed
§ 1.163(j)–1(b)(1)(iii).
(2) Anti-avoidance rules. The antiavoidance rules in paragraph (b)(22)(iv)
of this section apply to transactions
entered into on or after September 14,
2020.
(3) Swaps with significant
nonperiodic payments—(i) In general.
Except as provided in paragraph
(c)(3)(ii) of this section, the rules
provided in paragraph (b)(22)(ii) of this
section apply to notional principal
contracts entered into on or after
September 14, 2021. However, taxpayers
may choose to apply the rules provided
in paragraph (b)(22)(ii) of this section to
notional principal contracts entered into
before September 14, 2021.
(ii) Anti-avoidance rule. The antiavoidance rules in paragraph (b)(22)(iv)
of this section (applied without regard
to the references to paragraph (b)(22)(ii)
of this section) apply to a notional
principal contract entered into on or
after September 14, 2020.
§ 1.163(j)–2 Deduction for business
interest expense limited.
(a) Overview. This section provides
general rules regarding the section 163(j)
limitation. Paragraph (b) of this section
provides rules regarding the basic
computation of the section 163(j)
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limitation. Paragraph (c) of this section
provides rules for disallowed business
interest expense carryforwards.
Paragraph (d) of this section provides
rules regarding the small business
exemption from the section 163(j)
limitation. Paragraph (e) of this section
that is part of provides rules regarding
real estate mortgage investment
conduits (REMICs). Paragraph (f) of this
section provides rules regarding the
calculation of ATI with respect to
certain beneficiaries. Paragraph (g) of
this section provides rules regarding
tax-exempt organizations. Paragraph (h)
of this section provides examples
illustrating the application of this
section. Paragraph (i) of this section is
reserved. Paragraph (j) of this section
provides an anti-avoidance rule.
(b) General rule—(1) In general.
Except as otherwise provided in this
section or in §§ 1.163(j)–3 through
1.163(j)–11, the amount allowed as a
deduction for business interest expense
for the taxable year cannot exceed the
sum of—
(i) The taxpayer’s business interest
income for the taxable year;
(ii) 30 percent of the taxpayer’s ATI
for the taxable year, or zero if the
taxpayer’s ATI for the taxable year is
less than zero; and
(iii) The taxpayer’s floor plan
financing interest expense for the
taxable year.
(2) 50 percent ATI limitation for
taxable years beginning in 2019 or
2020—(i) In general. Except as
otherwise provided in section 163(j)(10)
and paragraph (b)(2) of this section, for
any taxable year beginning in 2019 or
2020, paragraph (b)(1)(ii) of this section
is applied by substituting 50 percent for
30 percent. The 50 percent ATI
limitation does not apply to
partnerships for taxable years beginning
in 2019. Further, for a partnership
taxable year beginning in 2020 for
which an election out of section
163(j)(10)(A)(i) has not been made,
§ 1.163(j)–6(f)(2)(xi) is applied by
substituting two for ten-thirds when
grossing up each partner’s final ATI
capacity excess amount.
(ii) Election out of the 50 percent ATI
limitation. A taxpayer may elect to not
have paragraph (b)(2)(i) of this section
apply for any taxable year beginning in
2019 or 2020. In the case of a
partnership, the election must be made
by the partnership and may be made
only for taxable years beginning in 2020.
(3) Election to use 2019 ATI in 2020—
(i) In general. Subject to paragraph
(b)(3)(ii), a taxpayer may elect to use the
taxpayer’s ATI for the last taxable year
beginning in 2019 (2019 ATI) as the ATI
for any taxable year beginning in 2020.
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(ii) Short taxable years. If an election
is made under paragraph (b)(3)(i) of this
section for a taxable year beginning in
2020 that is a short taxable year, the ATI
for such taxable year is equal to the
amount that bears the same ratio to 2019
ATI as the number of months in the
short taxable year bears to 12.
(4) Time and manner of making or
revoking the elections. The rules and
procedures regarding the time and
manner of making, or revoking, an
election under paragraphs (b)(2) and (3)
of this section are provided in Revenue
Procedure 2020–22, 2020–18 I.R.B. 745,
or in other guidance that may be issued
(see §§ 601.601(d) and 601.602 of this
chapter).
(c) Disallowed business interest
expense carryforward—(1) In general.
Any business interest expense
disallowed under paragraph (b) of this
section, or any disallowed disqualified
interest that is properly allocable to a
non-excepted trade or business under
§ 1.163(j)–10, is carried forward to the
succeeding taxable year as a disallowed
business interest expense carryforward,
and is therefore business interest
expense that is subject to paragraph (b)
of this section in such succeeding
taxable year. Disallowed business
interest expense carryforwards are not
re-allocated between non-excepted and
excepted trades or businesses in a
succeeding taxable year. Instead, the
carryforwards continue to be treated as
allocable to a non-excepted trade or
business. See § 1.163(j)–10(c)(4).
(2) Coordination with small business
exemption. If disallowed business
interest expense is carried forward
under the rules of paragraph (c)(1) of
this section to a taxable year in which
the small business exemption in
paragraph (d) of this section applies to
the taxpayer, then the general rule in
paragraph (b) of this section does not
apply to limit the deduction of the
disallowed business interest expense
carryforward of the taxpayer in that
taxable year. See § 1.163(j)–6(m)(3) for
rules applicable to the treatment of
excess business interest expense from a
partnership that is not subject to section
163(j) in a succeeding taxable year, and
see § 1.163(j)–6(m)(4) for rules
applicable to S corporations with
disallowed business interest expense
carryforwards that are not subject to
section 163(j) in a succeeding taxable
year.
(3) Cross-references—(i) For special
rules regarding disallowed business
interest expense carryforwards for
taxpayers that are C corporations,
including members of a consolidated
group, see § 1.163(j)–5.
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(ii) For special rules regarding
disallowed business interest expense
carryforwards of S corporations, see
§§ 1.163(j)–5(b)(2) and 1.163(j)–6(l)(5).
(iii) For special rules regarding
disallowed business interest expense
carryforwards from partnerships, see
§ 1.163(j)–6.
(iv)–(v) [Reserved]
(d) Small business exemption—(1)
Exemption. The general rule in
paragraph (b) of this section does not
apply to any taxpayer, other than a tax
shelter as defined in section 448(d)(3),
in any taxable year in which the
taxpayer meets the gross receipts test of
section 448(c) and the regulations in
this part under section 448 of the Code
for the taxable year. See § 1.163(j)–9(b)
for elections available under section
163(j)(7)(B) and 163(j)(7)(C) for real
property trades or businesses or farming
businesses that also may be exempt
small businesses. See § 1.163(j)–6(m) for
rules applicable to partnerships and S
corporations not subject to section
163(j).
(2) Application of the gross receipts
test—(i) In general. In the case of any
taxpayer that is not a corporation or a
partnership, and except as provided in
paragraphs (d)(2)(ii), (iii), and (iv) of this
section, the gross receipts test of section
448(c) and the regulations in this part
under section 448 of the Code are
applied in the same manner as if such
taxpayer were a corporation or
partnership.
(ii) Gross receipts of individuals.
Except as provided in paragraph
(d)(2)(iii) of this section (regarding
partnership and S corporation interests),
an individual taxpayer’s gross receipts
include all items specified as gross
receipts in regulations under section
448(c), whether or not derived in the
ordinary course of the taxpayer’s trade
or business. For purposes of section
163(j), an individual taxpayer’s gross
receipts do not include inherently
personal amounts, including, but not
limited to, personal injury awards or
settlements with respect to an injury of
the individual taxpayer, disability
benefits, Social Security benefits
received by the taxpayer during the
taxable year, and wages received as an
employee that are reported on Form W–
2.
(iii) Partners and S corporation
shareholders. Except when the
aggregation rules of section 448(c)
apply, each partner in a partnership
includes a share of partnership gross
receipts in proportion to such partner’s
distributive share (as determined under
section 704) of items of gross income
that were taken into account by the
partnership under section 703.
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Additionally, each shareholder in an S
corporation includes a pro rata share of
S corporation gross receipts.
(iv) Tax-exempt organizations. For
purposes of section 163(j), the gross
receipts of a tax-exempt organization
include only gross receipts taken into
account in determining its unrelated
business taxable income.
(e) REMICs. For the treatment of
interest expense by a REMIC as defined
in section 860D, see § 1.860C–2(b)(2)(ii).
(f) Trusts—(i) Calculation of ATI with
respect to certain trusts and estates. The
ATI of a trust or a decedent’s estate
taxable under section 641 is computed
without regard to deductions under
sections 642(c), 651, and 661.
(ii) Calculation of ATI with respect to
certain beneficiaries. The ATI of a
beneficiary (including a tax-exempt
beneficiary) of a trust or a decedent’s
estate is reduced by any income
(including any distributable net income)
received from the trust or estate by the
beneficiary to the extent such income
was necessary to permit a deduction
under section 163(j)(1)(B) and
§ 1.163(j)–2(b) for any business interest
expense of the trust or estate that was
in excess of any business interest
income of the trust or estate.
(g) Tax-exempt organizations. Except
as provided in paragraph (d) of this
section, the section 163(j) limitation
applies to tax-exempt organizations for
purposes of computing their unrelated
business taxable income under section
512. For rules on determining the gross
receipts of a tax-exempt organization for
purposes of the small business
exemption, see paragraph (d)(2)(iv) of
this section. For special rules applicable
to tax-exempt beneficiaries of a trust or
a decedent’s estate, see § 1.163(j)–2(f).
For special rules applicable to taxexempt corporations, see § 1.163(j)–4.
For special allocation rules applicable to
tax-exempt organizations, see § 1.163(j)–
10(a)(5).
(h) Examples. The examples in this
paragraph (h) illustrate the application
of section 163(j) and the provisions of
this section. Unless otherwise indicated,
X and Y are domestic C corporations; C
and D are U.S. resident individuals not
subject to any foreign income tax; PRS
is a domestic partnership with partners
who are all individuals; all taxpayers
use a calendar taxable year; the
exemption for certain small businesses
in section 163(j)(3) and paragraph (d) of
this section does not apply; and the
interest expense would be deductible
but for section 163(j).
(1) Example 1: Limitation on business
interest expense deduction—(i) Facts.
During its taxable year ending December
31, 2021, X has ATI of $100x. X has
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business interest expense of $50x,
which includes $10x of floor plan
financing interest expense, and business
interest income of $20x.
(ii) Analysis. For the 2021 taxable
year, X’s section 163(j) limitation is
$60x, which is the sum of its business
interest income ($20x), plus 30 percent
of its ATI ($100x × 30 percent = $30x),
plus its floor plan financing interest
expense ($10x). See § 1.163(j)–2(b).
Because X’s business interest expense
($50x) does not exceed X’s section 163(j)
limitation ($60x), X can deduct all $50x
of its business interest expense for the
2021 taxable year.
(2) Example 2: Carryforward of
business interest expense—(i) Facts. The
facts are the same as in Example 1 in
paragraph (h)(1)(i) of this section, except
that X has $80x of business interest
expense, which includes $10x of floor
plan financing interest expense.
(ii) Analysis. As in Example 1 in
paragraph (h)(1)(ii) of this section, X’s
section 163(j) limitation is $60x.
Because X’s business interest expense
($80x) exceeds X’s section 163(j)
limitation ($60x), X may only deduct
$60x of its business interest expense for
the 2021 taxable year, and the remaining
$20x of its business interest expense
will be carried forward to the
succeeding taxable year as a disallowed
business interest expense carryforward.
See § 1.163(j)–2(c).
(3) Example 3: ATI computation—(i)
Facts. During the 2020 taxable year, Y
has tentative taxable income of $30x,
which is determined without regard to
the application of the section 163(j)
limitation on business interest expense.
Y’s tentative taxable income includes
the following: $20x of business interest
income; $50x of business interest
expense, which includes $10x of floor
plan financing interest expense; $25x of
net operating loss deduction under
section 172; and $15x of depreciation
under section 167, of which $10x is
capitalized to inventory under section
263A. Of the $10x capitalized to
inventory, only $7x is recovered
through cost of goods sold during the
2020 taxable year and $3x remains in
ending inventory at the end of the 2020
taxable year. The $3x of ending
inventory is recovered through cost of
goods sold during the 2021 taxable year.
Y also has a disallowed business
interest expense carryforward from the
prior year of $8x.
(ii) Analysis. (A) For purposes of
determining the section 163(j) limitation
for 2020, Y’s disallowed business
interest expense carryforward is not
taken into account in determining
tentative taxable income or ATI. Y’s ATI
is $90x, calculated as follows:
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TABLE 1 TO PARAGRAPH (h)(3)(ii)(A)
Tentative taxable income ......
Less:
Floor plan financing interest ..
Business interest income ......
$30x
10x
20x
0x
(B) Plus:
TABLE 2 TO PARAGRAPH (h)(3)(ii)(B)
Business interest expense
Net operating loss deduction
Depreciation
$50x
25x
15x
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ATI
90x
(C) For Y’s 2021 taxable year, the $3x
of ending inventory that is recovered
through cost of goods sold in 2021 is not
added back to tentative taxable income
(TTI) in determining ATI because it was
already included as an addback in ATI
in Y’s 2020 taxable year. See § 1.163(j)–
1(b)(1)(iii).
(4) Example 4: Floor plan financing
interest expense—(i) Facts. C is the sole
proprietor of an automobile dealership
that uses a cash method of accounting.
In the 2021 taxable year, C paid $30x of
interest on a loan that was obtained to
purchase sedans for sale by the
dealership. The indebtedness is secured
by the sedans purchased with the loan
proceeds. In addition, C paid $20x of
interest on a loan, secured by the
dealership’s office equipment, which C
obtained to purchase convertibles for
sale by the dealership.
(ii) Analysis. For the purpose of
calculating C’s section 163(j) limitation,
only the $30x of interest paid on the
loan to purchase the sedans is floor plan
financing interest expense. The $20x
paid on the loan to purchase the
convertibles is not floor plan financing
interest expense for purposes of section
163(j) because the indebtedness was not
secured by the inventory of
convertibles. However, because under
§ 1.163(j)–10 the interest paid on the
loan to purchase the convertibles is
properly allocable to C’s dealership
trade or business, and because floor
plan financing interest expense is also
business interest expense, C has $50x of
business interest expense for the 2021
taxable year.
(5) Example 5: Interest not properly
allocable to non-excepted trade or
business—(i) Facts. The facts are the
same as in Example 4 in paragraph
(h)(4)(i) of this section, except that the
$20x of interest C pays is on acquisition
indebtedness obtained to purchase C’s
personal residence and not to purchase
convertibles for C’s dealership trade or
business.
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(ii) Analysis. Because the $20x of
interest expense is not properly
allocable to a non-excepted trade or
business, and therefore is not business
interest expense, C’s only business
interest expense is the $30x that C pays
on the loan used to purchase sedans for
sale in C’s dealership trade or business.
C deducts the $20x of interest related to
his residence under the rules of section
163(h), without regard to section 163(j).
(6) Example 6: Small business
exemption—(i) Facts. During the 2021
taxable year, D, the sole proprietor of a
trade or business reported on Schedule
C, has interest expense properly
allocable to that trade or business. D
does not conduct an electing real
property trade or business or an electing
farming business. D also earns gross
income from providing services as an
employee that is reported on a Form W–
2. Under section 448(c) and the
regulations in this part under section
448, D has average annual gross receipts
of $21 million, including $1 million of
wages in each of the three prior taxable
years and $2 million of income from
investments not related to a trade or
business in each of the three prior
taxable years. Also, in each of the three
prior taxable years, D received $5
million in periodic payments of
compensatory damages awarded in a
personal injury lawsuit.
(ii) Analysis. Section 163(j) does not
apply to D for the taxable year, because
D qualifies for the small business
exemption under § 1.163(j)–2(d). The
wages that D receives as an employee
and the compensatory damages that D
received from D’s personal injury
lawsuit are not gross receipts, as
provided in § 1.163(j)–2(d)(2)(ii). D may
deduct all of its business interest
expense for the 2021 taxable year
without regard to section 163(j).
(7) Example 7: Partnership with
excess business interest expense
qualifies for the small business
exemption in a succeeding taxable
year—(i) Facts. X and Y are equal
partners in partnership PRS. In addition
to being partners in PRS, X and Y each
operate their own sole proprietorships.
For the taxable year ending December
31, 2021, PRS is subject to section 163(j)
and has excess business interest
expense of $10x. For the taxable year
ending December 31, 2022, PRS has
$40x of business interest expense, and
X and Y have $20x of business interest
expense from their respective sole
proprietorships. For the taxable year
ending December 31, 2022, PRS and Y
qualify for the small business exemption
under § 1.163(j)–2(d), while X is subject
to section 163(j) and has a section 163(j)
limitation of $22x.
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(ii) Partnership-level analysis. For the
2021 taxable year, PRS allocates the
$10x of excess business interest expense
equally to X and Y ($5x each). See
§ 1.163(j)–6(f)(2). For the 2022 taxable
year, section 163(j) does not apply to
PRS because PRS qualifies for the small
business exemption. As a result, none of
PRS’s $40x of business interest expense
for the 2022 taxable year is subject to
the section 163(j) limitation at the
partnership level.
(iii) Partner-level analysis. For the
2022 taxable year, each partner treats its
$5x of excess business interest expense
from PRS as paid or accrued in that
year. See § 1.163(j)–6(m)(3). This
amount becomes business interest
expense that each partner must subject
to its own section 163(j) limitation, if
any. With this $5x, each partner has
$25x of business interest expense for the
2022 taxable year ($20x from its sole
proprietorship, plus $5x of excess
business interest expense treated as paid
or accrued in the 2020 taxable year). X
deducts $22x of its business interest
expense pursuant to its section 163(j)
limitation and carries forward the
remainder ($3x) as a disallowed
business interest expense carryforward
to the taxable year ending December 31,
2023. Y is not subject to section 163(j)
because Y qualifies for the small
business exemption. Y therefore deducts
all $25x of its business interest expense
for the 2022 taxable year.
(8) Example 8: Aggregation of gross
receipts—(i) Facts. X and Y are domestic
C corporations under common control,
within the meaning of section 52(a) and
§ 1.52–1(b). X’s only trade or business is
a farming business described in
§ 1.263A–4(a)(4). During the taxable
year ending December 31, 2020, X has
average annual gross receipts under
section 448(c) of $6 million. During the
same taxable year, Y has average annual
gross receipts under section 448(c) of
$21 million.
(ii) Analysis. Because X and Y are
under common control, they must
aggregate gross receipts for purposes of
section 448(c) and the small business
exemption in § 1.163(j)–2(d). See section
448(c)(2). Therefore, X and Y are both
considered to have $27 million in
average annual gross receipts for 2020.
X and Y must separately apply section
163(j) to determine any limitation on the
deduction for business interest expense.
Assuming X otherwise meets the
requirements in § 1.163(j)–9 in 2020, X
may elect for its farming business to be
an excepted trade or business.
(i) [Reserved]
(j) Anti-avoidance rule—(1) In
general. Arrangements entered into with
a principal purpose of avoiding the
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rules of section 163(j) or the section
163(j) regulations, including the use of
multiple entities to avoid the gross
receipts test of section 448(c), may be
disregarded or recharacterized by the
Commissioner of the IRS to the extent
necessary to carry out the purposes of
section 163(j).
(2) Examples. The examples in this
paragraph (j)(2) illustrate the application
of this section.
(i) Example 1—(A) Facts. Individual
A operates an excepted trade or
business (Business X) and a nonexcepted trade or business (Business Y).
With a principal purpose of avoiding
the rules of section 163(j) or the
regulations in this part under section
163(j) of the Code, A contributes
Business X to newly-formed C
corporation B in exchange for stock; A
then causes B to borrow funds from a
third party and distributes a portion of
the borrowed funds to A for use in
Business Y. B takes the position that its
interest payments on the debt are not
subject to the section 163(j) limitation
because B is engaged solely in an
excepted trade or business.
(B) Analysis. A has entered into an
arrangement with a principal purpose of
avoiding the rules of section 163(j) or
the regulations in this part under
section 163(j). Thus, under paragraph
(j)(1) of this section, the Commissioner
of the IRS may disregard or
recharacterize this transaction to the
extent necessary to carry out the
purposes of section 163(j). In this case,
payments of interest on the debt may be
recharacterized as payments of interest
properly allocable to a non-excepted
trade or business subject to the section
163(j) limitation.
(ii) Example 2—(A) Facts. Partnership
UTP has two non-excepted trades or
businesses. Business A has gross income
of $1000x and gross deductions of
$200x. Business B has gross income of
$100x and gross deductions of $600x.
With a principal purpose of avoiding
the rules in section 163(j) or the
regulations in this part under section
163(j), UTP and a partner of UTP form
partnership LTP and UTP contributes
Business B to LTP prior to borrowing
funds. UTP takes the position that it
does not take its share of LTP gross
deductions into account when
computing its ATI.
(B) Analysis. UTP has entered into an
arrangement with a principal purpose of
avoiding the rules of section 163(j) or
the regulations in this part under
section 163(j). Thus, under paragraph
(j)(1) of this section, the Commissioner
of the IRS may disregard or
recharacterize this transaction to the
extent necessary to carry out the
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purposes of section 163(j). In this case,
UTP’s share of gross deductions from
LTP may be recharacterized as gross
deductions incurred directly by UTP
solely for purposes of computing UTP’s
ATI.
(k) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
§ 1.163(j)–3 Relationship of the section
163(j) limitation to other provisions
affecting interest.
(a) Overview. This section contains
rules regarding the relationship between
section 163(j) and certain other
provisions of the Code. Paragraph (b) of
this section provides the general rules
concerning the relationship between
section 163(j) and certain other
provisions of the Code. Paragraph (c) of
this section provides examples
illustrating the application of this
section. For rules regarding the
relationship between sections 163(j) and
704(d), see § 1.163(j)–6(h)(1) and (2).
(b) Coordination of section 163(j) with
certain other provisions—(1) In general.
Section 163(j) and the regulations in this
part under section 163(j) of the Code
generally apply only to business interest
expense that would be deductible in the
current taxable year without regard to
section 163(j). Thus, for example, a
taxpayer must apply § 1.163–8T, if
applicable, to determine which items of
interest expense are investment interest
under section 163(d) before applying the
rules in this section to interest expense.
Except as otherwise provided in this
section, section 163(j) applies after the
application of provisions that subject
interest expense to disallowance,
deferral, capitalization, or other
limitation. For the rules that must be
applied in determining whether excess
business interest is paid or accrued by
a partner, see section 163(j)(4)(B)(ii) and
§ 1.163(j)–6.
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(2) Disallowed interest provisions. For
purposes of section 163(j), business
interest expense does not include
interest expense that is permanently
disallowed as a deduction under
another provision of the Code, such as
in section 163(e)(5)(A)(i), (f), (l), or (m),
or section 264(a), 265, 267A, or 279.
(3) Deferred interest provisions. Other
than sections 461(l), 465, and 469, Code
provisions that defer the deductibility of
interest expense, such as section
163(e)(3) and (e)(5)(A)(ii), 267(a)(2) and
(3), 1277, or 1282, apply before the
application of section 163(j).
(4) At risk rules, passive activity loss
provisions, and limitation on excess
business losses of noncorporate
taxpayers. Section 163(j) generally
applies to limit the deduction for
business interest expense before the
application of sections 461(l), 465, and
469. However, in determining tentative
taxable income for purposes of
computing ATI, sections 461(l), 465,
and 469 are taken into account.
(5) Capitalized interest expenses.
Section 163(j) applies after the
application of provisions that require
the capitalization of interest, such as
sections 263A and 263(g). Capitalized
interest expense under those sections is
not treated as business interest expense
for purposes of section 163(j). For
ordering rules that determine whether
interest expense is capitalized under
section 263A(f), see the regulations
under section 263A(f), including
§ 1.263A–9(g).
(6) Reductions under section 246A.
Section 246A applies before section
163(j). Any reduction in the dividends
received deduction under section 246A
reduces the amount of interest expense
taken into account under section 163(j).
(7) Section 381. Disallowed business
interest expense carryforwards are items
to which an acquiring corporation
succeeds under section 381(a). See
section 381(c)(20) and §§ 1.163(j)–5(c)
and 1.381(c)(20)–1.
(8) Section 382. For rules governing
the interaction of sections 163(j) and
382, see section 382(d)(3) and (k)(1),
§§ 1.163(j)–5(e) and 1.163(j)–11(c), the
regulations in this part under sections
382 and 383 of the Code, and §§ 1.1502–
91 through 1.1502–99.
(c) Examples. The examples in this
paragraph (c) illustrate the application
of section 163(j) and the provisions of
this section. Unless otherwise indicated,
X and Y are calendar-year domestic C
corporations; D is a U.S. resident
individual not subject to any foreign
income tax; none of the taxpayers have
floor plan financing interest expense;
and the exemption for certain small
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businesses in § 1.163(j)–2(d) does not
apply.
(1) Example 1: Disallowed interest
expense—(i) Facts. In 2021, X has $30x
of interest expense. Of X’s interest
expense, $10x is permanently
disallowed under section 265. X’s
business interest income is $3x and X’s
ATI is $90x.
(ii) Analysis. Under paragraph (b)(2)
of this section, the $10x interest expense
that is permanently disallowed under
section 265 cannot be taken into
consideration for purposes of section
163(j) in the 2021 taxable year. X’s
section 163(j) limitation, or the amount
of business interest expense that X may
deduct is limited to $30x under
§ 1.163(j)–2(b), determined by adding
X’s business interest income ($3x) and
30 percent of X’s 2019 ATI ($27x).
Therefore, in the 2021 taxable year,
none of the $20x of X’s deduction for its
business interest expense is disallowed
under section 163(j).
(2) Example 2: Deferred interest
expense—(i) Facts. In 2021, Y has no
business interest income, $120x of ATI,
and $70x of interest expense. Of Y’s
interest expense, $30x is not currently
deductible under section 267(a)(2). The
$30x expense is allowed as a deduction
under section 267(a)(2) in 2022.
(ii) Analysis. Under paragraph (b)(3)
of this section, section 267(a)(2) is
applied before section 163(j).
Accordingly, $30x of Y’s interest
expense cannot be taken into
consideration for purposes of section
163(j) in 2021 because it is not currently
deductible under section 267(a)(2).
Accordingly, in 2021, if the interest
expense is properly allocable to a nonexcepted trade or business, Y will have
$4x of disallowed business interest
expense because the $40x of business
interest expense in 2021 ($70x¥$30x)
exceeds 30 percent of its ATI for the
taxable year ($36x). The $30x of interest
expense not allowed as a deduction in
the 2021 taxable year under section
267(a)(2) will be taken into account in
determining the business interest
expense deduction under section 163(j)
in 2022, the taxable year in which it is
allowed as a deduction under section
267(a)(2), if it is allocable to a trade or
business. Additionally, the $4x of
disallowed business interest expense in
2021 will be carried forward to 2022 as
a disallowed business interest expense
carryforward. See § 1.163(j)–2(c).
(3) Example 3: Passive activity loss—
(i) Facts. D is engaged in a rental activity
treated as a passive activity within the
meaning of section 469. For the 2021
taxable year, D receives $200x of rental
income and incurs $300x of expenses all
properly allocable to the rental activity,
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consisting of $150x of interest expense,
$60x of maintenance expenses, and
$90x of depreciation expense. D’s ATI is
$400x.
(ii) Analysis. Under paragraph (b)(4)
of this section, section 163(j) is applied
before the section 469 passive loss rules
apply, except that section 469 is taken
into account in the determination of
tentative taxable income for purposes of
computing ATI. D’s section 163(j)
limitation is $120x, determined by
adding to D’s business interest income
($0), floor plan financing ($0), and 30
percent of D’s ATI ($120x). See
§ 1.163(j)–2(b). Because D’s business
interest expense of $150x exceeds D’s
section 163(j) limitation for 2021, $30x
of D’s business interest expense is
disallowed under section 163(j) and will
be carried forward as a disallowed
business interest expense carryforward.
See § 1.163(j)–2(c). Because the section
163(j) limitation is applied before the
limitation under section 469, only
$120x of the business interest expense
allowable under section 163(j) is
included in determining D’s passive
activity loss limitation for the 2021 tax
year under section 469. The $30x of
disallowed business interest expense is
not an allowable deduction under
section 163(j) and, therefore, is not a
deduction under section 469 in the
current taxable year. See § 1.469–2(d)(8).
(4) Example 4: Passive activity loss by
taxpayer that also participates in a nonpassive activity—(i) Facts. For 2021, D
has no business interest income and ATI
of $1,000x, entirely attributable to a
passive activity within the meaning of
section 469. D has business interest
expense of $1,000x, $900x of which is
properly allocable to a passive activity
and $100x of which is properly
allocable to a non-passive activity in
which D materially participates. D has
other business deductions that are not
subject to section 469 of $600x, and a
section 469 passive loss from the
previous year of $250x.
(ii) Analysis. Under paragraph (b)(4)
of this section, section 163(j) is applied
before the section 469 passive loss rules
apply. D’s section 163(j) limitation is
$300x, determined by adding D’s
business interest income ($0), floor plan
financing ($0), and 30 percent of D’s
ATI ($300x)). Next, applying the
limitation under section 469 to the
$300x business interest expense
deduction allowable under section
163(a) and (j), $270x (a proportionate
amount of the $300x (0.90 × $300x)) is
business interest expense included in
determining D’s passive activity loss
limitation under section 469, and $30x
(a proportionate amount of the $300x
(0.10 × $300)) is business interest
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expense not included in determining
D’s passive activity loss limitation
under section 469. Because D’s interest
expense of $1,000x exceeds 30 percent
of its ATI for 2021, $700x of D’s interest
expense is disallowed under section
163(j) and will be carried forward as a
disallowed business interest expense
carryforward. Section 469 does not
apply to any portion of the $700x
disallowed business interest expense
because that business interest expense is
not an allowable deduction under
section 163(j) and, therefore, is not an
allowable deduction under section 469
in the current taxable year. See § 1.469–
2(d)(8).
(5) Example 5: ATI calculation with
passive activity loss—(i) Facts. D is an
individual who engages in a trade or
business, V, as a sole proprietorship. D
relies on employees to perform most of
the work and, as a result, D does not
materially participate in V. Therefore, V
is a passive activity of D. V is not an
excepted trade or business. In Year 1, V
generates $500x of passive income,
$400x of business interest expense, and
$600x of ordinary and necessary
expenses deductible under section 162
(not including any interest described in
§ 1.163(j)–1(b)(22)). No disallowed
business interest expense carryforward
has been carried to Year 1 from a prior
year, and no amounts have been carried
over to Year 1 from a prior year under
either section 465(a)(2) or section
469(b).
(ii) Tentative taxable income. Under
§ 1.163(j)–1(b)(43), tentative taxable
income is determined as though all
business interest expense was not
subject to the section 163(j) limitation.
Sections 461(l), 465, and 469 apply in
the determination of tentative taxable
income. For year 1, D has $500x of
allowable deductions and a $500x
tentative passive activity loss under
section 469, because D’s $1000x of
passive expenses exceeds D’s $500x of
passive income from V. The tentative
disallowance of $500x is generally
allocated pro rata between D’s passive
expenses under § 1.469–1T(f)(2)(ii)(A).
In this case, fifty percent ($500x of
passive activity loss divided by $1000x
of total passive expenses) of each
category of passive expense is
tentatively disallowed: $200x of
business interest expense and $300x of
section 162 expense. D’s tentative
taxable income is $0 (zero), which is
determined by reducing $500x of gross
income by the remaining $200x of
business interest expense and $300x of
section 162 expense
($500x¥$200x¥$300x).
(iii) ATI. Under section § 1.163(j)–
1(b)(1), to determine ATI, D must add
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business interest expense to tentative
taxable income, but only to the extent
that the business interest expense
reduced tentative taxable income, or
$200x. The $200x of business interest
expense that was tentatively disallowed
under section 469 is not added to
tentative taxable income to determine
ATI. D’s ATI is $200x, which is
determined by adding the $200x of
business interest expense that reduced
tentative taxable income to D’s tentative
taxable income, or $0 (0 + $200x).
(iv) Section 163(j) limitation. D’s
section 163(j) limitation in Year 1 is D’s
business interest income, or $0, plus 30
percent of ATI, or $60x (30 percent ×
$200x ATI), plus D’s floor plan
financing, or $0, for a total of $60x ($0
+ $60x + $0). Before the application of
section 469, D has $60x of deductible
business interest expense and $340x of
disallowed business interest expense
carryforward under § 1.163(j)–2(c).
(v) Passive activity loss. Because D’s
passive deductions exceed the passive
income from V, and D does not have any
passive income from other sources,
section 469 applies to limit D’s passive
loss from V. Having first applied section
163(j), D has $660x of passive expenses,
determined by adding D’s $60x of
business interest expense that is
allowed by section 163(j) as a deduction
and $600x of section 162 expense ($60x
+ $600x). D offsets $500x of the passive
expenses against $500x of passive
income; therefore, D has a passive
activity loss of $160x in Year 1,
determined as the excess of D’s total
passive expenses over D’s passive
income ($660x¥$500x). The amount of
D’s loss from the passive activity that is
disallowed under section 469 ($160x) is
generally ratably allocated to each of D’s
passive activity deductions under
§ 1.469–1T(f)(2)(ii)(A). As a general rule,
each deduction is multiplied by the
ratio of the total passive loss to total
passive expenses (160x/660x). Of D’s
$60x business interest expense, $14.55x
(($160x/$660x) × $60x) is disallowed in
Year 1. Additionally, of D’s $600x
section 162 expense, $145.45x (($160x/
$660x) × $600x) is disallowed. The
amounts disallowed under section
469(a)(1) and § 1.469–2T(f)(2) are
carried over to the succeeding taxable
year under section 469(b) and § 1.469–
1(f)(4).
(6) Example 6: Effect of passive
activity loss carryforwards—(i) Facts.
The facts are the same as in Example 5
in paragraph (c)(5)(i) of this section. In
Year 2, V generates $500x of passive
income, $100x of business interest
expense, and $0 (zero) of other
deductible expenses. D is not engaged in
any other trade or business activities. A
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disallowed business interest expense
carryforward of $340x has been carried
to Year 2 from Year 1. Under section
469, D has a suspended loss from Year
1 that includes $14.55x of business
interest expense and $145.45x of section
162 expense. These amounts are treated
as passive activity deductions in Year 2.
(ii) Tentative taxable income. To
determine D’s tentative taxable income,
D must first determine D’s allowable
deductions. In year 2, D has $260x of
allowable deductions, which includes
$100x of business interest expense
generated Year 2, $14.55x of business
interest expense disallowed in Year 1 by
section 469, and $145.45x of section 162
expense disallowed in Year 1 by section
469 ($100x + $14.55x + $145.45x)). D’s
disallowed business interest expense
carryforward from Year 1 is not taken
into account in determining tentative
taxable income. See § 1.163(j)–1(b)(43).
Additionally, the $14.55x of business
interest expense disallowed in Year 1 by
section 469 is not business interest
expense in Year 2 because it was
deductible after the application of
section 163(j) (but before the application
of section 469) in Year 1. D does not
have a tentative passive activity loss in
Year 2, because D’s $500x of passive
income from V exceeds D’s $260x of
tentative passive expenses. Therefore,
D’s tentative taxable income in Year 2
is $240x, which is determined by
subtracting D’s allowable deductions
other than disallowed business interest
expense carryforwards, or $260x, from
D’s gross income, or $500x
($500x¥$260x).
(iii) ATI. D’s ATI in Year 2 is $340x,
which is determined by adding D’s
business interest expense, or $100x, to
D’s tentative taxable income, or $240x
($240x + $100x). Because disallowed
business interest expense carryforwards
are not taken into account in
determining tentative taxable income,
there is no corresponding adjustment for
disallowed business interest expense
carryforwards in calculating ATI.
Therefore, there is no adjustment for D’s
$340x of disallowed business interest
expense carryforward in calculating D’s
ATI. D has no other adjustments to
determine ATI.
(iv) Section 163(j) limitation. D’s
section 163(j) limitation in Year 2 is
$102x, which is determined by adding
D’s business interest income, or $0, 30
percent of D’s ATI for year 2, $102
($340x × 30 percent), and D’s floor plan
financing for Year 2, or $0 ($0 + ($102x)
+ $0). Accordingly, before the
application of section 469 in Year 2,
$102x of D’s $440x of total business
interest expense (determined by adding
$340x of disallowed business interest
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expense carryforward from Year 1 and
$100x of business interest expense in
Year 2) is deductible. D has $338x of
disallowed business interest expense
carryforward that will carry forward to
subsequent taxable years under
§ 1.163(j)–2(c), determined by
subtracting D’s deductible business
interest expense in Year 2, or $102x,
from D’s total business interest expense
in Year 2, or $440x ($440x¥$102x).
(v) Section 469. After applying the
section 163(j) limitation, D applies
section 469 to determine if any amount
of D’s expense is a disallowed passive
activity loss. For Year 2, D has $262x of
passive expenses, determined by adding
D’s business interest expense deduction
allowed by section 163(j) ($102x), D’s
section 162 expense carried forward
from Year 1 under section 469
($145.45x), and D’s interest expense
carried forward from Year 1 under
section 469 which is not business
interest expense in Year 2, or $14.55x
($102x + $145.45x + $14.55x).
Therefore, D has $238x of net passive
income in Year 2, determined by
reducing D’s total passive income in
Year 2 ($500x), by D’s disallowed
passive activity loss, or $262x
($500x¥$262x). D does not have a
passive activity loss in Year 2, and no
part of D’s $262x of passive expenses is
disallowed in Year 2 under section 469.
(7) Example 7: Capitalized interest
expense—(i) Facts. In 2020, X has $50x
of interest expense. Of X’s interest
expense, $10x is required to be
capitalized under section 263A. X
capitalizes this interest expense to a
depreciable asset. X’s business interest
income is $9x and X’s ATI is $80x. X
makes the election in § 1.163(j)–
2(b)(2)(ii) to use 30 percent, rather than
50 percent, of ATI in determining X’s
section 163(j) limitation for the 2020
taxable year.
(ii) Analysis. Under paragraph (b)(5)
of this section, section 263A is applied
before section 163(j). Accordingly, $10x
of X’s interest expense cannot be taken
into consideration for purposes of
section 163(j) in 2020. Additionally,
under paragraph (b)(5) of this section,
X’s $10 of capitalized interest expense
is not business interest expense for
purposes of section 163(j). As a result,
when X recovers its capitalized interest
expense through depreciation
deductions, such capitalized interest
expense will not be taken into account
as business interest expense in
determining X’s section 163(j)
limitation. X’s section 163(j) limitation
in 2020, or the amount of business
interest expense that X may deduct, is
limited to $33x under § 1.163(j)–2(b),
determined by adding X’s business
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interest income ($9x) and 30 percent of
X’s 2020 ATI ($24x). X therefore has $7x
of disallowed business interest expense
in 2020 that will be carried forward to
2021 as a disallowed business interest
expense carryforward.
(d) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
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§ 1.163(j)–4 General rules applicable to C
corporations (including REITs, RICs, and
members of consolidated groups) and taxexempt corporations.
(a) Scope. This section provides rules
regarding the computation of items of
income and expense under section
163(j) for taxpayers that are C
corporations, including, for example,
members of a consolidated group,
REITs, RICs, tax-exempt corporations,
and cooperatives. Paragraph (b) of this
section provides rules regarding the
characterization of items of income,
gain, deduction, or loss. Paragraph (c) of
this section provides rules regarding
adjustments to earnings and profits.
Paragraph (d) of this section provides
rules applicable to members of a
consolidated group. Paragraph (e) of this
section provides rules governing the
ownership of partnership interests by
members of a consolidated group.
Paragraph (f) of this section provides
cross-references to other rules within
the 163(j) regulations that may be
applicable to C corporations.
(b) Characterization of items of
income, gain, deduction, or loss—(1)
Interest expense and interest income.
Solely for purposes of section 163(j), all
interest expense of a taxpayer that is a
C corporation is treated as properly
allocable to a trade or business.
Similarly, solely for purposes of section
163(j), all interest income of a taxpayer
that is a C corporation is treated as
properly allocable to a trade or business.
For rules governing the allocation of
interest expense and interest income
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between excepted and non-excepted
trades or businesses, see § 1.163(j)–10.
(2) Adjusted taxable income. Solely
for purposes of section 163(j), all items
of income, gain, deduction, or loss of a
taxpayer that is a C corporation are
treated as properly allocable to a trade
or business. For rules governing the
allocation of tax items between excepted
and non-excepted trades or businesses,
see § 1.163(j)–10.
(3) Investment interest, investment
income, investment expenses, and
certain other tax items of a partnership
with a C corporation partner—(i)
Characterization as expense or income
properly allocable to a trade or
business. For purposes of section 163(j),
any investment interest, investment
income, or investment expense (within
the meaning of section 163(d)) that a
partnership pays, receives, or accrues
and that is allocated to a C corporation
partner as a separately stated item is
treated by the C corporation partner as
properly allocable to a trade or business
of that partner. Similarly, for purposes
of section 163(j), any other tax items of
a partnership that are neither properly
allocable to a trade or business of the
partnership nor described in section
163(d) and that are allocated to a C
corporation partner as separately stated
items are treated as properly allocable to
a trade or business of that partner.
(ii) Effect of characterization on
partnership. The characterization of a
partner’s tax items pursuant to
paragraph (b)(3)(i) of this section does
not affect the characterization of these
items at the partnership level.
(iii) Separately stated interest expense
and interest income of a partnership not
treated as excess business interest
expense or excess taxable income of a
C corporation partner. Investment
interest expense and other interest
expense of a partnership that is treated
as business interest expense by a C
corporation partner under paragraph
(b)(3)(i) of this section is not treated as
excess business interest expense of the
partnership. Investment interest income
and other interest income of a
partnership that is treated as business
interest income by a C corporation
partner under paragraph (b)(3)(i) of this
section is not treated as excess taxable
income of the partnership. For rules
governing excess business interest
expense and excess taxable income, see
§ 1.163(j)–6.
(iv) Treatment of deemed inclusions
of a domestic partnership that are not
allocable to any trade or business. If a
United States shareholder that is a
domestic partnership includes amounts
in gross income under sections 951(a) or
951A(a) that are not properly allocable
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56775
to a trade or business of the domestic
partnership, then, notwithstanding
paragraph (b)(3)(i) of this section, to the
extent a C corporation partner,
including an indirect partner in the case
of tiered partnerships, takes such
amounts into account as a distributive
share in accordance with section 702
and § 1.702–1(a)(8)(ii), the C corporation
partner may not treat such amounts as
properly allocable to a trade or business
of the C corporation partner.
(4) Application to RICs and REITs—(i)
In general. Except as otherwise
provided in paragraphs (b)(4)(ii) and
(iii) of this section, the rules in this
paragraph (b) apply to RICs and REITs.
(ii) Tentative taxable income of RICs
and REITs. The tentative taxable income
of a RIC or REIT for purposes of
calculating ATI is the tentative taxable
income of the corporation, without any
adjustment that would be made under
section 852(b)(2) or 857(b)(2) to
compute investment company taxable
income or real estate investment trust
taxable income, respectively. For
example, the tentative taxable income of
a RIC or REIT is not reduced by the
deduction for dividends paid, but is
reduced by the dividends received
deduction (DRD) and the other
deductions described in sections
852(b)(2)(C) and 857(b)(2)(A). See
paragraph (b)(4)(iii) of this section for an
adjustment to ATI in respect of these
items.
(iii) Other adjustments to adjusted
taxable income for RICs and REITs. In
the case of a taxpayer that, for a taxable
year, is a RIC to which section 852(b)
applies or a REIT to which section
857(b) applies, the taxpayer’s ATI for
the taxable year is increased by the
amounts of any deductions described in
section 852(b)(2)(C) or 857(b)(2)(A).
(5) Application to tax-exempt
corporations. The rules in this
paragraph (b) apply to a tax-exempt
corporation only with respect to that
corporation’s items of income, gain,
deduction, or loss that are taken into
account in computing the corporation’s
unrelated business taxable income, as
defined in section 512.
(6) Adjusted taxable income of
cooperatives. Solely for purposes of
computing the ATI of a cooperative
under § 1.163(j)–1(b)(1), tentative
taxable income is not reduced by the
amount of any patronage dividend
under section 1382(b)(1) or by any
amount paid in redemption of
nonqualified written notices of
allocation distributed as patronage
dividends under section 1382(b)(2) (for
cooperatives subject to taxation under
sections 1381 through 1388), any
amount described in section 1382(c) (for
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cooperatives described in section
1381(a)(1) and section 521), or any
equivalent amount deducted by an
organization that operates on a
cooperative basis but is not subject to
taxation under sections 1381 through
1388.
(7) Examples. The principles of this
paragraph (b) are illustrated by the
following examples. For purposes of the
examples in this paragraph (b)(7) of this
section, T is a taxable domestic C
corporation whose taxable year ends on
December 31; T is neither a
consolidated group member nor a RIC or
a REIT; neither T nor PS1, a domestic
partnership, owns at least 80 percent of
the stock of any corporation; neither T
nor PS1 qualifies for the small business
exemption in § 1.163(j)–2(d) or is
engaged in an excepted trade or
business; T has no floor plan financing
expense; all interest expense is
deductible except for the potential
application of section 163(j); and the
facts set forth the only corporate or
partnership activity.
(i) Example 1: C corporation items
properly allocable to a trade or
business—(A) Facts. In taxable year
2021, T’s tentative taxable income
(without regard to the application of
section 163(j)) is $320x. This amount is
comprised of the following tax items:
$1,000x of revenue from inventory sales;
$500x of ordinary and necessary
business expenses (excluding interest
and depreciation); $200x of interest
expense; $50x of interest income; $50x
of depreciation deductions under
section 168; and a $20x gain on the sale
of stock.
(B) Analysis. For purposes of section
163(j), each of T’s tax items is treated as
properly allocable to a trade or business.
Thus, T’s ATI for the 2021 taxable year
is $520x ($320x of tentative taxable
income + $200x business interest
expense¥$50x business interest income
+ $50x depreciation deductions =
$520x), and its section 163(j) limitation
for the 2021 taxable year is $206x ($50x
of business interest income + 30 percent
of its ATI (30 percent × $520x) = $206x).
As a result, all $200x of T’s interest
expense is deductible in the 2021
taxable year under section 163(j).
(C) Taxable year beginning in 2022.
The facts are the same as in Example 1
in paragraph (b)(7)(i)(A) of this section,
except that the taxable year begins in
2022 and therefore depreciation
deductions are not added back to ATI
under § 1.163(j)–1(b)(1)(i)(E). As a
result, T’s ATI for 2022 is $470x ($320x
of tentative taxable income + $200x
business interest expense¥$50x
business interest income = $470x), and
its section 163(j) limitation for the 2022
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taxable year is $191x ($50x of business
interest income + 30 percent of its ATI
(30 percent × $470x) = $191x). As a
result, T may only deduct $191x of its
business interest expense for the taxable
year, and the remaining $9x is carried
forward to the 2023 taxable year as a
disallowed business interest expense
carryforward. See § 1.163(j)–2(c).
(ii) Example 2: C corporation
partner—(A) Facts. T and individual A
each own a 50 percent interest in PS1,
a general partnership. PS1 borrows
funds from a third party (Loan 1) and
uses those funds to buy stock in
publicly-traded corporation X. PS1’s
only activities are holding X stock (and
receiving dividends) and making
payments on Loan 1. In the 2021 taxable
year, PS1 receives $150x in dividends
and pays $100x in interest on Loan 1.
(B) Analysis. For purposes of section
163(d) and (j), PS1 has investment
interest expense of $100x and
investment income of $150x, and PS1
has no interest expense or interest
income that is properly allocable to a
trade or business. PS1 allocates its
investment interest expense and
investment income equally to its two
partners pursuant to § 1.163(j)–6(k).
Pursuant to paragraph (b)(3) of this
section, T’s allocable share of PS1’s
investment interest expense is treated as
a business interest expense of T, and T’s
allocable share of PS1’s investment
income is treated as properly allocable
to a trade or business of T. This business
interest expense is not treated as excess
business interest expense, and this
income is not treated as excess taxable
income. See paragraph (b)(3)(iii) of this
section. T’s treatment of its allocable
share of PS1’s investment interest
expense and investment income as
business interest expense and income
properly allocable to a trade or business,
respectively, does not affect the
character of these items at the PS1 level
and does not affect the character of A’s
allocable share of PS1’s investment
interest and investment income.
(C) Partnership engaged in a trade or
business. The facts are the same as in
Example 2 in paragraph (b)(7)(ii)(A) of
this section, except that PS1 also is
engaged in Business 1, and PS1 borrows
funds from a third party to finance
Business 1 (Loan 2). In 2021, Business
1 earns $150x of net income (excluding
interest expense and depreciation), and
PS1 pays $100x of interest on Loan 2.
For purposes of section 163(d) and (j),
PS1 treats the interest paid on Loan 2
as properly allocable to a trade or
business. As a result, PS1 has
investment interest expense of $100x
(attributable to Loan 1), business
interest expense of $100x (attributable
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to Loan 2), $150x of investment income,
and $150x of income from Business 1.
PS1’s ATI is $150x (its net income from
Business 1 excluding interest and
depreciation), and its section 163(j)
limitation is $45x (30 percent × $150x).
Pursuant to § 1.163(j)–6, PS1 has $55x of
excess business interest expense
($100x¥$45x), half of which ($27.5x) is
allocable to T. Additionally, pursuant to
paragraph (b)(3)(i) of this section, T’s
allocable share of PS1’s investment
interest expense ($50x) is treated as a
business interest expense of T for
purposes of section 163(j), and T’s
allocable share of PS1’s investment
income ($75x) is treated as properly
allocable to a trade or business of T.
Therefore, with respect to T’s interest in
PS1, T is treated as having $50x of
business interest expense that is not
treated as excess business interest
expense, $75x of income that is properly
allocable to a trade or business, and
$27.5x of excess business interest
expense.
(c) Effect on earnings and profits—(1)
In general. In the case of a taxpayer that
is a domestic C corporation, except as
otherwise provided in paragraph (c)(2)
of this section, the disallowance and
carryforward under § 1.163(j)–2 (and
§ 1.163(j)–5, in the case of a taxpayer
that is a consolidated group member) of
a deduction for business interest
expense of the taxpayer or of a
partnership in which the taxpayer is a
partner does not affect whether or when
the business interest expense reduces
the taxpayer’s earnings and profits. In
the case of a foreign corporation, the
disallowance and carryforward of a
deduction for the corporation’s business
interest expense under § 1.163(j)–2 does
not affect whether and when such
business interest expense reduces the
corporation’s earnings and profits. Thus,
for example, if a United States person
has elected under section 1295 to treat
a passive foreign investment company
(as defined in section 1297) (PFIC) as a
qualified electing fund, then the
disallowance and carryforward of a
deduction for the PFIC’s business
interest expense under § 1.163(j)–2 does
not affect whether or when such
business interest expense reduces the
PFIC’s earnings and profits.
(2) Special rule for RICs and REITs. In
the case of a taxpayer that is a RIC or
a REIT for the taxable year in which a
deduction for the taxpayer’s business
interest expense is disallowed under
§ 1.163(j)–2(b), or in which the RIC or
REIT is allocated any excess business
interest expense from a partnership
under section 163(j)(4)(B)(i) and
§ 1.163(j)–6, the taxpayer’s earnings and
profits are adjusted in the taxable year
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or years in which the business interest
expense is deductible or, if earlier, in
the first taxable year for which the
taxpayer no longer is a RIC or a REIT.
(3) Special rule for partners that are
C corporations. If a taxpayer that is a C
corporation is allocated any excess
business interest expense from a
partnership, and if all or a portion of the
excess business interest expense has not
yet been treated as business interest
expense by the taxpayer at the time of
the taxpayer’s disposition of all or a
portion of its interest in the partnership,
the taxpayer must increase its earnings
and profits immediately prior to the
disposition by an amount equal to the
amount of the basis adjustment required
under section 163(j)(4)(B)(iii)(II) and
§ 1.163(j)–6(h)(3).
(4) Examples. The principles of this
paragraph (c) are illustrated by the
following examples. For purposes of the
examples in this paragraph (c)(4), except
as otherwise provided in the examples,
X is a taxable domestic C corporation
whose taxable year ends on December
31; X is not a member of a consolidated
group; X does not qualify for the small
business exemption under § 1.163(j)–
2(d); X is not engaged in an excepted
trade or business; X has no floor plan
financing indebtedness; all interest
expense is deductible except for the
potential application of section 163(j); X
has no accumulated earnings and profits
at the beginning of the 2021 taxable
year; and the facts set forth the only
corporate activity.
(i) Example 1: Earnings and profits of
a taxable domestic C corporation other
than a RIC or a REIT—(A) Facts. X is
a corporation that does not intend to
qualify as a RIC or a REIT for its 2021
taxable year. In that year, X has tentative
taxable income (without regard to the
application of section 163(j)) of $0,
which includes $100x of gross income
and $100x of interest expense on a loan
from an unrelated third party. X also
makes a $100x distribution to its
shareholders that year.
(B) Analysis. The $100x of interest
expense is business interest expense for
purposes of section 163(j) (see
paragraph (b)(1) of this section). X’s ATI
in the 2021 taxable year is $100x ($0 of
tentative taxable income computed
without regard to $100x of business
interest expense). Thus, X may deduct
$30x of its $100x of business interest
expense in the 2021 taxable year under
§ 1.163(j)–2(b) (30 percent × $100x), and
X may carry forward the remainder
($70x) to X’s 2022 taxable year as a
disallowed business interest expense
carryforward under § 1.163(j)–2(c).
Although X may not currently deduct
all $100x of its business interest
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expense in the 2021 taxable year, X
must reduce its earnings and profits in
that taxable year by the full amount of
its business interest expense ($100x) in
that taxable year. As a result, no portion
of X’s distribution of $100x to its
shareholders in the 2021 taxable year is
a dividend within the meaning of
section 316(a).
(ii) Example 2: RIC adjusted taxable
income and earnings and profits—(A)
Facts. X is a corporation that intends to
qualify as a RIC for its 2021 taxable year.
In that taxable year, X’s only items are
$100x of interest income, $50x of
dividend income from C corporations
that only issue common stock and in
which X has less than a twenty percent
interest (by vote and value), $10x of net
capital gain, and $125x of interest
expense. None of the dividends are
received on debt financed portfolio
stock under section 246A. The DRD
determined under section 243(a) with
respect to X’s $50x of dividend income
is $25x. X pays $42x in dividends to its
shareholders, meeting the requirements
of section 562 during X’s 2021 taxable
year, including $10x that X reports as
capital gain dividends in written
statements furnished to X’s
shareholders.
(B) Analysis. (1) Under paragraph (b)
of this section, all of X’s interest
expense is considered business interest
expense, all of X’s interest income is
considered business interest income,
and all of X’s other income is
considered to be properly allocable to a
trade or business. Under paragraph
(b)(4)(ii) of this section, prior to the
application of section 163(j), X’s
tentative taxable income is $10x ($100x
business interest income + $50x
dividend income + $10x net capital
gain¥$125x business interest
expense¥$25x DRD = $10x). Under
paragraph (b)(4)(iii) of this section, X’s
ATI is increased by the DRD. As such,
X’s ATI for the 2021 taxable year is $60x
($10x tentative taxable income + $125x
business interest expense¥$100x
business interest income + $25x DRD =
$60x).
(2) X may deduct $118x of its $125x
of business interest expense in the 2021
taxable year under section 163(j)(1)
($100x business interest income + (30
percent × $60x of ATI) = $118x), and X
may carry forward the remainder ($7x)
to X’s 2022 taxable year. See § 1.163(j)–
2(b) and (c).
(3) After the application of section
163(j), X has taxable income of $17x
($100x interest income + $50x dividend
income + $10x capital gain¥$25x
DRD¥$118x allowable interest expense
= $17x) for the 2021 taxable year. X will
have investment company taxable
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56777
income (ICTI) in the amount of $0 ($17x
taxable income¥$10x capital gain +
$25x DRD¥$32x dividends paid
deduction for ordinary dividends = $0).
The excess of X’s net capital gain ($10x)
over X’s dividends paid deduction
determined with reference to capital
gain dividends ($10x) is also $0.
(4) Under paragraph (c)(2) of this
section, X will not reduce its earnings
and profits by the amount of interest
expense disallowed as a deduction in
the 2021 taxable year under section
163(j). Thus, X has current earnings and
profits in the amount of $42x ($100x
interest income + $50x dividend income
+ $10x capital gain¥$118x allowable
business interest expense = $42x) before
giving effect to dividends paid during
the 2021 taxable year.
(iii) Example 3: Carryforward of
disallowed interest expense—(A) Facts.
The facts are the same as the facts in
Example 2 in paragraph (c)(4)(ii)(A) of
this section for the 2021 taxable year. In
addition, X has $50x of interest income
and $20x of interest expense for the
2022 taxable year.
(B) Analysis. Under paragraph (b) of
this section, all of X’s interest expense
is considered business interest expense,
all of X’s interest income is considered
business interest income, and all of X’s
other income is considered to be
properly allocable to a trade or business.
Because X’s $50x of business interest
income exceeds the $20x of business
interest expense from the 2022 taxable
year and the $7x of disallowed business
interest expense carryforward from the
2021 taxable year, X may deduct $27x
of business interest expense in the 2022
taxable year. Under paragraph (c)(2) of
this section, X must reduce its current
earnings and profits for the 2022 taxable
year by the full amount of the
deductible business interest expense
($27x).
(iv) Example 4: REIT adjusted taxable
income and earnings and profits—(A)
Facts. X is a corporation that intends to
qualify as a REIT for its 2021 taxable
year. X is not engaged in an excepted
trade or business and is not engaged in
a trade or business that is eligible to
make any election under section
163(j)(7). In that year, X’s only items are
$100x of mortgage interest income, $30x
of dividend income from C corporations
that only issue common stock and in
which X has less than a ten percent
interest (by vote and value), $10x of net
capital gain from the sale of mortgages
on real property that is not property
described in section 1221(a)(1), and
$125x of interest expense. None of the
dividends are received on debt financed
portfolio stock under section 246A. The
DRD determined under section 243(a)
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with respect to X’s $30x of dividend
income is $15x. X pays $28x in
dividends meeting the requirements of
section 562 during X’s 2021 taxable
year, including $10x that X properly
designates as capital gain dividends
under section 857(b)(3)(B).
(B) Analysis. (1) Under paragraph (b)
of this section, all of X’s interest
expense is considered business interest
expense, all of X’s interest income is
considered business interest income,
and all of X’s other income is
considered to be properly allocable to a
trade or business. Under paragraph
(b)(4)(ii) of this section, prior to the
application of section 163(j), X’s
tentative taxable income is $0 ($100x
business interest income + $30x
dividend income + $10x net capital
gain¥$125x business interest
expense¥$15x DRD = $0). Under
paragraph (b)(4)(iii) of this section, X’s
ATI is increased by the DRD. As such,
X’s ATI for the 2021 taxable year is $40x
($0 tentative taxable income + $125x
business interest expense¥$100x
business interest income + $15x DRD =
$40x).
(2) X may deduct $112x of its $125x
of business interest expense in the 2021
taxable year under section 163(j)(1)
($100x business interest income + (30
percent × $40x of ATI) = $112x), and X
may carry forward the remainder of its
business interest expense ($13x) to X’s
2022 taxable year.
(3) After the application of section
163(j), X has taxable income of $13x
($100x business interest income + $30x
dividend income + $10x capital
gain¥$15x DRD¥$112x allowable
business interest expense = $13x) for the
2021 taxable year. X will have real
estate investment trust taxable income
(REITTI) in the amount of $0 ($13x
taxable income + $15x of DRD¥$28x
dividends paid deduction = $0).
(4) Under paragraph (c)(2) of this
section, X will not reduce earnings and
profits by the amount of business
interest expense disallowed as a
deduction in the 2021 taxable year.
Thus, X has current earnings and profits
in the amount of $28x ($100x business
interest income + $30x dividend income
+ $10x capital gain¥$112x allowable
business interest expense = $28x) before
giving effect to dividends paid during
X’s 2021 taxable year.
(v) Example 5: Carryforward of
disallowed interest expense—(A) Facts.
The facts are the same as in Example 4
in paragraph (c)(4)(iv)(A) of this section
for the 2021 taxable year. In addition, X
has $50x of mortgage interest income
and $20x of interest expense for the
2022 taxable year. X has no other tax
items for the 2022 taxable year.
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(B) Analysis. Because X’s $50x of
business interest income exceeds the
$20x of business interest expense from
the 2022 taxable year and the $13x of
disallowed business interest expense
carryforwards from the 2021 taxable
year, X may deduct $33x of business
interest expense in 2022. Under
paragraph (c)(2) of this section, X must
reduce its current earnings and profits
for 2022 by the full amount of the
deductible interest expense ($33x).
(d) Special rules for consolidated
groups—(1) Scope. This paragraph (d)
provides rules applicable to members of
a consolidated group. For all members
of a consolidated group for a
consolidated return year, the
computations required by section 163(j)
and the regulations in this part under
section 163(j) are made in accordance
with the rules of this paragraph (d)
unless otherwise provided elsewhere in
the section 163(j) regulations. For rules
governing the ownership of partnership
interests by members of a consolidated
group, see paragraph (e) of this section.
(2) Calculation of the section 163(j)
limitation for members of a
consolidated group—(i) In general. A
consolidated group has a single section
163(j) limitation, the absorption of
which is governed by § 1.163(j)–
5(b)(3)(ii).
(ii) Interest. For purposes of
determining whether amounts, other
than amounts in respect of
intercompany obligations (as defined in
§ 1.1502–13(g)(2)(ii)), intercompany
items (as defined in § 1.1502–13(b)(2)),
or corresponding items (as defined in
§ 1.1502–13(b)(3)), are treated as interest
within the meaning of § 1.163(j)–
1(b)(22), all members of a consolidated
group are treated as a single taxpayer.
(iii) Calculation of business interest
expense and business interest income
for a consolidated group. For purposes
of calculating the section 163(j)
limitation for a consolidated group, the
consolidated group’s current-year
business interest expense and business
interest income, respectively, are the
sum of each member’s current-year
business interest expense and business
interest income, including amounts
treated as business interest expense and
business interest income under
paragraph (b)(3) of this section.
(iv) Calculation of adjusted taxable
income. For purposes of calculating the
ATI for a consolidated group, the
tentative taxable income is the
consolidated group’s consolidated
taxable income, determined under
§ 1.1502–11 but without regard to any
carryforwards or disallowances under
section 163(j). Further, for purposes of
calculating the ATI of the group,
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intercompany items and corresponding
items are disregarded to the extent that
they offset in amount. Thus, for
example, certain portions of the
intercompany items and corresponding
items of a group member engaged in a
non-excepted trade or business will not
be included in ATI to the extent that the
counterparties to the relevant
intercompany transactions are engaged
in one or more excepted trades or
businesses.
(v) Treatment of intercompany
obligations—(A) In general. Except as
otherwise provided in paragraph
(d)(2)(v)(B) of this section, for purposes
of determining a member’s business
interest expense and business interest
income, and for purposes of calculating
the consolidated group’s ATI, all
intercompany obligations, as defined in
§ 1.1502–13(g)(2)(ii), are disregarded.
Therefore, except as otherwise provided
in paragraph (d)(2)(v)(B) of this section,
interest expense and interest income
from intercompany obligations are not
treated as business interest expense and
business interest income.
(B) Repurchase premium. This
paragraph (d)(2)(v)(B) applies if a
member of a consolidated group
purchases an obligation of another
member of the same consolidated group
in a transaction to which § 1.1502–
13(g)(5) applies. Notwithstanding the
general rule of paragraph (d)(2)(v)(A) of
this section, if, as a result of the deemed
satisfaction of the obligation under
§ 1.1502–13(g)(5)(ii), the debtor member
has repurchase premium that is
deductible under § 1.163–7(c), such
repurchase premium is treated as
interest that is subject to the section
163(j) limitation. See § 1.163(j)–
1(b)(22)(i)(H).
(3) Investment adjustments. For rules
governing investment adjustments
within a consolidated group, see
§ 1.1502–32(b).
(4) Examples. The principles in this
paragraph (d) are illustrated by the
following examples. For purposes of the
examples in this paragraph (d)(4), S is
a member of the calendar-year
consolidated group of which P is the
common parent; the P group does not
qualify for the small business exemption
in § 1.163(j)–2(d); no member of the P
group is engaged in an excepted trade or
business; all interest expense is
deductible except for the potential
application of section 163(j); and the
facts set forth the only corporate
activity.
(i) Example 1: Calculation of the
section 163(j) limitation—(A) Facts. In
the 2021 taxable year, P has $50x of
separate tentative taxable income after
taking into account $65x of interest paid
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on a loan from a third party (without
regard to any disallowance under
section 163(j)) and $35x of depreciation
deductions under section 168. In turn,
S has $40x of separate tentative taxable
income in the 2021 taxable year after
taking into account $10x of depreciation
deductions under section 168. S has no
interest expense in the 2021 taxable
year. The P group’s tentative taxable
income the 2021 taxable year is $90x,
determined under § 1.1502–11 without
regard to any disallowance under
section 163(j).
(B) Analysis. As provided in
paragraph (b)(1) of this section, P’s
interest expense is treated as business
interest expense for purposes of section
163(j). If P and S were to apply the
section 163(j) limitation on a separateentity basis, then P’s ATI would be
$150x ($50x + $65x + $35x = $150x), its
section 163(j) limitation would be $45x
(30 percent × $150x = $45x), and a
deduction for $20x of its $65x of
business interest expense would be
disallowed in the 2021 taxable year
under section 163(j). However, as
provided in paragraph (d)(2) of this
section, the P group computes a single
section 163(j) limitation, and that
computation begins with the P group’s
tentative taxable income (as determined
prior to the application of section
163(j)), or $90x. The P group’s ATI is
$200x ($50x + $40x + $65x + $35x +
$10x = $200x). Thus, the P group’s
section 163(j) limitation for the 2021
taxable year is $60x (30 percent × $200x
= $60x). As a result, all but $5x of the
P group’s business interest expense is
deductible in the 2021 taxable year. P
carries over the $5x of disallowed
business interest expense to the
succeeding taxable year.
(ii) Example 2: Intercompany
obligations—(A) Facts. On January 1,
2021, G, a corporation unrelated to P
and S, lends P $100x in exchange for a
note that accrues interest at a 10 percent
annual rate. A month later, P lends
$100x to S in exchange for a note that
accrues interest at a 12 percent annual
rate. In 2021, P accrues and pays $10x
of interest to G on P’s note, and S
accrues and pays $12x of interest to P
on S’s note. For that year, the P group’s
only other items of income, gain,
deduction, and loss are $40x of income
earned by S from the sale of inventory,
and a $30x deductible expense arising
from P’s payment of tort liability claims.
(B) Analysis. As provided in
paragraph (d)(2)(v) of this section, the
intercompany obligation between P and
S is disregarded in determining P and
S’s business interest expense and
business interest income and in
determining the P group’s ATI. For
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purposes of section 163(j), P has $10x of
business interest expense and a $30x
deduction for the payment of tort
liability claims, and S has $40x of
income. The P group’s ATI is $10x
($40x¥$30x = $10x), and its section
163(j) limitation is $3x (30 percent ×
$10x = $3x). The P group may deduct
$3x of its business interest expense in
the 2021 taxable year. A deduction for
P’s remaining $7x of business interest
expense is disallowed in the 2021
taxable year, and this amount is carried
forward to the 2022 taxable year.
(e) Ownership of partnership interests
by members of a consolidated group.
(1) [Reserved]
(2) Change in status of a member. A
change in status of a member (that is,
becoming or ceasing to be a member of
the group) is not treated as a disposition
for purposes of section
163(j)(4)(B)(iii)(II) and § 1.163(j)–6(h)(3).
(3) Basis adjustments under § 1.1502–
32. A member’s allocation of excess
business interest expense from a
partnership and the resulting decrease
in basis in the partnership interest
under section 163(j)(4)(B)(iii)(I) is not a
noncapital, nondeductible expense for
purposes of § 1.1502–32(b)(3)(iii).
Additionally, an increase in a member’s
basis in a partnership interest under
section 163(j)(4)(B)(iii)(II) to reflect
excess business interest expense not
deducted by the consolidated group is
not tax-exempt income for purposes of
§ 1.1502–32(b)(3)(ii). Investment
adjustments are made under § 1.1502–
32(b)(3)(i) when the excess business
interest expense from the partnership is
converted into business interest
expense, deducted, and absorbed by the
consolidated group. See § 1.1502–32(b).
(4) Excess business interest expense
and § 1.1502–36. Excess business
interest expense is a Category D asset
within the meaning of § 1.1502–
36(d)(4)(i).
(f) Cross-references. For rules
governing the treatment of disallowed
business interest expense carryforwards
for C corporations, including rules
governing the treatment of disallowed
business interest expense carryforwards
when members enter or leave a
consolidated group, see § 1.163(j)–5. For
rules governing the application of
section 163(j) to a C corporation or a
consolidated group engaged in both
excepted and non-excepted trades or
businesses, see § 1.163(j)–10.
(g) Applicability date—(1) In general.
This section applies to taxable years
beginning on or after November 13,
2020. However, taxpayers and their
related parties, within the meaning of
sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
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56779
to a taxable year beginning after
December 31, 2017, so long as the
taxpayers and their related parties
consistently apply the rules of the
section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
(2) [Reserved]
§ 1.163(j)–5 General rules governing
disallowed business interest expense
carryforwards for C corporations.
(a) Scope and definitions—(1) Scope.
This section provides rules regarding
disallowed business interest expense
carryforwards for taxpayers that are C
corporations, including members of a
consolidated group. Paragraph (b) of this
section provides rules regarding the
treatment of disallowed business
interest expense carryforwards.
Paragraph (c) of this section provides a
cross-reference to other rules regarding
disallowed business interest expense
carryforwards in transactions to which
section 381(a) applies. Paragraph (d) of
this section provides rules regarding
limitations on disallowed business
interest expense carryforwards from
separate return limitation years (SRLYs).
Paragraph (e) of this section provides
cross-references to other rules regarding
the application of section 382 to
disallowed business interest expense
carryforwards. Paragraph (f) of this
section provides a cross-reference to
other rules regarding the overlap of the
SRLY limitation with section 382.
Paragraph (g) of this section references
additional rules that may limit the
deductibility of interest or the use of
disallowed business interest expense
carryforwards.
(2) Definitions—(i) Allocable share of
the consolidated group’s remaining
section 163(j) limitation. The term
allocable share of the consolidated
group’s remaining section 163(j)
limitation means, with respect to any
member of a consolidated group, the
product of the consolidated group’s
remaining section 163(j) limitation and
the member’s remaining current-year
interest ratio.
(ii) Consolidated group’s remaining
section 163(j) limitation. The term
consolidated group’s remaining section
163(j) limitation means the amount of
the consolidated group’s section 163(j)
limitation calculated pursuant to
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
§ 1.163(j)–4(d)(2), reduced by the
amount of interest deducted by
members of the consolidated group
pursuant to paragraph (b)(3)(ii)(C)(2) of
this section.
(iii) Remaining current-year interest
ratio. The term remaining current-year
interest ratio means, with respect to any
member of a consolidated group for a
particular taxable year, the ratio of the
remaining current-year business interest
expense of the member after applying
the rule in paragraph (b)(3)(ii)(C)(2) of
this section, to the sum of the amounts
of remaining current-year business
interest expense for all members of the
consolidated group after applying the
rule in paragraph (b)(3)(ii)(C)(2) of this
section.
(b) Treatment of disallowed business
interest expense carryforwards—(1) In
general. The amount of any business
interest expense of a C corporation not
allowed as a deduction for any taxable
year as a result of the section 163(j)
limitation is carried forward to the
succeeding taxable year as a disallowed
business interest expense carryforward
under section 163(j)(2) and § 1.163(j)–
2(c).
(2) Deduction of business interest
expense. For a taxpayer that is a C
corporation, current-year business
interest expense is deducted in the
current taxable year before any
disallowed business interest expense
carryforwards from a prior taxable year
are deducted in that year. Disallowed
business interest expense carryforwards
are deducted in the order of the taxable
years in which they arose, beginning
with the earliest taxable year, subject to
certain limitations (for example, the
limitation under section 382). For
purposes of section 163(j), disallowed
disqualified interest is treated as carried
forward from the taxable year in which
a deduction was disallowed under old
section 163(j).
(3) Consolidated groups—(i) In
general. A consolidated group’s
disallowed business interest expense
carryforwards for the current
consolidated return year (the current
year) are the carryforwards from the
group’s prior consolidated return years
plus any carryforwards from separate
return years.
(ii) Deduction of business interest
expense—(A) General rule. All currentyear business interest expense of
members of a consolidated group is
deducted in the current year before any
disallowed business interest expense
carryforwards from prior taxable years
are deducted in the current year.
Disallowed business interest expense
carryforwards from prior taxable years
are deducted in the order of the taxable
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18:00 Sep 11, 2020
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years in which they arose, beginning
with the earliest taxable year, subject to
the limitations described in this section.
(B) Section 163(j) limitation equals or
exceeds the current-year business
interest expense and disallowed
business interest expense carryforwards
from prior taxable years. If a
consolidated group’s section 163(j)
limitation for the current year equals or
exceeds the aggregate amount of its
members’ current-year business interest
expense and disallowed business
interest expense carryforwards from
prior taxable years that are available for
deduction, then none of the current-year
business interest expense or disallowed
business interest expense carryforwards
is subject to disallowance in the current
year under section 163(j). However, a
deduction for the members’ business
interest expense may be subject to
limitation under other provisions of the
Code or the Income Tax Regulations
(see, for example, paragraphs (c), (d), (e),
and (f) of this section).
(C) Current-year business interest
expense and disallowed business
interest expense carryforwards exceed
section 163(j) limitation. If the aggregate
amount of members’ current-year
business interest expense and
disallowed business interest expense
carryforwards from prior taxable years
exceeds the consolidated group’s
section 163(j) limitation for the current
year, then the following rules apply in
the order provided:
(1) The group first determines
whether its section 163(j) limitation for
the current year equals or exceeds the
aggregate amount of the members’
current-year business interest expense.
(i) If the group’s section 163(j)
limitation for the current year equals or
exceeds the aggregate amount of the
members’ current-year business interest
expense, then no amount of the group’s
current-year business interest expense is
subject to disallowance in the current
year under section 163(j). Once the
group has taken into account its
members’ current-year business interest
expense, the group applies the rules of
paragraph (b)(3)(ii)(C)(4) of this section.
(ii) If the aggregate amount of
members’ current-year business interest
expense exceeds the group’s section
163(j) limitation for the current year,
then the group applies the rule in
paragraph (b)(3)(ii)(C)(2) of this section.
(2) If this paragraph (b)(3)(ii)(C)(2)
applies (see paragraph (b)(3)(ii)(C)(1)(ii)
of this section), then each member with
current-year business interest expense
and with current-year business interest
income or floor plan financing interest
expense deducts current-year business
interest expense in an amount that does
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not exceed the sum of the member’s
business interest income and floor plan
financing interest expense for the
current year.
(3) After applying the rule in
paragraph (b)(3)(ii)(C)(2) of this section,
if the group has any section 163(j)
limitation remaining for the current
year, then each member with remaining
current-year business interest expense
deducts a portion of its expense based
on its allocable share of the
consolidated group’s remaining section
163(j) limitation.
(4) If this paragraph (b)(3)(ii)(C)(4)
applies (see paragraph (b)(3)(ii)(C)(1)(i)
of this section), and if the group has any
section 163(j) limitation remaining for
the current year after applying the rules
in paragraph (b)(3)(ii)(C)(1) of this
section, then disallowed business
interest expense carryforwards
permitted to be deducted (including
under paragraph (d)(1)(A) of this
section) in the current year are to be
deducted in the order of the taxable
years in which they arose, beginning
with the earliest taxable year.
Disallowed business interest expense
carryforwards from taxable years ending
on the same date that are available to
offset tentative taxable income for the
current year generally are to be
deducted on a pro rata basis under the
principles of paragraph (b)(3)(ii)(C)(3) of
this section. For example, assume that P
and S are the only members of a
consolidated group with a section 163(j)
limitation for the current year (Year 2)
of $200x; the amount of current-year
business interest expense deducted in
Year 2 is $100x; and P and S,
respectively, have $140x and $60x of
disallowed business interest expense
carryforwards from Year 1 that are not
subject to limitation under paragraph
(c), (d), or (e) of this section. Under
these facts, P would be allowed to
deduct $70x of its carryforwards from
Year 1 ($100x × ($140x/($60x + $140x))
= $70x), and S would be allowed to
deduct $30x of its carryforwards from
Year 1 ($100x × ($60x/($60x + $140x))
= $30x). But see § 1.383–1(d)(1)(ii),
providing that, if losses subject to and
not subject to the section 382 limitation
are carried from the same taxable year,
losses subject to the limitation are
deducted before losses not subject to the
limitation.
(5) Each member with remaining
business interest expense after applying
the rules of this paragraph (b)(3)(ii),
taking into account the limitations in
paragraphs (c), (d), (e), and (f) of this
section, carries the expense forward to
the succeeding taxable year as a
disallowed business interest expense
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
corporation’s first separate return year
after its change in status.
(iv) Example: Deduction of interest
expense—(A) Facts. (1) P wholly owns
A, which is a member of the
consolidated group of which P is the
common parent. P and A each borrow
money from Z, an unrelated third party.
The business interest expense of P and
A in Years 1, 2, and 3, and the P group’s
section 163(j) limitation for those years,
are as follows:
offset tentative taxable income in the
consolidated return year, are first made
available for deduction during that
consolidated return year. See § 1.1502–
76(b)(1)(i); see also § 1.1502–36(d)
(regarding reductions of deferred
deductions on the transfer of loss shares
of subsidiary stock). Only the amount
that is neither deducted by the group in
that consolidated return year nor
otherwise reduced under the Code or
regulations may be carried to the
carryforward under section 163(j)(2) and
§ 1.163(j)–2(c).
(iii) Departure from group. If a
corporation ceases to be a member
during a consolidated return year, the
corporation’s current-year business
interest expense from the taxable period
ending on the day of the corporation’s
change in status as a member, as well as
the corporation’s disallowed business
interest expense carryforwards from
prior taxable years that are available to
56781
TABLE 1 TO PARAGRAPH (b)(3)(iv)(A)(1)
P’s business
interest
expense
Year
1 ...................................................................................................................................................
2 ...................................................................................................................................................
3 ...................................................................................................................................................
(2) P and A have neither business
interest income nor floor plan financing
interest expense in Years 1, 2, and 3.
Additionally, the P group is neither
eligible for the small business
exemption in § 1.163(j)–2(d) nor
engaged in an excepted trade or
business.
(B) Analysis—(1) Year 1. In Year 1,
the aggregate amount of the P group
members’ current-year business interest
expense ($150x + $50x) exceeds the P
group’s section 163(j) limitation ($100x).
As a result, the rules of paragraph
(b)(3)(ii)(C) of this section apply.
Because the P group members’ currentyear business interest expense exceeds
the group’s section 163(j) limitation for
Year 1, P and A must apply the rule in
paragraph (b)(3)(ii)(C)(2) of this section.
Pursuant to paragraph (b)(3)(ii)(C)(2) of
this section, each of P and A must
deduct its current-year business interest
expense to the extent of its business
interest income and floor plan financing
interest expense. Neither P nor A has
business interest income or floor plan
financing interest expense in Year 1.
Next, pursuant to paragraph
(b)(3)(ii)(C)(3) of this section, each of P
and A must deduct a portion of its
current-year business interest expense
based on its allocable share of the
consolidated group’s remaining section
$150x
60x
25x
A’s business
interest
expense
$50x
90x
50x
P group’s
section 163(j)
limitation
$100x
120x
185x
interest income or floor plan financing
interest expense in Year 2. Next,
pursuant to paragraph (b)(3)(ii)(C)(3) of
this section, each of P and A must
deduct a portion of its current-year
business interest expense based on its
allocable share of the consolidated
group’s remaining section 163(j)
limitation ($120x). P’s allocable share is
$48x (($120x × ($60x/$150x)) = $48x),
and A’s allocable share is $72x (($120x
× ($90x/$150x)) = $72x). Accordingly, in
Year 2, P deducts $48x of current-year
business interest expense, and A
deducts $72x of current-year business
interest expense. P has a disallowed
business interest expense carryforward
from Year 2 of $12x ($60x¥$48x =
$12x), and A has a disallowed business
interest expense carryforward from Year
2 of $18x ($90x¥$72x = $18x).
Additionally, because the P group has
no section 163(j) limitation remaining
after deducting current-year business
interest expense in Year 2, the full
amount of P and A’s disallowed
business interest expense carryforwards
from Year 1 ($75x and $25x,
respectively) also are carried forward to
Year 3. As a result, at the beginning of
Year 3, P and A’s respective disallowed
business interest expense carryforwards
are as follows:
163(j) limitation ($100x). P’s allocable
share is $75x ($100x × ($150x/$200x) =
$75x), and A’s allocable share is $25x
($100x × ($50x/$200x) = $25x).
Accordingly, in Year 1, P deducts $75x
of its current-year business interest
expense, and A deducts $25x of its
current-year business interest expense.
P has a disallowed business interest
expense carryforward from Year 1 of
$75x ($150x¥$75x = $75x), and A has
a disallowed business interest expense
carryforward from Year 1 of $25x
($50x¥$25x = $25x).
(2) Year 2. In Year 2, the aggregate
amount of the P group members’
current-year business interest expense
($60x + $90x) and disallowed business
interest expense carryforwards ($75x +
$25x) exceeds the P group’s section
163(j) limitation ($120x). As a result, the
rules of paragraph (b)(3)(ii)(C) of this
section apply. Because the P group
members’ current-year business interest
expense exceeds the group’s section
163(j) limitation for Year 2, P and A
must apply the rule in paragraph
(b)(3)(ii)(C)(2) of this section. Pursuant
to paragraph (b)(3)(ii)(C)(2) of this
section, each of P and A must deduct its
current-year business interest expense
to the extent of its business interest
income and floor plan financing interest
expense. Neither P nor A has business
khammond on DSKJM1Z7X2PROD with RULES2
TABLE 2 TO PARAGRAPH (b)(3)(iv)(B)(2)
Year 1
disallowed
business
interest
expense
carryforwards
P ...................................................................................................................................................
A ...................................................................................................................................................
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E:\FR\FM\14SER2.SGM
$75x
25x
14SER2
Year 2
disallowed
business
interest
expense
carryforwards
$12x
18x
Total
disallowed
business
interest
expense
carryforwards
$87x
43x
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TABLE 2 TO PARAGRAPH (b)(3)(iv)(B)(2)—Continued
Year 1
disallowed
business
interest
expense
carryforwards
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Total ......................................................................................................................................
(3) Year 3. In Year 3, the aggregate
amount of the P group members’
current-year business interest expense
($25x + $50x = $75x) and disallowed
business interest expense carryforwards
($130x) exceeds the P group’s section
163(j) limitation ($185x). As a result, the
rules of paragraph (b)(3)(ii)(C) of this
section apply. Because the P group’s
section 163(j) limitation for Year 3
equals or exceeds the P group members’
current-year business interest expense,
no amount of the members’ current-year
business interest expense is subject to
disallowance under section 163(j) (see
paragraph (b)(3)(ii)(C)(1) of this section).
After each of P and A deducts its
current-year business interest expense,
the P group has $110x of section 163(j)
limitation remaining for Year 3
($185x¥$25x¥$50x = $110x). Next,
pursuant to paragraph (b)(3)(ii)(C)(4) of
this section, $110x of disallowed
business interest expense carryforwards
are deducted on a pro rata basis,
beginning with carryforwards from Year
1. Because the total amount of
carryforwards from Year 1 ($100x) is
less than the section 163(j) limitation
remaining after the deduction of Year 3
business interest expense ($110x), all of
the Year 1 carryforwards are deducted
in Year 3. After current-year business
interest expense and Year 1
carryforwards are deducted, the P
group’s remaining section 163(j)
limitation in Year 3 is $10x. Because the
Year 2 carryforwards ($30x) exceed the
remaining section 163(j) limitation
($10x), under paragraph (b)(3)(ii)(C)(4)
of this section, each of P and A will
deduct a portion of its Year 2
carryforwards based on its allocable
share of the consolidated group’s
remaining section 163(j) limitation. P’s
allocable share is $4x (($10x × ($12x/
$30x)) = $4x), and A’s allocable share is
$6x (($10x × ($18x/$30x)) = $6x).
Accordingly, P and A may deduct $4x
and $6x, respectively, of their Year 2
carryforwards. For Year 4, P and A have
$8x and $12x of disallowed business
interest expense carryforwards from
Year 2, respectively.
(c) Disallowed business interest
expense carryforwards in transactions to
which section 381(a) applies. For rules
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18:00 Sep 11, 2020
Jkt 250001
governing the application of section
381(c)(20) to disallowed business
interest expense carryforwards,
including limitations on an acquiring
corporation’s use of the disallowed
business interest expense carryforwards
of the transferor or distributor
corporation in the acquiring
corporation’s first taxable year ending
after the date of distribution or transfer,
see § 1.381(c)(20)–1.
(d) Limitations on disallowed business
interest expense carryforwards from
separate return limitation years—(1)
General rule—(A) Cumulative section
163(j) SRLY limitation. This paragraph
(d) applies to disallowed business
interest expense carryforwards of a
member arising in a SRLY (see § 1.1502–
1(f))) or treated as arising in a SRLY
under the principles of § 1.1502–21(c)
and (g). The amount of the
carryforwards described in the
preceding sentence that are included in
the consolidated group’s business
interest expense deduction for any
taxable year under paragraph (b) of this
section may not exceed the aggregate
section 163(j) limitation for all
consolidated return years of the group,
determined by reference only to the
member’s items of income, gain,
deduction, and loss, and reduced
(including below zero) by the member’s
business interest expense (including
disallowed business interest expense
carryforwards) absorbed by the group in
all consolidated return years
(cumulative section 163(j) SRLY
limitation). For purposes of computing
the member’s cumulative section 163(j)
SRLY limitation, intercompany items
referred to in § 1.163(j)–4(d)(2)(iv) are
included, with the exception of interest
items with regard to intercompany
obligations. See § 1.163(j)–4(d)(2)(v).
Thus, for purposes of this paragraph (d),
income and expense items arising from
intercompany transactions (other than
interest income and expense with regard
to intercompany obligations) are
included in the calculation of the
cumulative section 163(j) SRLY
limitation. In addition, items of interest
expense with regard to intercompany
obligations are not characterized as
business interest expense for purposes
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Frm 00098
Fmt 4701
Sfmt 4700
100x
Year 2
disallowed
business
interest
expense
carryforwards
30x
Total
disallowed
business
interest
expense
carryforwards
130x
of the reduction described in the second
sentence of this paragraph (d)(1)(A).
(B) Subgrouping. For purposes of this
paragraph (d), the SRLY subgroup
principles of § 1.1502–21(c)(2)(i) (with
regard to carryovers of SRLY losses)
apply with appropriate adjustments.
(2) Deduction of disallowed business
interest expense carryforwards arising
in a SRLY. Notwithstanding paragraph
(d)(1) of this section, disallowed
business interest expense carryforwards
of a member arising in a SRLY are
available for deduction by the
consolidated group in the current year
only to the extent the group has
remaining section 163(j) limitation for
the current year after the deduction of
current-year business interest expense
and disallowed business interest
expense carryforwards from earlier
taxable years that are permitted to be
deducted in the current year (see
paragraph (b)(3)(ii)(A) of this section).
SRLY-limited disallowed business
interest expense carryforwards are
deducted on a pro rata basis (under the
principles of paragraph (b)(3)(ii)(C)(3) of
this section) with non-SRLY limited
disallowed business interest expense
carryforwards from taxable years ending
on the same date. See also § 1.1502–
21(b)(1).
(3) Examples. The principles of this
paragraph (d) are illustrated by the
following examples. For purposes of the
examples in this paragraph (d)(3),
unless otherwise stated, P, R, S, and T
are taxable domestic C corporations that
are not RICs or REITs and that file their
tax returns on a calendar-year basis;
none of P, R, S, or T qualifies for the
small business exemption under section
163(j)(3) or is engaged in an excepted
trade or business; all interest expense is
deductible except for the potential
application of section 163(j); and the
facts set forth the only corporate
activity.
(i) Example 1: Determination of SRLY
limitation—(A) Facts. Individual A
owns P. In 2021, A forms T, which pays
or accrues a $100x business interest
expense for which a deduction is
disallowed under section 163(j) and that
is carried forward to 2022. P does not
pay or accrue business interest expense
in 2021, and P has no disallowed
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
business interest expense carryforwards
from prior taxable years. At the close of
2021, P acquires all of the stock of T,
which joins with P in filing a
consolidated return beginning in 2022.
Neither P nor T pays or accrues business
interest expense in 2022, and the P
group has a section 163(j) limitation of
$300x in that year. This limitation
would be $70x if determined by
reference solely to T’s items for all
consolidated return years of the P group.
(B) Analysis. T’s $100x of disallowed
business interest expense carryforwards
from 2021 arose in a SRLY. P’s
acquisition of T was not an ownership
change as defined by section 382(g);
thus, T’s disallowed business interest
expense carryforwards are subject to the
SRLY limitation in paragraph (d)(1) of
this section. T’s cumulative section
163(j) SRLY limitation for 2022 is the P
group’s section 163(j) limitation,
determined by reference solely to T’s
items for all consolidated return years of
the P group ($70x). See paragraph (d)(1)
of this section. Thus, $70x of T’s
disallowed business interest expense
carryforwards are available to be
deducted by the P group in 2022, and
the remaining $30x of T’s disallowed
business interest expense carryforwards
are carried forward to 2023. After the P
group deducts $70x of T’s disallowed
business interest expense carryforwards,
T’s cumulative section 163(j) SRLY
limitation is reduced by $70x to $0.
(C) Cumulative section 163(j) SRLY
limitation of $0. The facts are the same
as in Example 1 in paragraph (d)(3)(i)(A)
of this section, except that T’s
cumulative section 163(j) SRLY
limitation for 2022 is $0. Because the
amount of T’s disallowed business
interest expense carryforwards that may
be deducted by the P group in 2022 may
not exceed T’s cumulative section 163(j)
SRLY limitation, none of T’s
carryforwards from 2021 may be
deducted by the P group in 2022.
Because none of T’s disallowed business
interest expense carryforwards are
absorbed by the P group in 2022, T’s
cumulative section 163(j) SRLY
limitation remains at $0 entering 2023.
(ii) Example 2: Cumulative section
163(j) SRLY limitation less than zero—
(A) Facts. P and S are the only members
of a consolidated group. P has neither
current-year business interest expense
nor disallowed business interest
expense carryforwards. For the current
year, the P group has a section 163(j)
limitation of $150x, $25x of which is
attributable to P, and $125x of which is
attributable to S. S has $100x of
disallowed business interest expense
carryforwards that arose in a SRLY and
$150x of current-year business interest
expense. S’s cumulative section 163(j)
SRLY limitation entering the current
year (computed by reference solely to
S’s items for all consolidated return
years of the P group) is $0.
(B) Analysis. Under paragraph (d)(1)
of this section, S’s cumulative section
163(j) SRLY limitation is increased by
$125x to reflect S’s tax items for the
current year. The P group’s section
163(j) limitation permits the P group to
deduct all $150x of S’s current-year
business interest expense. S’s
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cumulative section 163(j) SRLY
limitation is reduced by the $150x of S’s
business interest expense absorbed by
the P group in the current year, which
results in a ¥$25x balance. Thus, none
of S’s SRLY’d disallowed business
interest expense carryforwards may be
deducted by the P group in the current
year. Entering the subsequent year, S’s
cumulative section 163(j) SRLY
limitation remains ¥$25x.
(iii) Example 3: Pro rata absorption of
SRLY-limited disallowed business
interest expense carryforwards—(A)
Facts. P, R, and S are the only members
of a consolidated group, and no member
has floor plan financing or business
interest income. P has $60x of currentyear business interest expense and $40x
of disallowed business interest expense
carryforwards from the previous year,
which was not a separate return year. R
has $120x of current-year business
interest expense and $80x of disallowed
business interest expense carryforwards
from the previous year, which was not
a separate return year. S has $70x of
current-year business interest expense
and $30x of disallowed business interest
expense carryforwards from the
previous year, which was a separate
return year. The P group has a section
163(j) limitation of $300x, $50x of
which is attributable to P, $90x to R,
and $160x to S. S’s cumulative section
163(j) SRLY limitation entering the
current year (computed by reference
solely to S’s items for all consolidated
return years of the P group) is $0.
TABLE 3 TO PARAGRAPH (d)(3)(iii)(A)
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Current-year
business
interest
expense
Disallowed
business
interest
expense
carryforwards
from prior
taxable year
Section 163(j)
limitation
P ...................................................................................................................................................
R ..................................................................................................................................................
S ...................................................................................................................................................
$60x
120x
70x
$40x
80x
(SRLY) 30x
$50x
90x
160x
Total ......................................................................................................................................
250x
150x
300x
(B) Analysis. Under paragraph (d)(1)
of this section, S’s cumulative section
163(j) SRLY limitation is increased in
the current year by $160x. The P group’s
section 163(j) limitation permits the P
group to deduct all $70x of S’s currentyear business interest expense (and all
$180x of P and R’s current-year business
interest expense). S’s cumulative section
163(j) SRLY limitation is reduced by the
$70x of S’s business interest expense
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absorbed by the P group in the current
year, resulting in a $90x balance.
Because the P group has $50x of section
163(j) limitation remaining after the
absorption of current-year business
interest expense, the P group can absorb
$50x of its members’ disallowed
business interest expense carryforwards.
Under paragraph (d)(2) of this section,
SRLY-limited disallowed business
interest expense carryforwards are
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deducted on a pro rata basis with other
disallowed business interest expense
carryforwards from the same taxable
year. Accordingly, the P group can
deduct $10x ($50x × ($30x/$150x)) of
S’s SRLY-limited disallowed business
interest expense carryforwards. S’s
cumulative section 163(j) SRLY
limitation is reduced (to $80x) by the
$10x of SRLY-limited disallowed
business interest carryforwards
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absorbed by the P group in the current
year.
(C) Cumulative section 163(j) SRLY
limitation of ¥$75x. The facts are the
same as in Example 3 in paragraph
(d)(3)(iii)(A) of this section, except that
S’s cumulative section 163(j) SRLY
limitation entering the current year is
¥$75x. After adjusting for S’s tax items
for the current year ($160x) and the P
group’s absorption of S’s current-year
business interest expense ($70x), S’s
cumulative section 163(j) SRLY
limitation is $15x (¥$75x +
$160x¥$70x). Because S’s cumulative
section 163(j) SRLY limitation ($15x) is
less than the amount of S’s SRLYlimited disallowed business interest
expense carryforwards ($30x), the pro
rata calculation under paragraph (d)(2)
of this section is applied to $15x (rather
than $30x) of S’s carryforwards.
Accordingly, the P group can deduct
$5.56x ($50x × ($15x/$135x)) of S’s
SRLY-limited disallowed business
interest expense carryforwards. S’s
cumulative section 163(j) SRLY
limitation is reduced (to $9.44x) by the
$5.56x of SRLY-limited disallowed
business interest carryforwards
absorbed by the P group in the current
year.
(e) Application of section 382—(1)
Pre-change loss. For rules governing the
treatment of a disallowed business
interest expense as a pre-change loss for
purposes of section 382, see §§ 1.382–
2(a) and 1.382–6. For rules governing
the application of section 382 to
disallowed disqualified interest
carryforwards, see § 1.163(j)–11(c)(4).
(2) Loss corporation. For rules
governing when a disallowed business
interest expense causes a corporation to
be a loss corporation within the
meaning of section 382(k)(1), see
§ 1.382–2(a). For the application of
section 382 to disallowed disqualified
interest carryforwards, see § 1.163(j)–
11(c)(4).
(3) Ordering rules for utilization of
pre-change losses and for absorption of
the section 382 limitation. For ordering
rules for the utilization of disallowed
business interest expense, net operating
losses, and other pre-change losses, and
for the absorption of the section 382
limitation, see § 1.383–1(d).
(4) Disallowed business interest
expense from the pre-change period in
the year of a testing date. For rules
governing the treatment of disallowed
business interest expense from the prechange period (within the meaning of
§ 1.382–6(g)(2)) in the year of a testing
date, see § 1.382–2.
(5) Recognized built-in loss. For a rule
providing that a section 382 disallowed
business interest carryforward (as
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defined in § 1.382–2(a)(7)) is not treated
as a recognized built-in loss for
purposes of section 382, see § 1.382–
7(d)(5).
(f) Overlap of SRLY limitation with
section 382. For rules governing the
overlap of the application of section 382
and the application of the SRLY rules,
see § 1.1502–21(g).
(g) Additional limitations. Additional
rules provided under the Code or
regulations also apply to limit the use of
disallowed business interest expense
carryforwards. For rules governing the
relationship between section 163(j) and
other provisions affecting the
deductibility of interest, see § 1.163(j)–
3.
(h) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
§ 1.163(j)–6 Application of the section
163(j) limitation to partnerships and
subchapter S corporations.
(a) Overview. If a deduction for
business interest expense of a
partnership or an S corporation is
subject to the section 163(j) limitation,
section 163(j)(4) provides that the
section 163(j) limitation applies at the
partnership or S corporation level and
any deduction for business interest
expense is taken into account in
determining the nonseparately stated
taxable income or loss of the
partnership or S corporation. Once a
partnership or an S corporation
determines its business interest
expense, business interest income, ATI,
and floor plan financing interest
expense, the partnership or S
corporation calculates its section 163(j)
limitation by applying the rules of
§ 1.163(j)–2(b) and this section.
Paragraph (b) of this section provides
definitions used in this section.
Paragraph (c) of this section provides
rules regarding the character of a
partnership’s deductible business
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interest expense and excess business
interest expense. Paragraph (d) of this
section provides rules regarding the
calculation of a partnership’s ATI and
floor plan financing interest expense.
Paragraph (e) of this section provides
rules regarding a partner’s ATI and
business interest income. Paragraph (f)
of this section provides an eleven-step
computation necessary for properly
allocating a partnership’s deductible
business interest expense and section
163(j) excess items to its partners.
Paragraph (g) of this section applies
carryforward rules at the partner level if
a partnership has excess business
interest expense. Paragraph (h) of this
section provides basis adjustment rules,
and paragraph (k) of this section
provides rules regarding investment
items of a partnership. Paragraph (l) of
this section provides rules regarding S
corporations. Paragraph (m) of this
section provides rules for partnerships
and S corporations not subject to section
163(j). Paragraph (o) of this section
provides examples illustrating the rules
of this section.
(b) Definitions. In addition to the
definitions contained in § 1.163(j)–1, the
following definitions apply for purposes
of this section.
(1) Section 163(j) items. The term
section 163(j) items means the
partnership or S corporation’s business
interest expense, business interest
income, and items comprising ATI.
(2) Partner basis items. The term
partner basis items means any items of
income, gain, loss, or deduction
resulting from either an adjustment to
the basis of partnership property used in
a non-excepted trade or business made
pursuant to section 743(b) or the
operation of section 704(c)(1)(C)(i) with
respect to such property. Partner basis
items also include section 743(b) basis
adjustments used to increase or decrease
a partner’s share of partnership gain or
loss on the sale of partnership property
used in a non-excepted trade or
business (as described in § 1.743–
1(j)(3)(i)) and amounts resulting from
the operation of section 704(c)(1)(C)(i)
used to decrease a partner’s share of
partnership gain or increase a partner’s
share of partnership loss on the sale of
such property.
(3) Remedial items. The term remedial
items means any allocation to a partner
of remedial items of income, gain, loss,
or deduction pursuant to section 704(c)
and § 1.704–3(d).
(4) Excess business interest income.
The term excess business interest
income means the amount by which a
partnership’s or S corporation’s
business interest income exceeds its
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business interest expense in a taxable
year.
(5) Deductible business interest
expense. The term deductible business
interest expense means the amount of a
partnership’s or S corporation’s
business interest expense that is
deductible under section 163(j) in the
current taxable year following the
application of the limitation contained
in § 1.163(j)–2(b).
(6) Section 163(j) excess items. The
term section 163(j) excess items means
the partnership’s excess business
interest expense, excess taxable income,
and excess business interest income.
(7) Non-excepted assets. The term
non-excepted assets means assets from
a non-excepted trade or business.
(8) Excepted assets. The term
excepted assets means assets from an
excepted trade or business.
(c) Business interest income and
business interest expense of a
partnership—
(1)–(2) [Reserved]
(3) Character of business interest
expense. If a partnership has deductible
business interest expense, such
deductible business interest expense is
not subject to any additional application
of section 163(j) at the partner-level
because it is taken into account in
determining the nonseparately stated
taxable income or loss of the
partnership. However, for all other
purposes of the Code, deductible
business interest expense and excess
business interest expense retain their
character as business interest expense at
the partner-level. For example, for
purposes of section 469, such business
interest expense retains its character as
either passive or non-passive in the
hands of the partner. Additionally, for
purposes of section 469, deductible
business interest expense and excess
business interest expense from a
partnership remain interest derived
from a trade or business in the hands of
a partner even if the partner does not
materially participate in the
partnership’s trade or business activity.
For additional rules regarding the
interaction between sections 465, 469,
and 163(j), see § 1.163(j)–3.
(d) Adjusted taxable income of a
partnership—(1) Tentative taxable
income of a partnership. For purposes
of computing a partnership’s ATI under
§ 1.163(j)–1(b)(1), the tentative taxable
income of a partnership is the
partnership’s taxable income
determined under section 703(a), but
computed without regard to the
application of the section 163(j)
limitation.
(2) Section 734(b), partner basis items,
and remedial items. A partnership takes
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into account items resulting from
adjustments made to the basis of its
property pursuant to section 734(b) for
purposes of calculating its ATI pursuant
to § 1.163(j)–1(b)(1). However, partner
basis items and remedial items are not
taken into account in determining a
partnership’s ATI under § 1.163(j)–
1(b)(1). Instead, partner basis items and
remedial items are taken into account by
the partner in determining the partner’s
ATI pursuant to § 1.163(j)–1(b)(1). See
Example 6 in paragraph (o)(6) of this
section.
(e) Adjusted taxable income and
business interest income of partners—
(1) Modification of adjusted taxable
income for partners. The ATI of a
partner in a partnership generally is
determined in accordance with
§ 1.163(j)–1(b)(1), without regard to such
partner’s distributive share of any items
of income, gain, deduction, or loss of
such partnership, except as provided for
in paragraph (m) of this section, and is
increased by such partner’s distributive
share of such partnership’s excess
taxable income determined under
paragraph (f) of this section. For rules
regarding corporate partners, see
§ 1.163(j)–4(b)(3).
(2) Partner basis items and remedial
items. Partner basis items and remedial
items are taken into account as items
derived directly by the partner in
determining the partner’s ATI for
purposes of the partner’s section 163(j)
limitation. If a partner is allocated
remedial items, such partner’s ATI is
increased or decreased by the amount of
such items. Additionally, to the extent
a partner is allocated partner basis
items, such partner’s ATI is increased or
decreased by the amount of such items.
See Example 6 in paragraph (o)(6) of
this section.
(3) Disposition of partnership
interests. If a partner recognizes gain or
loss upon the disposition of interests in
a partnership, and the partnership in
which the interest is being disposed
owns only non-excepted trade or
business assets, the gain or loss on the
disposition of the partnership interest is
included in the partner’s ATI. See
§ 1.163(j)–10(b)(4)(ii) for dispositions of
interests in partnerships that own—
(i) Non-excepted assets and excepted
assets; or
(ii) Investment assets; or
(iii) Both.
(4) Double counting of business
interest income and floor plan financing
interest expense prohibited. For
purposes of calculating a partner’s
section 163(j) limitation, the partner
does not include—
(i) Business interest income from a
partnership that is subject to section
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56785
163(j), except to the extent the partner
is allocated excess business interest
income from that partnership pursuant
to paragraph (f)(2) of this section; and
(ii) The partner’s allocable share of
the partnership’s floor plan financing
interest expense, because such floor
plan financing interest expense already
has been taken into account by the
partnership in determining its
nonseparately stated taxable income or
loss for purposes of section 163(j).
(f) Allocation and determination of
section 163(j) excess items made in the
same manner as nonseparately stated
taxable income or loss of the
partnership—(1) Overview—(i) In
general. The purpose of this paragraph
is to provide guidance regarding how a
partnership must allocate its deductible
business interest expense and section
163(j) excess items, if any, among its
partners. For purposes of section
163(j)(4) and this section, allocations
and determinations of deductible
business interest expense and section
163(j) excess items are considered made
in the same manner as the
nonseparately stated taxable income or
loss of the partnership if, and only if,
such allocations and determinations are
made in accordance with the elevenstep computation set forth in paragraphs
(f)(2)(i) through (xi) of this section. A
partnership first determines its section
163(j) limitation, total amount of
deductible business interest expense,
and section 163(j) excess items under
paragraph (f)(2)(i) of this section. The
partnership then applies paragraphs
(f)(2)(ii) through (xi) of this section, in
that order, to determine how those items
of the partnership are allocated among
its partners. At the conclusion of the
eleven-step computation set forth in
paragraphs (f)(2)(i) through (xi) of this
section, the total amount of deductible
business interest expense and section
163(j) excess items allocated to each
partner will equal the partnership’s total
amount of deductible business interest
expense and section 163(j) excess items.
(ii) Relevance solely for purposes of
section 163(j). No rule set forth in
paragraph (f)(2) of this section prohibits
a partnership from making an allocation
to a partner of any item of partnership
income, gain, loss, or deduction that is
otherwise permitted under section 704
and the regulations under section 704 of
the Code. Accordingly, any calculations
in paragraphs (f)(2)(i) through (xi) of this
section are solely for the purpose of
determining each partner’s deductible
business interest expense and section
163(j) excess items and do not otherwise
affect any other provision under the
Code, such as section 704(b).
Additionally, floor plan financing
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interest expense is not allocated in
accordance with paragraph (f)(2) of this
section. Instead, floor plan financing
interest expense of a partnership is
allocated to its partners under section
704(b) and is taken into account as a
nonseparately stated item of loss for
purposes of section 163(j).
(2) Steps for allocating deductible
business interest expense and section
163(j) excess items—(i) Partnershiplevel calculation required by section
163(j)(4)(A). First, a partnership must
determine its section 163(j) limitation
pursuant to § 1.163(j)–2(b). This
calculation determines a partnership’s
total amounts of excess business interest
income, excess taxable income, excess
business interest expense (that is, the
partnership’s section 163(j) excess
items), and deductible business interest
expense under section 163(j) for a
taxable year.
(ii) Determination of each partner’s
relevant section 163(j) items. Second, a
partnership must determine each
partner’s allocable share of each section
163(j) item under section 704(b) and the
regulations under section 704 of the
Code, including any allocations under
section 704(c), other than remedial
items. Only section 163(j) items that
were actually taken into account in the
partnership’s section 163(j) calculation
under paragraph (f)(2)(i) of this section
are taken into account for purposes of
this paragraph (f)(2)(ii). Partner basis
items, allocations of investment income
and expense, remedial items, and
amounts determined for the partner
under § 1.163–8T are not taken into
account for purposes of this paragraph
(f)(2)(ii). For purposes of paragraphs
(f)(2)(ii) through (xi) of this section, the
term allocable ATI means a partner’s
distributive share of the partnership’s
ATI (that is, a partner’s distributive
share of gross income and gain items
comprising ATI less such partner’s
distributive share of gross loss and
deduction items comprising ATI), the
term allocable business interest income
means a partner’s distributive share of
the partnership’s business interest
income, and the term allocable business
interest expense means a partner’s
distributive share of the partnership’s
business interest expense that is not
floor plan financing interest expense. If
the partnership determines that each
partner has a pro rata share of allocable
ATI, allocable business interest income,
and allocable business interest expense,
then the partnership may bypass
paragraphs (f)(2)(iii) through (xi) of this
section and allocate its section 163(j)
excess items in the same proportion. See
Example 1 through Example 16 in
paragraphs (o)(1) through (16),
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respectively. This pro-rata exception
does not result in allocations of section
163(j) excess items that vary from the
array of allocations of section 163(j)
excess items that would have resulted
had paragraphs (f)(2)(iii) through (xi)
been applied.
(iii) Partner-level comparison of
business interest income and business
interest expense. Third, a partnership
must compare each partner’s allocable
business interest income to such
partner’s allocable business interest
expense. Paragraphs (f)(2)(iii) through
(v) of this section determine how a
partnership must allocate its excess
business interest income among its
partners, as well as the amount of each
partner’s allocable business interest
expense that is not deductible business
interest expense after taking the
partnership’s business interest income
into account. To the extent a partner’s
allocable business interest income
exceeds its allocable business interest
expense, the partner has an allocable
business interest income excess. The
aggregate of all the partners’ allocable
business interest income excess
amounts is the total allocable business
interest income excess. To the extent a
partner’s allocable business interest
expense exceeds its allocable business
interest income, the partner has an
allocable business interest income
deficit. The aggregate of all the partners’
allocable business interest income
deficit amounts is the total allocable
business interest income deficit. These
amounts are required to perform
calculations in paragraphs (f)(2)(iv) and
(v) of this section, which appropriately
reallocate allocable business interest
income excess to partners with allocable
business interest income deficits in
order to reconcile the partner-level
calculation under paragraph (f)(2)(iii) of
this section with the partnership-level
result under paragraph (f)(2)(i) of this
section.
(iv) Matching partnership and
aggregate partner excess business
interest income. Fourth, a partnership
must determine each partner’s final
allocable business interest income
excess. A partner’s final allocable
business interest income excess is
determined by reducing, but not below
zero, such partner’s allocable business
interest income excess (if any) by the
partner’s step four adjustment amount.
A partner’s step four adjustment
amount is the product of the total
allocable business interest income
deficit and the ratio of such partner’s
allocable business interest income
excess to the total allocable business
interest income excess. The rules of this
paragraph (f)(2)(iv) ensure that,
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following the application of paragraph
(f)(2)(xi) of this section, the aggregate of
all the partners’ allocations of excess
business interest income equals the total
amount of the partnership’s excess
business interest income as determined
in paragraph (f)(2)(i) of this section.
(v) Remaining business interest
expense determination. Fifth, a
partnership must determine each
partner’s remaining business interest
expense. A partner’s remaining business
interest expense is determined by
reducing, but not below zero, such
partner’s allocable business interest
income deficit (if any) by such partner’s
step five adjustment amount. A
partner’s step five adjustment amount is
the product of the total allocable
business interest income excess and the
ratio of such partner’s allocable business
interest income deficit to the total
allocable business interest income
deficit. Generally, a partner’s remaining
business interest expense is a partner’s
allocable business interest income
deficit adjusted to reflect a reallocation
of allocable business interest income
excess from other partners. Determining
a partner’s remaining business interest
expense is necessary to perform an ATI
calculation that begins in paragraph
(f)(2)(vii) of this section.
(vi) Determination of final allocable
ATI. Sixth, a partnership must
determine each partner’s final allocable
ATI. Paragraphs (f)(2)(vi) through (x) of
this section determine how a
partnership must allocate its excess
taxable income and excess business
interest expense among its partners.
(A) Positive allocable ATI. To the
extent a partner’s income and gain items
comprising its allocable ATI exceed its
deduction and loss items comprising its
allocable ATI, the partner has positive
allocable ATI. The aggregate of all the
partners’ positive allocable ATI amounts
is the total positive allocable ATI.
(B) Negative allocable ATI. To the
extent a partner’s deduction and loss
items comprising its allocable ATI
exceed its income and gain items
comprising its allocable ATI, the partner
has negative allocable ATI. The
aggregate of all the partners’ negative
allocable ATI amounts is the total
negative allocable ATI.
(C) Final allocable ATI. Any partner
with a negative allocable ATI, or an
allocable ATI of $0, has a positive
allocable ATI of $0. Any partner with a
positive allocable ATI of $0 has a final
allocable ATI of $0. The final allocable
ATI of any partner with a positive
allocable ATI greater than $0 is such
partner’s positive allocable ATI
reduced, but not below zero, by the
partner’s step six adjustment amount. A
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partner’s step six adjustment amount is
the product of the total negative
allocable ATI and the ratio of such
partner’s positive allocable ATI to the
total positive allocable ATI. The total of
the partners’ final allocable ATI
amounts must equal the partnership’s
ATI amount used to compute its section
163(j) limitation pursuant to § 1.163(j)–
2(b).
(vii) Partner-level comparison of 30
percent of adjusted taxable income and
remaining business interest expense.
Seventh, a partnership must compare
each partner’s ATI capacity to such
partner’s remaining business interest
expense as determined under paragraph
(f)(2)(v) of this section. A partner’s ATI
capacity is the amount that is 30 percent
of such partner’s final allocable ATI as
determined under paragraph (f)(2)(vi) of
this section. A partner’s final allocable
ATI is grossed down to 30 percent prior
to being compared to its remaining
business interest expense in this
calculation to parallel the partnership’s
adjustment to its ATI under section
163(j)(1)(B). To the extent a partner’s
ATI capacity exceeds its remaining
business interest expense, the partner
has an ATI capacity excess. The
aggregate of all the partners’ ATI
capacity excess amounts is the total ATI
capacity excess. To the extent a
partner’s remaining business interest
expense exceeds its ATI capacity, the
partner has an ATI capacity deficit. The
aggregate of all the partners’ ATI
capacity deficit amounts is the total ATI
capacity deficit. These amounts (which
may be subject to adjustment under
paragraph (f)(2)(viii) of this section) are
required to perform calculations in
paragraphs (f)(2)(ix) and (x) of this
section, which appropriately reallocate
ATI capacity excess to partners with
ATI capacity deficits in order to
reconcile the partner-level calculation
under paragraph (f)(2)(vii) of this
section with the partnership-level result
under paragraph (f)(2)(i) of this section.
(viii) Partner priority right to ATI
capacity excess determination. (A)
Eighth, the partnership must determine
whether it is required to make any
adjustments described in this paragraph
(f)(2)(viii) and, if it is, make such
adjustments. The rules of this paragraph
(f)(2)(viii) are necessary to account for
adjustments made to a partner’s
allocable ATI in paragraph (f)(2)(vi) of
this section to ensure that the partners
who had a negative allocable ATI do not
inappropriately benefit under the rules
of paragraphs (f)(2)(ix) through (xi) of
this section to the detriment of the
partners who had positive allocable
ATI. The partnership must perform the
calculations and make the necessary
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adjustments described under paragraphs
(f)(2)(viii)(B) and (C) or paragraph
(f)(2)(viii)(D) of this section if, and only
if, there is—
(1) An excess business interest
expense amount greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI
amount greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATI capacity excess
amount greater than $0 under paragraph
(f)(2)(vii) of this section.
(B) A partnership must determine
each partner’s priority amount and
usable priority amount. A partner’s
priority amount is 30 percent of the
amount by which a partner’s positive
allocable ATI under paragraph
(f)(2)(vi)(A) of this section exceeds such
partner’s final allocable ATI under
paragraph (f)(2)(vi)(C) of this section.
However, only partners with an ATI
capacity deficit as determined under
paragraph (f)(2)(vii) of this section can
have a priority amount greater than $0.
The aggregate of all the partners’
priority amounts is the total priority
amount. A partner’s usable priority
amount is the lesser of such partner’s
priority amount or such partner’s ATI
capacity deficit as determined under
paragraph (f)(2)(vii) of this section. The
aggregate of all the partners’ usable
priority amounts is the total usable
priority amount. If the total ATI
capacity excess amount, as determined
under paragraph (f)(2)(vii) of this
section, is greater than or equal to the
total usable priority amount, then the
partnership must perform the
adjustments described in paragraph
(f)(2)(viii)(C) of this section. If the total
usable priority amount is greater than
the total ATI capacity excess amount, as
determined under paragraph (f)(2)(vii)
of this section, then the partnership
must perform the adjustments described
in paragraph (f)(2)(viii)(D) of this
section.
(C) For purposes of paragraph
(f)(2)(ix) of this section, each partner’s
final ATI capacity excess amount is $0.
For purposes of paragraph (f)(2)(x) of
this section, the following terms have
the following meanings for each partner:
(1) Each partner’s ATI capacity deficit
is such partner’s ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section, reduced by such
partner’s usable priority amount.
(2) The total ATI capacity deficit is
the total ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section, reduced by the total
usable priority amount.
(3) The total ATI capacity excess is
the total ATI capacity excess as
determined under paragraph (f)(2)(vii)
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56787
of this section, reduced by the total
usable priority amount.
(D) Any partner with a priority
amount greater than $0 is a priority
partner. Any partner that is not a
priority partner is a non-priority
partner. For purposes of paragraph
(f)(2)(ix) of this section, each partner’s
final ATI capacity excess amount is $0.
For purposes of paragraph (f)(2)(x) of
this section, each non-priority partner’s
final ATI capacity deficit amount is
such partner’s ATI capacity deficit as
determined under paragraph (f)(2)(vii)
of this section. For purposes of
paragraph (f)(2)(x) of this section, the
following terms have the following
meanings for priority partners.
(1) Each priority partner must
determine its step eight excess share. A
partner’s step eight excess share is the
product of the total ATI capacity excess
as determined under paragraph
(f)(2)(vii) of this section and the ratio of
the partner’s priority amount to the total
priority amount.
(2) To the extent a priority partner’s
step eight excess share exceeds its ATI
capacity deficit as determined under
paragraph (f)(2)(vii) of this section, such
excess amount is the priority partner’s
ATI capacity excess for purposes of
paragraph (f)(2)(x) of this section. The
total ATI capacity excess is the
aggregate of the priority partners’ ATI
capacity excess amounts as determined
under this paragraph (f)(2)(viii)(D)(2).
(3) To the extent a priority partner’s
ATI capacity deficit as determined
under paragraph (f)(2)(vii) of this
section exceeds its step eight excess
share, such excess amount is the
priority partner’s ATI capacity deficit
for purposes of paragraph (f)(2)(x) of this
section. The total ATI capacity deficit is
the aggregate of the priority partners’
ATI capacity deficit amounts as
determined under this paragraph
(f)(2)(viii)(D)(3).
(ix) Matching partnership and
aggregate partner excess taxable
income. Ninth, a partnership must
determine each partner’s final ATI
capacity excess. A partner’s final ATI
capacity excess amount is determined
by reducing, but not below zero, such
partner’s ATI capacity excess (if any) by
the partner’s step nine adjustment
amount. A partner’s step nine
adjustment amount is the product of the
total ATI capacity deficit and the ratio
of such partner’s ATI capacity excess to
the total ATI capacity excess. The rules
of this paragraph (f)(2)(ix) ensure that,
following the application of paragraph
(f)(2)(xi) of this section, the aggregate of
all the partners’ allocations of excess
taxable income equals the total amount
of the partnership’s excess taxable
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income as determined in paragraph
(f)(2)(i) of this section.
(x) Matching partnership and
aggregate partner excess business
interest expense. Tenth, a partnership
must determine each partner’s final ATI
capacity deficit. A partner’s final ATI
capacity deficit amount is determined
by reducing, but not below zero, such
partner’s ATI capacity deficit (if any) by
the partner’s step ten adjustment
amount. A partner’s step ten adjustment
amount is the product of the total ATI
capacity excess and the ratio of such
partner’s ATI capacity deficit to the total
ATI capacity deficit. Generally, a
partner’s final ATI capacity deficit is a
partner’s ATI capacity deficit adjusted
to reflect a reallocation of ATI capacity
excess from other partners. The rules of
this paragraph (f)(2)(x) ensure that,
following the application of paragraph
(f)(2)(xi) of this section, the aggregate of
all the partners’ allocations of excess
business interest expense equals the
total amount of the partnership’s excess
business interest expense as determined
in paragraph (f)(2)(i) of this section.
(xi) Final section 163(j) excess item
and deductible business interest
expense allocation. Eleventh, a
partnership must allocate section 163(j)
excess items and deductible business
interest expense to its partners. Excess
business interest income calculated
under paragraph (f)(2)(i) of this section,
if any, is allocated dollar for dollar by
the partnership to its partners with final
allocable business interest income
excess amounts. Excess business
interest expense calculated under
paragraph (f)(2)(i) of this section, if any,
is allocated dollar for dollar to partners
with final ATI capacity deficit amounts.
After grossing up each partner’s final
ATI capacity excess amount by tenthirds, excess taxable income calculated
under paragraph (f)(2)(i) of this section,
if any, is allocated dollar for dollar to
partners with final ATI capacity excess
amounts. A partner’s allocable business
interest expense is deductible business
interest expense to the extent it exceeds
such partner’s share of excess business
interest expense. See Example 17
through Example 21 in paragraphs
(o)(17) through (21) of this section,
respectively.
(g) Carryforwards—(1) In general. The
amount of any business interest expense
not allowed as a deduction to a
partnership by reason of § 1.163(j)–2(b)
and paragraph (f)(2) of this section for
any taxable year is—
(i) Not treated as business interest
expense of the partnership in the
succeeding taxable year; and
(ii) Subject to paragraph (g)(2) of this
section, treated as excess business
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interest expense, which is allocated to
each partner pursuant to paragraph (f)(2)
of this section.
(2) Treatment of excess business
interest expense allocated to partners. If
a partner is allocated excess business
interest expense from a partnership
under paragraph (f)(2) of this section for
any taxable year and the excess business
interest expense is treated as such under
paragraph (h)(2) of this section—
(i) Solely for purposes of section
163(j), such excess business interest
expense is treated as business interest
expense paid or accrued by the partner
in the next succeeding taxable year in
which the partner is allocated excess
taxable income or excess business
interest income from such partnership,
but only to the extent of such excess
taxable income or excess business
interest income; and
(ii) Any portion of such excess
business interest expense remaining
after the application of paragraph
(g)(2)(i) of this section is excess business
interest expense that is subject to the
limitations of paragraph (g)(2)(i) of this
section in succeeding taxable years,
unless paragraph (m)(3) of this section
applies. See Example 1 through
Example 16 in paragraphs (o)(1) through
(16) of this section, respectively.
(3) Excess taxable income and excess
business interest income ordering rule.
In the event a partner has excess
business interest expense from a prior
taxable year and is allocated excess
taxable income or excess business
interest income from the same
partnership in a succeeding taxable
year, the partner must treat, for
purposes of section 163(j), the excess
business interest expense as business
interest expense paid or accrued by the
partner in an amount equal to the
partner’s share of the partnership’s
excess taxable income or excess
business interest income in such
succeeding taxable year. See Example 2
through Example 16 in paragraphs (o)(2)
through (16) of this section,
respectively.
(h) Basis adjustments—(1) Section
704(d) ordering. Deductible business
interest expense and excess business
interest expense are subject to section
704(d). If a partner is subject to a
limitation on loss under section 704(d)
and a partner is allocated losses from a
partnership in a taxable year, § 1.704–
1(d)(2) requires that the limitation on
losses under section 704(d) be
apportioned amongst these losses based
on the character of each loss (each
grouping of losses based on character
being a section 704(d) loss class). If
there are multiple section 704(d) loss
classes in a given year, § 1.704–1(d)(2)
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requires the partner to apportion the
limitation on losses under section
704(d) to each section 704(d) loss class
proportionately. For purposes of
applying this proportionate rule, any
deductible business interest expense
and business interest expense of an
exempt entity (whether allocated to the
partner in the current taxable year or
suspended under section 704(d) in a
prior taxable year), any excess business
interest expense allocated to the partner
in the current taxable year, and any
excess business interest expense from a
prior taxable year that was suspended
under section 704(d) (negative section
163(j) expense) shall comprise the same
section 704(d) loss class. Once the
partner determines the amount of
limitation on losses apportioned to this
section 704(d) loss class, any deductible
business interest expense is taken into
account before any excess business
interest expense or negative section
163(j) expense. See Example 7 in
paragraph (o)(7) of this section.
(2) Excess business interest expense
basis adjustments. The adjusted basis of
a partner in a partnership interest is
reduced, but not below zero, by the
amount of excess business interest
expense allocated to the partner
pursuant to paragraph (f)(2) of this
section. Negative section 163(j) expense
is not treated as excess business interest
expense in any subsequent year until
such negative section 163(j) expense is
no longer suspended under section
704(d). Therefore, negative section
163(j) expense does not affect, and is not
affected by, any allocation of excess
taxable income to the partner.
Accordingly, any excess taxable income
allocated to a partner from a partnership
while the partner still has negative
section 163(j) expense will be included
in the partner’s ATI. However, once the
negative section 163(j) expense is no
longer suspended under section 704(d),
it becomes excess business interest
expense, which is subject to the general
rules in paragraph (g) of this section.
See Example 8 in paragraph (o)(8) of
this section.
(3) Partner basis adjustment upon
disposition of partnership interest. If a
partner (transferor) disposes of an
interest in a partnership, the adjusted
basis of the partnership interest being
disposed of (transferred interest) is
increased immediately before the
disposition by the amount of the excess
(if any) of the amount of the basis
reduction under paragraph (h)(2) of this
section over the portion of any excess
business interest expense allocated to
the transferor under paragraph (f)(2) of
this section which has previously been
treated under paragraph (g) of this
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section as business interest expense
paid or accrued by the transferor,
multiplied by the ratio of the fair market
value of the transferred interest to the
total fair market value of the transferor’s
partnership interest immediately prior
to the disposition. Therefore, the
adjusted basis of the transferred interest
is not increased immediately before the
disposition by any allocation of excess
business interest expense from the
partnership that did not reduce the
transferor’s adjusted basis in its
partnership interest pursuant to
paragraph (h) of this section prior to the
disposition, or by any excess business
interest expense that was treated under
paragraph (g) of this section as business
interest expense paid or accrued by the
transferor prior to the disposition. If the
transferor disposes of all of its
partnership interest, no deduction
under section 163(j) is allowed to the
transferor or transferee under chapter 1
of subtitle A of the Code for any excess
business interest expense or negative
section 163(j) expense. If the transferor
disposes of a portion of its partnership
interest, no deduction under section
163(j) is allowed to the transferor or
transferee under chapter 1 of subtitle A
of the Code for the amount of excess
business interest expense proportionate
to the transferred interest. The amount
of excess business interest expense
proportionate to the partnership interest
retained by the transferor shall remain
as excess business interest expense of
the transferor until such time as such
excess business interest expense is
treated as business interest expense paid
or accrued by the transferor pursuant to
paragraph (g) of this section. Further, if
the transferor disposes of a portion of its
partnership interest, any negative
section 163(j) expense shall remain
negative section 163(j) expense of the
transferor partner until such negative
section 163(j) expense is no longer
suspended under section 704(d). For
purposes of this paragraph, a
disposition includes a distribution of
money or other property by the
partnership to a partner in complete
liquidation of its interest in the
partnership. Further, solely for purposes
of this section, each partner is
considered to have disposed of its
partnership interest if the partnership
terminates under section 708(b)(1). See
Example 9 and Example 10 in
paragraphs (o)(9) and (o)(10) of this
section, respectively.
(i)–(j) [Reserved]
(k) Investment items and certain other
items. Any item of a partnership’s
income, gain, deduction, or loss that is
investment interest income or expense
pursuant to § 1.163–8T, and any other
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tax item of a partnership that is neither
properly allocable to a trade or business
of the partnership nor described in
section 163(d), is allocated to each
partner in accordance with section
704(b) and the regulations under section
704 of the Code, and the effect of such
allocation for purposes of section 163 is
determined at the partner-level. See
§ 1.163(j)–4(b)(3), section 163(d), and
§ 1.163–8T.
(l) S corporations—(1) In general—(i)
Corporate level limitation. In the case of
any S corporation, the section 163(j)
limitation is applied at the S
corporation level, and any deduction
allowed for business interest expense is
taken into account in determining the
nonseparately stated taxable income or
loss of the S corporation. An S
corporation determines its section 163(j)
limitation in the same manner as set
forth in § 1.163(j)–2(b). Allocations of
excess taxable income and excess
business interest income are made in
accordance with the shareholders’ pro
rata interests in the S corporation
pursuant to section 1366(a)(1) after
determining the S corporation’s section
163(j) limitation pursuant to § 1.163(j)–
2(b). See Example 22 and Example 23 in
paragraphs (o)(22) and (23) of this
section, respectively.
(ii) Short taxable periods. For rules on
applying the section 163(j) limitation
where an S corporation has a two short
taxable periods or where its taxable year
consists of two separate taxable years
see §§ 1.1362–3(c), 1.1368–1(g), and
1.1377–1(b).
(2) Character of deductible business
interest expense. If an S corporation has
deductible business interest expense,
such deductible business interest
expense is not subject to any additional
application of section 163(j) at the
shareholder-level because such
deductible business interest expense is
taken into account in determining the
nonseparately stated taxable income or
loss of the S corporation. However, for
all other purposes of the Code,
deductible business interest expense
retains its character as business interest
expense at the shareholder-level. For
example, for purposes of section 469,
such deductible business interest
expense retains its character as either
passive or non-passive in the hands of
the shareholder. Additionally, for
purposes of section 469, deductible
business interest expense from an S
corporation remains interest derived
from a trade or business in the hands of
a shareholder even if the shareholder
does not materially participate in the S
corporation’s trade or business activity.
For additional rules regarding the
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56789
interaction between sections 465, 469,
and 163(j), see § 1.163(j)–3.
(3) Adjusted taxable income of an S
corporation. The ATI of an S
corporation generally is determined in
accordance with § 1.163(j)–1(b)(1). For
purposes of computing the S
corporation’s ATI, the tentative taxable
income of the S corporation is
determined under section 1363(b) and
includes—
(i) Any item described in section
1363(b)(1); and
(ii) Any item described in § 1.163(j)–
1(b)(1), to the extent such item is
consistent with subchapter S of the
Code.
(4) Adjusted taxable income and
business interest income of S
corporation shareholders—(i) Adjusted
taxable income of S corporation
shareholders. The ATI of an S
corporation shareholder is determined
in accordance with § 1.163(j)–1(b)(1)
without regard to such shareholder’s
distributive share of any items of
income, gain, deduction, or loss of such
S corporation, except as provided in
paragraph (m), and is increased by such
shareholder’s distributive share of such
S corporation’s excess taxable income.
(ii) Disposition of S corporation stock.
If a shareholder of an S corporation
recognizes gain or loss upon the
disposition of stock of the S corporation,
and the corporation the stock of which
is being disposed of only owns nonexcepted trade or business assets, the
gain or loss on the disposition of the
stock is included in the shareholder’s
ATI. See § 1.163(j)–10(b)(4)(ii) for
dispositions of stock of S corporations
that own—
(A) Non-excepted assets and excepted
assets; or
(B) Investment assets; or
(C) Both.
(iii) Double counting of business
interest income and floor plan financing
interest expense prohibited. For
purposes of calculating an S corporation
shareholder’s section 163(j) limitation,
the shareholder does not include—
(A) Business interest income from an
S corporation that is subject to section
163(j), except to the extent the
shareholder is allocated excess business
interest income from that S corporation
pursuant to paragraph (l)(1) of this
section; and
(B) The shareholder’s share of the S
corporation’s floor plan financing
interest expense, because such floor
plan financing interest expense already
has been taken into account by the S
corporation in determining its
nonseparately stated taxable income or
loss for purposes of section 163(j).
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(5) Carryforwards. The amount of any
business interest expense not allowed as
a deduction for any taxable year by
reason of the limitation contained in
§ 1.163(j)–2(b) is carried forward in the
succeeding taxable year as a disallowed
business interest expense carryforward
under the rules set forth in § 1.163(j)–
2(c) (whether to an S corporation
taxable year or a C corporation taxable
year). For purposes of applying section
163(j), S corporations are subject to the
same ordering rules as a C corporation
that is not a member of a consolidated
group. See § 1.163(j)–5(b)(2).
(6) Basis adjustments and disallowed
business interest expense carryforwards.
An S corporation shareholder’s adjusted
basis in its S corporation stock is
reduced, but not below zero, when a
disallowed business interest expense
carryforward becomes deductible under
section 163(j).
(7) Accumulated adjustment
accounts. The accumulated adjustment
account of an S corporation is adjusted
to take into account business interest
expense in the year in which the S
corporation treats such business interest
expense as deductible under the section
163(j) limitation. See section 1368(e)(1).
(8) Termination of qualified
subchapter S subsidiary election. If a
corporation’s qualified subchapter S
subsidiary election terminates and any
disallowed business interest expense
carryforward is attributable to the
activities of the qualified subchapter S
subsidiary at the time of termination,
such disallowed business interest
expense carryforward remains with the
parent S corporation, and no portion of
these items is allocable to the former
qualified subchapter S subsidiary.
(9) Investment items. Any item of an
S corporation’s income, gain, deduction,
or loss that is investment interest
income or expense pursuant to § 1.163–
8T is allocated to each shareholder in
accordance with the shareholders’ pro
rata interests in the S corporation
pursuant to section 1366(a)(1). See
section 163(d) and § 1.163–8T.
(10) Application of section 382. In the
event of an ownership change, within
the meaning of section 382(g), the S
corporation’s business interest expense
is subject to section 382. Therefore, the
allocation of the S corporation’s
business interest expense between the
pre-change period (as defined in
§ 1.382–6(g)(2)) and the post-change
period (as defined in § 1.382–6(g)(3)),
and the determination of the amount
that is deducted and carried forward, is
determined pursuant to § 1.382–6. If the
date of the ownership change is also the
date of a qualifying disposition (as
defined in § 1.1368–1(g)(2)) or the date
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for a termination of shareholder interest
(as defined in § 1.1377–1(b)(4)), then—
(i) The rules of this paragraph govern
the S corporation’s business interest
expense;
(ii) The S corporation must make an
election under § 1.382–6(b) with respect
to such date if it also makes an election
under § 1.1368–1(g)(2) or a shareholder
termination election to apply normal tax
accounting rules, as applicable, with
respect to such date; and
(iii) The S corporation may not make
an election under § 1.382–6(b) with
respect to such date if it does not make
an election under § 1.1368–1(g)(2) or a
termination election under § 1.1377–
1(b)(1), as applicable, with respect to
such date.
(m) Partnerships and S corporations
not subject to section 163(j)—(1) Exempt
partnerships and S corporations. If the
small business exemption in § 1.163(j)–
2(d) applies to a partnership or an S
corporation in a taxable year (exempt
entity), the general rule in § 1.163(j)–2
and this section does not apply to limit
the deduction for business interest
expense of the exempt entity in that
taxable year. Additionally, if a partner
or S corporation shareholder is allocated
business interest expense from an
exempt entity, such business interest
expense is not subject to the section
163(j) limitation at the partner’s or S
corporation shareholder’s level.
However, see paragraph (h)(1) of this
section. Further, a partner or S
corporation shareholder of an exempt
entity includes its share of non-excepted
trade or business items of income, gain,
loss, and deduction (including business
interest expense and business interest
income) of such exempt entity when
calculating its ATI. However, if a
partner’s or S corporation shareholder’s
allocations of non-excepted trade or
business items of loss and deduction
from an exempt entity exceed its
allocations of non-excepted trade or
business items of income and gain from
such exempt entity (net loss allocation),
then such net loss allocation will not
reduce a partner’s or S corporation
shareholder’s ATI. See Example 11 and
Example 12 in paragraphs (o)(11) and
(12) of this section, respectively.
(2) Partnerships and S corporations
engaged in excepted trades or
businesses. To the extent a partnership
or an S corporation is engaged in an
excepted trade or business, the general
rule in § 1.163(j)–2 and this section does
not apply to limit the deduction for
business interest expense that is
allocable to such excepted trade or
business. If a partner or S corporation
shareholder is allocated any section
163(j) item that is allocable to an
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excepted trade or business of the
partnership or S corporation (excepted
163(j) items), such excepted 163(j) items
are excluded from the partner’s or
shareholder’s section 163(j) deduction
calculation. See § 1.163(j)–10(c)
(regarding the allocation of items
between excepted and non-excepted
trades or businesses). See also Example
13 in paragraph (o)(13) of this section.
(3) Treatment of excess business
interest expense from partnerships that
are exempt entities in a succeeding
taxable year. If a partner is allocated
excess business interest expense from a
partnership and, in a succeeding taxable
year, such partnership is an exempt
entity, then the partner shall treat any
of its excess business interest expense
that was previously allocated from such
partnership as business interest expense
paid or accrued by the partner in such
succeeding taxable year, which is
potentially subject to limitation at the
partner level under section 163(j).
However, if a partner is allocated excess
business interest expense from a
partnership and, in a succeeding taxable
year, such partnership engages in
excepted trades or businesses, then the
partner shall not treat any of its excess
business interest expense that was
previously allocated from such
partnership as business interest expense
paid or accrued by the partner in such
succeeding taxable year by reason of the
partnership engaging in excepted trades
or businesses. See Example 14 through
Example 16 in paragraphs (o)(14)
through (o)(16) of this section,
respectively. For rules regarding the
treatment of excess business interest
expense from a partnership that
terminates under section 708(b)(1), see
paragraph (h)(3) of this section.
(4) S corporations with disallowed
business interest expense carryforwards
prior to becoming exempt entities. If an
S corporation has a disallowed business
interest expense carryforward for a
taxable year and, in a succeeding
taxable year, such S corporation is an
exempt entity, then such disallowed
business interest expense
carryforward—
(i) Continues to be carried forward at
the S corporation level;
(ii) Is no longer subject to the section
163(j) limitation; and
(iii) Is taken into account in
determining the nonseparately stated
taxable income or loss of the S
corporation.
(n) [Reserved]
(o) Examples. The examples in this
paragraph illustrate the provisions of
section 163(j) as applied to partnerships
and subchapter S corporations. For
purposes of these examples, unless
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stated otherwise, each partnership and S
corporation is subject to the provisions
of section 163(j), is only engaged in nonexcepted trades or businesses, was
created or organized in the United
States, and uses the calendar year for its
annual accounting period. Unless stated
otherwise, all partners and shareholders
are subject to the provisions of section
163(j), are not subject to a limitation
under section 704(d) or 1366(d), have no
tax items other than those listed in the
example, are U.S. citizens, and use the
calendar year for their annual
accounting period. The phrase ‘‘section
163(j) limit’’ shall equal the maximum
potential deduction allowed under
section 163(j)(1). Unless stated
otherwise, business interest expense
means business interest expense that is
not floor plan financing interest
expense. With respect to partnerships,
all allocations are in accordance with
section 704(b) and the regulations in
this part under section 704 of the Code.
(1) Example 1—(i) Facts. X and Y are
equal partners in partnership PRS. In
Year 1, PRS has $100 of ATI and $40 of
business interest expense. PRS allocates
the items comprising its $100 of ATI
$50 to X and $50 to Y. PRS allocates its
$40 of business interest expense $20 to
X and $20 to Y. X has $100 of ATI and
$20 of business interest expense from its
sole proprietorship. Y has $0 of ATI and
$20 of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 1, PRS’s
section 163(j) limit is 30 percent of its
ATI, or $30 ($100 × 30 percent). Thus,
PRS has $30 of deductible business
interest expense and $10 of excess
business interest expense. Such $30 of
deductible business interest expense is
includable in PRS’s nonseparately
stated income or loss, and is not subject
to further limitation under section 163(j)
at the partners’ level.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
are each allocated $15 of deductible
business interest expense and $5 of
excess business interest expense. At the
end of Year 1, X and Y each have $5 of
excess business interest expense from
PRS, which is not treated as paid or
accrued by the partner until such
partner is allocated excess taxable
income or excess business interest
income from PRS in a succeeding
taxable year. Pursuant to § 1.163(j)–
6(e)(1), X and Y, in computing their
limit under section 163(j), do not
increase any of their section 163(j) items
by any of PRS’s section 163(j) items. X
and Y each increase their outside basis
in PRS by $30 ($50¥$20).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
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has $100 of ATI and $20 of business
interest expense from its sole
proprietorship. X’s section 163(j) limit is
$30 ($100 × 30 percent). Thus, X’s $20
of business interest expense is
deductible business interest expense. Y,
in computing its limit under section
163(j), has $20 of business interest
expense from its sole proprietorship. Y’s
section 163(j) limit is $0 ($0 × 30
percent). Thus, Y’s $20 of business
interest expense is not allowed as a
deduction and is treated as business
interest expense paid or accrued by Y in
Year 2.
(2) Example 2—(i) Facts. The facts are
the same as in Example 1 in paragraph
(o)(1)(i) of this section. In Year 2, PRS
has $200 of ATI, $0 of business interest
income, and $30 of business interest
expense. PRS allocates the items
comprising its $200 of ATI $100 to X
and $100 to Y. PRS allocates its $30 of
business interest expense $15 to X and
$15 to Y. X has $100 of ATI and $20 of
business interest expense from its sole
proprietorship. Y has $0 of ATI and $20
of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
$60 ($200 × 30 percent). Thus, PRS has
$100 of excess taxable income, $30 of
deductible business interest expense,
and $0 of excess business interest
expense. Such $30 of deductible
business interest expense is includable
in PRS’s nonseparately stated income or
loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
are each allocated $50 of excess taxable
income, $15 of deductible business
interest expense, and $0 of excess
business interest expense. As a result, X
and Y each increase their ATI by $50.
Because X and Y are each allocated $50
of excess taxable income from PRS, and
excess business interest expense from a
partnership is treated as paid or accrued
by a partner to the extent excess taxable
income and excess business interest
income are allocated from such
partnership to a partner, X and Y each
treat $5 of excess business interest
expense (the carryforward from Year 1)
as paid or accrued in Year 2. X and Y
each increase their outside basis in PRS
by $85 ($100¥$15).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $150 of ATI ($100 from its sole
proprietorship, plus $50 excess taxable
income) and $25 of business interest
expense ($20 from its sole
proprietorship, plus $5 excess business
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56791
interest expense treated as paid or
accrued in Year 2). X’s section 163(j)
limit is $45 ($150 × 30 percent). Thus,
X’s $25 of business interest expense is
deductible business interest expense. At
the end of Year 2, X has $0 of excess
business interest expense from PRS ($5
from Year 1, less $5 treated as paid or
accrued in Year 2). Y, in computing its
limit under section 163(j), has $50 of
ATI ($0 from its sole proprietorship,
plus $50 excess taxable income) and $45
of business interest expense ($20 from
its sole proprietorship, plus $20
disallowed business interest expense
from Year 1, plus $5 excess business
interest expense treated as paid or
accrued in Year 2). Y’s section 163(j)
limit is $15 ($50 × 30 percent). Thus,
$15 of Y’s business interest expense is
deductible business interest expense.
The $30 of Y’s business interest expense
not allowed as a deduction ($45
business interest expense, less $15
section 163(j) limit) is treated as
business interest expense paid or
accrued by Y in Year 3. At the end of
Year 2, Y has $0 of excess business
interest expense from PRS ($5 from Year
1, less $5 treated as paid or accrued in
Year 2).
(3) Example 3—(i) Facts. The facts are
the same as in Example 1 in paragraph
(o)(1)(i) of this section. In Year 2, PRS
has $0 of ATI, $60 of business interest
income, and $40 of business interest
expense. PRS allocates its $60 of
business interest income $30 to X and
$30 to Y. PRS allocates its $40 of
business interest expense $20 to X and
$20 to Y. X has $100 of ATI and $20 of
business interest expense from its sole
proprietorship. Y has $0 of ATI and $20
of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
$60 (($0 × 30 percent) + $60). Thus, PRS
has $20 of excess business interest
income, $0 of excess taxable income,
$40 of deductible business interest
expense, and $0 of excess business
interest expense. Such $40 of deductible
business interest expense is includable
in PRS’s nonseparately stated income or
loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
are each allocated $10 of excess
business interest income, and $20 of
deductible business interest expense. As
a result, X and Y each increase their
business interest income by $10.
Because X and Y are each allocated $10
of excess business interest income from
PRS, and excess business interest
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expense from a partnership is treated as
paid or accrued by a partner to the
extent excess taxable income and excess
business interest income are allocated
from such partnership to a partner, X
and Y each treat $5 of excess business
interest expense (the carryforward from
Year 1) as paid or accrued in Year 2. X
and Y each increase their outside basis
in PRS by $10 ($30¥$20).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $100 of ATI (from its sole
proprietorship), $10 of business interest
income (from the allocation of $10 of
excess business interest income from
PRS), and $25 of business interest
expense ($20 from its sole
proprietorship, plus $5 excess business
interest expense treated as paid or
accrued in Year 2). X’s section 163(j)
limit is $40 (($100 × 30 percent) + $10).
Thus, X’s $25 of business interest
expense is deductible business interest
expense. At the end of Year 2, X has $0
of excess business interest expense from
PRS ($5 from Year 1, less $5 treated as
paid or accrued in Year 2). Y, in
computing its limit under section 163(j),
has $0 of ATI (from its sole
proprietorship), $10 of business interest
income, and $45 of business interest
expense ($20 from its sole
proprietorship, plus $20 disallowed
business interest expense from Year 1,
plus $5 excess business interest expense
treated as paid or accrued in Year 2). Y’s
section 163(j) limit is $10 (($0 × 30
percent) + $10). Thus, $10 of Y’s
business interest expense is deductible
business interest expense. The $35 of
Y’s business interest expense not
allowed as a deduction ($45 business
interest expense, less $10 section 163(j)
limit) is treated as business interest
expense paid or accrued by Y in Year 3.
At the end of Year 2, Y has $0 of excess
business interest expense from PRS ($5
from Year 1, less $5 treated as paid or
accrued in Year 2).
(4) Example 4—(i) Facts. The facts are
the same as in Example 1 in paragraph
(o)(1)(i) of this section. In Year 2, PRS
has $100 of ATI, $60 of business interest
income, and $40 of business interest
expense. PRS allocates the items
comprising its $100 of ATI $50 to X and
$50 to Y. PRS allocates its $60 of
business interest income $30 to X and
$30 to Y. PRS allocates its $40 of
business interest expense $20 to X and
$20 to Y. X has $100 of ATI and $20 of
business interest expense from its sole
proprietorship. Y has $0 of ATI and $20
of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
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$90 (($100 × 30 percent)) + $60). Thus,
PRS has $20 of excess business interest
income, $100 of excess taxable income,
$40 of deductible business interest
expense, and $0 of excess business
interest expense. Such $40 of deductible
business interest expense is includable
in PRS’s nonseparately stated income or
loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
are each allocated $10 of excess
business interest income, $50 of excess
taxable income, and $20 of deductible
business interest expense. As a result, X
and Y each increase their business
interest income by $10 and ATI by $50.
Because X and Y are each allocated $10
of excess business interest income and
$50 of excess taxable income from PRS,
and excess business interest expense
from a partnership is treated as paid or
accrued by a partner to the extent excess
taxable income and excess business
interest income are allocated from such
partnership to a partner, X and Y each
treat $5 of excess business interest
expense (the carryforward from Year 1)
as paid or accrued in Year 2. X and Y
each increase their outside basis in PRS
by $60 ($80¥$20).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $150 of ATI ($100 from its sole
proprietorship, plus $50 excess taxable
income), $10 of business interest
income, and $25 of business interest
expense ($20 from its sole
proprietorship, plus $5 excess business
interest expense treated as paid or
accrued in Year 2). X’s section 163(j)
limit is $55 (($150 × 30 percent) + $10).
Thus, $25 of X’s business interest
expense is deductible business interest
expense. At the end of Year 2, X has $0
of excess business interest expense from
PRS ($5 from Year 1, less $5 treated as
paid or accrued in Year 2). Y, in
computing its limit under section 163(j),
has $50 of ATI ($0 from its sole
proprietorship, plus $50 excess taxable
income), $10 of business interest
income, and $45 of business interest
expense ($20 from its sole
proprietorship, plus $20 disallowed
business interest expense from Year 1,
plus $5 excess business interest expense
treated as paid or accrued in Year 2). Y’s
section 163(j) limit is $25 (($50 × 30
percent) + $10). Thus, $25 of Y’s
business interest expense is deductible
business interest expense. Y’s $20 of
business interest expense not allowed as
a deduction ($45 business interest
expense, less $25 section 163(j) limit) is
treated as business interest expense paid
or accrued by Y in Year 3. At the end
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of Year 2, Y has $0 of excess business
interest expense from PRS ($5 from Year
1, less $5 treated as paid or accrued in
Year 2).
(5) Example 5—(i) Facts. The facts are
the same as in Example 1 in paragraph
(o)(1)(i) of this section. In Year 2, PRS
has $100 of ATI, $11.20 of business
interest income, and $40 of business
interest expense. PRS allocates the items
comprising its $100 of ATI $50 to X and
$50 to Y. PRS allocates its $11.20 of
business interest income $5.60 to X and
$5.60 to Y. PRS allocates its $40 of
business interest expense $20 to X and
$20 to Y. X has $100 of ATI and $20 of
business interest expense from its sole
proprietorship. Y has $0 of ATI and $20
of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
$41.20 (($100 × 30 percent) + $11.20).
Thus, PRS has $0 of excess business
interest income, $4 of excess taxable
income, and $40 of deductible business
interest expense. Such $40 of deductible
business interest expense is includable
in PRS’s nonseparately stated income or
loss, and is not subject to further
limitation under section 163(j) at the
partners’ level.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
are each allocated $2 of excess taxable
income, $20 of deductible business
interest expense, and $0 of excess
business interest expense. As a result, X
and Y each increase their ATI by $2.
Because X and Y are each allocated $2
of excess taxable income from PRS, and
excess business interest expense from a
partnership is treated as paid or accrued
by a partner to the extent excess taxable
income and excess business interest
income are allocated from such
partnership to a partner, X and Y each
treat $2 of excess business interest
expense (a portion of the carryforward
from Year 1) as paid or accrued in Year
2. X and Y each increase their outside
basis in PRS by $35.60 ($55.60¥$20).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $102 of ATI ($100 from its sole
proprietorship, plus $2 excess taxable
income), $0 of business interest income,
and $22 of business interest expense
($20 from its sole proprietorship, plus
$2 excess business interest expense
treated as paid or accrued). X’s section
163(j) limit is $30.60 ($102 × 30
percent). Thus, X’s $22 of business
interest expense is deductible business
interest expense. At the end of Year 2,
X has $3 of excess business interest
expense from PRS ($5 from Year 1, less
$2 treated as paid or accrued in Year 2).
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Y, in computing its limit under section
163(j), has $2 of ATI ($0 from its sole
proprietorship, plus $2 excess taxable
income), $0 of business interest income,
and $42 of business interest expense
($20 from its sole proprietorship, plus
$20 disallowed business interest
expense from Year 1, plus $2 excess
business interest expense treated as paid
or accrued in Year 2). Y’s section 163(j)
limit is $0.60 ($2 × 30 percent). Thus,
$0.60 of Y’s business interest expense is
deductible business interest expense.
Y’s $41.40 of business interest expense
not allowed as a deduction ($42
business interest expense, less $0.60
section 163(j) limit) is treated as
business interest expense paid or
accrued by Y in Year 3. At the end of
Year 2, Y has $3 of excess business
interest expense from PRS ($5 from Year
1, less $2 treated as paid or accrued in
Year 2).
(6) Example 6—(i) Facts. In Year 1, X,
Y, and Z formed partnership PRS. Upon
formation, X and Y each contributed
$100, and Z contributed non-excepted
and non-depreciable trade or business
property with a basis of $0 and fair
market value of $100 (Blackacre). PRS
allocates all items pro rata between its
partners. Immediately after the
formation of PRS, Z sold all of its
interest in PRS to A for $100 (assume
the interest sale is respected for U.S.
Federal income tax purposes). In
connection with the interest transfer,
PRS made a valid election under section
754. Therefore, after the interest sale, A
had a $100 positive section 743(b)
adjustment in Blackacre. In Year 1, PRS
had $0 of ATI, $15 of business interest
expense, and $0 of business interest
income. Pursuant to § 1.163(j)–6(f)(2),
PRS allocated each of the partners $5 of
excess business interest expense. In
Year 2, PRS sells Blackacre for $100
which generated $100 of ATI. The sale
of Blackacre was PRS’s only item of
income in Year 2. In accordance with
section 704(c), PRS allocates all $100 of
gain resulting from the sale of Blackacre
to A. Additionally, PRS has $15 of
business interest expense, all of which
it allocates to X. A has $50 of ATI and
$20 of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its
ATI, or $30 ($100 × 30 percent). Thus,
PRS has $15 of deductible business
interest expense and $50 of excess
taxable income. Such $15 of deductible
business interest expense is includable
in PRS’s nonseparately stated income or
loss, and is not subject to further
limitation under section 163(j) at X’s
level.
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(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X is
allocated $15 of deductible business
interest expense and X’s outside basis in
PRS is reduced by $15. A is allocated
$50 of excess taxable income and, as a
result, A increases its ATI by $50.
Because A is allocated $50 of excess
taxable income, and excess business
interest expense from a partnership is
treated as paid or accrued by a partner
to the extent excess taxable income and
excess business interest income are
allocated from such partnership to a
partner, A treats $5 of excess business
interest expense (the carryforward from
Year 1) as paid or accrued in Year 2.
PRS’s $100 of gain allocated to A in
Year 2 is fully reduced by A’s $100
section 743(b) adjustment. Therefore, at
the end of Year 2, there is no change to
A’s outside basis in PRS.
(iv) Partner-level. A, in computing its
limit under section 163(j), has $0 of ATI
($50 from its sole proprietorship, plus
$50 excess taxable income, less $100
ATI reduction as a result of A’s section
743(b) adjustment under § 1.163(j)–
6(e)(2)) and $25 of business interest
expense ($20 from its sole
proprietorship, plus $5 excess business
interest expense treated as paid or
accrued in Year 2). A’s section 163(j)
limit is $0 ($0 × 30 percent). Thus, all
$25 of A’s business interest expense is
not allowed as a deduction and is
treated as business interest expense paid
or accrued by A in Year 3.
(7) Example 7—(i) Facts. X and Y are
equal partners in partnership PRS. At
the beginning of Year 1, X and Y each
have an outside basis in PRS of $5. In
Year 1, PRS has $0 of ATI, $20 of
business interest income, and $40 of
business interest expense. PRS allocates
its $20 of business interest income $10
to X and $10 to Y. PRS allocates $40 of
business interest expense $20 to X and
$20 to Y. X has $100 of ATI and $20 of
business interest expense from its sole
proprietorship. Y has $0 of ATI and $20
of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 1, PRS’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
$20 (($0 × 30 percent) + $20). Thus, PRS
has $0 of excess business interest
income, $0 of excess taxable income,
$20 of deductible business interest
expense, and $20 of excess business
interest expense. Such $20 of deductible
business interest expense is includable
in nonseparately stated income or loss
of PRS, and not subject to further
limitation under section 163(j) by the
partners.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
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56793
are each allocated $10 of deductible
business interest expense and $10 of
excess business interest expense. After
adjusting each partner’s respective basis
for business interest income under
section 705(a)(1)(A), pursuant to
§ 1.163(j)–6(h)(1), X and Y each take
their $10 of deductible business interest
expense into account when reducing
their outside basis in PRS before taking
the $10 of excess business interest
expense into account. Following each
partner’s reduction in outside basis due
to the $10 of deductible business
interest expense, each partner has $5 of
outside basis remaining in PRS.
Pursuant to § 1.163(j)–6(h)(2), each
partner has $5 of excess business
interest expense and $5 of negative
section 163(j) expense. In sum, at the
end of Year 1, X and Y each have $5 of
excess business interest expense from
PRS which reduces each partner’s
outside basis to $0 (and is not treated as
paid or accrued by the partners until
such partner is allocated excess taxable
income or excess business interest
income from PRS in a succeeding
taxable year), and $5 of negative section
163(j) expense (which is suspended
under section 704(d) and not treated as
excess business interest expense of the
partners until such time as the negative
section 163(j) expense is no longer
subject to a limitation under section
704(d)).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $100 of ATI (from its sole
proprietorship) and $20 of business
interest expense (from its sole
proprietorship). X’s section 163(j) limit
is $30 ($100 × 30 percent). Thus, $20 of
X’s business interest expense is
deductible business interest expense. Y,
in computing its limit under section
163(j), has $20 of business interest
expense (from its sole proprietorship).
Y’s section 163(j) limit is $0 ($0 × 30
percent). Thus, $20 of Y’s business
interest expense is not allowed as a
deduction in Year 1, and is treated as
business interest expense paid or
accrued by Y in Year 2.
(8) Example 8—(i) Facts. The facts are
the same as in Example 7 in paragraph
(o)(7)(i) of this section. In Year 2, PRS
has $20 of gross income that is taken
into account in determining PRS’s ATI
(in other words, properly allocable to a
trade or business), $30 of gross
deductions from an investment activity,
and $0 of business interest expense. PRS
allocates the items comprising its $20 of
ATI $10 to X and $10 to Y. PRS
allocates the items comprising its $30 of
gross deductions $15 to X and $15 to Y.
X has $100 of ATI and $20 of business
interest expense from its sole
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proprietorship. Y has $0 of ATI and $20
of business interest expense from its
sole proprietorship.
(ii) Partnership-level. In Year 2, PRS’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
$6 ($20 × 30 percent). Because PRS has
no business interest expense, all $20 of
its ATI is excess taxable income.
(iii) Partner-level allocations.
Pursuant to § 1.163(j)–6(f)(2), X and Y
are each allocated $10 of excess taxable
income. Because X and Y are each
allocated $10 of excess taxable income
from PRS, X and Y each increase their
ATI by $10. Pursuant to § 1.704–
(1)(d)(2), each partner’s limitation on
losses under section 704(d) must be
allocated to its distributive share of each
such loss. Thus, each partner reduces its
adjusted basis of $10 (attributable to the
allocation of items comprising PRS’s
ATI in Year 2) by $7.50 of gross
deductions from Year 2 ($10 × ($15 of
total gross deductions from Year 2/$20
of total losses disallowed)), and $2.50 of
excess business interest expense that
was carried over as negative section
163(j) expense from Year 1 ($10 × ($5 of
negative section 163(j) expense treated
as excess business interest expense
solely for the purposes of section
704(d)/$20 of total losses disallowed)).
Following the application of section
704(d), each partner has $7.50 of excess
business interest expense from PRS ($5
excess business interest expense from
Year 1, plus $2.50 of excess business
interest expense that was formerly
negative section 163(j) expense carried
over from Year 1). Excess business
interest expense from a partnership is
treated as paid or accrued by a partner
to the extent excess taxable income and
excess business interest income are
allocated from such partnership to the
partner. As a result, X and Y each treat
$7.50 of excess business interest
expense as paid or accrued in Year 2.
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $110 of ATI ($100 from its sole
proprietorship, plus $10 excess taxable
income) and $27.50 of business interest
expense ($20 from its sole
proprietorship, plus $7.50 excess
business interest expense treated as paid
or accrued in Year 2). X’s section 163(j)
limit is $33 ($110 × 30 percent). Thus,
$27.50 of X’s business interest expense
is deductible business interest expense.
At the end of Year 2, X has $0 of excess
business interest expense from PRS ($5
from Year 1, plus $2.50 treated as excess
business interest expense in Year 2, less
$7.50 treated as paid or accrued in Year
2), and $2.50 of negative section 163(j)
expense from PRS. Y, in computing its
limit under section 163(j), has $10 of
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ATI ($0 from its sole proprietorship,
plus $10 excess taxable income) and
$47.50 of business interest expense ($20
from its sole proprietorship, plus $20
disallowed business interest expense
from Year 1, plus $7.50 excess business
interest expense treated as paid or
accrued in Year 2). Y’s section 163(j)
limit is $3 ($10 × 30 percent). Thus, $3
of Y’s business interest expense is
deductible business interest expense.
The $44.50 of Y’s business interest
expense not allowed as a deduction
($47.50 business interest expense, less
$3 section 163(j) limit) is treated as
business interest expense paid or
accrued by Y in Year 3. At the end of
Year 2, Y has $0 of excess business
interest expense from PRS ($5 from Year
1, plus $2.50 treated as excess business
interest expense in Year 2, less $7.50
treated as paid or accrued in Year 2),
and $2.50 of negative section 163(j)
expense from PRS.
(9) Example 9—(i) Facts. X and Y are
equal partners in partnership PRS, and
are not members of a consolidated
group. At the beginning of Year 1, X and
Y each have $120 of outside basis in
PRS. Neither X nor Y’s share of
partnership liabilities exceeds the
adjusted basis of its entire interest. In
Year 1, X is allocated $20 of excess
business interest expense, which
reduces its outside basis from $120 to
$100. In Year 2, X sells 80 percent of its
interest in PRS to Z for $160.
Immediately prior to the sale, X’s entire
PRS interest had a fair market value of
$200 and the transferred portion of the
interest had a fair market value of $160.
(ii) Basis adjustment. Immediately
before the sale to Z, X increases its basis
in the portion of the interest sold by 80
percent of the amount of the excess of
the amount of the basis reduction under
paragraph (h)(2) of this section ($20)
over the portion of any excess business
interest expense allocated the partner
under paragraph (f)(2) of this section
that has previously been treated under
paragraph (g) of this section as business
interest expense paid or accrued by X
($0). Therefore, X’s basis in the portion
of its interest sold is $96 (($100 × 80%)
+ ($20 × 80%)), and X’s gain is $64
($160¥$96). Following the sale, X has
$20 of outside basis in its remaining
partnership interest and $4 of excess
business interest expense.
(10) Example 10—(i) Facts. X and Y
are equal partners in partnership PRS,
and are not members of a consolidated
group. At the beginning of Year 1, X and
Y each have an outside basis in PRS of
$10. Neither X nor Y’s share of
partnership liabilities exceeds the
adjusted basis of its entire interest. In
Year 1, X is allocated $8 of excess
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business interest expense and $12 of
loss from PRS. As a result, X has $4 of
excess business interest expense, $4 of
negative section 163(j) expense, $6 of
allowable loss, $6 of loss suspended
under section 704(d), and $0 of outside
basis in PRS at the end of Year 1. In
Year 2, X sells 50 percent of its interest
in PRS to Z for $20. Immediately prior
to the sale, X’s entire partnership
interest had a fair market value of $40
and the transferred portion of the
interest had a fair market value of $20.
(ii) Basis adjustment. Immediately
before the sale to Z, X increases its basis
in the portion of the interest sold by 50
percent of the amount of the excess of
the amount of the basis reduction under
paragraph (h)(2) of this section ($4) over
the portion of any excess business
interest expense allocated the partner
under paragraph (f)(2) of this section
that has previously been treated under
paragraph (g) of this section as business
interest expense paid or accrued by X
($0). Therefore, X’s basis in the portion
of its interest sold is $2 (($0 × 50%) +
$2), and X’s gain is $18 ($20¥$2).
Following the sale, X has $0 of outside
basis in its remaining partnership
interest, $2 of excess business interest
expense, $4 of negative section 163(j)
expense, and $6 of loss suspended
under section 704(d).
(11) Example 11—(i) Facts. X (a
corporation), Y (an individual), and Z
(an individual) are equal partners in
partnership PRS. X, Y, and Z are subject
to section 163(j). PRS is not subject to
section 163(j) under section 163(j)(3). In
2021, PRS has $150 of trade or business
income (not taking into account
business interest income or business
interest expense), $30 of business
interest income, and $45 of business
interest expense. PRS also has $75 of
investment income and $60 of
investment interest expense. PRS
allocates its items of income, gain, loss,
and deduction equally among its
partners. X, Y, and Z each have $10 of
business interest expense from their
respective businesses.
(ii) Partnership-level. PRS is not
subject to section 163(j) by reason of
section 163(j)(3). As a result, none of
PRS’s $45 of business interest expense
is subject to the section 163(j)
limitation.
(iii) Partner-level allocations. Because
PRS is not subject to section 163(j) by
reason of section 163(j)(3), PRS’s $45 of
business interest expense does not
retain its character as business interest
expense for purposes of section 163(j).
As a result, such business interest
expense is not subject to the section
163(j) limitation at the level of either the
partnership or partner. Additionally,
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pursuant to § 1.163(j)–6(m)(1), each
partner includes its share of nonexcepted trade or business items of
income, gain, loss, and deduction
(including business interest expense
and business interest income) of PRS
when calculating its ATI. As a result,
each partner increases its ATI by $45
(one third of $150 + $30¥$45). Also, X
increases its ATI by an additional $25
because its items of investment income
and loss from PRS are recharacterized as
non-excepted trade or business income
and loss at its level pursuant to
§§ 1.163(j)–4(b)(3)(i) and 1.163(j)–
10(b)(6). Further, X increases its
business interest expense by its $20
allocation of investment interest
expense from PRS pursuant to
§§ 1.163(j)–4(b)(3)(i) and 1.163(j)–
10(b)(6).
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $70 of ATI and $30 of business
interest expense. X’s section 163(j) limit
is $21 ($70 × 30 percent). Thus, X has
$21 of deductible business interest
expense. X’s $9 of business interest
expense not allowed as a deduction is
treated as business interest expense paid
or accrued by X in 2020. Y and Z, in
computing their respective limits under
section 163(j), each have $45 of ATI and
$10 of business interest expense. Y and
Z each have a section 163(j) limit of
$13.50 ($45¥30 percent). Thus, Y and
Z each have $10 of deductible business
interest expense.
(12) Example 12—(i) Facts. The facts
are the same as in Example 11 in
paragraph (o)(11)(i) of this section,
except PRS has $200 of depreciation
deductions in addition to its other items
of income, gain, loss, and deduction.
(ii) Partnership-level. Same analysis
as Example 11 in paragraph (o)(11)(ii) of
this section.
(iii) Partner-level allocations. Because
PRS is not subject to section 163(j) by
reason of section 163(j)(3), PRS’s $45 of
business interest expense does not
retain its character as business interest
expense for purposes of section 163(j).
As a result, such business interest
expense is not subject to the section
163(j) limitation at the level of either the
partnership or partner. Additionally,
pursuant to § 1.163(j)–6(m)(1), each
partner includes its share of nonexcepted trade or business items of
income, gain, loss, and deduction
(including business interest expense
and business interest income) of PRS
when calculating its ATI; however, a net
loss allocation of trade or business items
from an exempt entity does not reduce
a partner’s ATI. Because each of the
partners has a net loss allocation of
trade or business items from PRS, none
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of the partners adjust their ATI for the
trade or business items of PRS. X, the
corporate partner, increases its ATI by
$25 because its items of investment
income and loss from PRS are
recharacterized as trade or business
income and loss at its level pursuant to
§§ 1.163(j)–4(b)(3)(i) and 1.163(j)–
10(b)(6). Further, X increases its
business interest expense by its $20
allocation of investment interest
expense from PRS pursuant to
§§ 1.163(j)–4(b)(3)(i) and 1.163(j)–
10(b)(6).
(iv) Partner-level computations. In
computing its limit under section 163(j),
each partner has $0 of ATI and $10 of
business interest expense. Each
partner’s section 163(j) limit is $0 ($0 ×
30 percent). Thus, each partner’s $10 of
business interest expense is not allowed
as a deduction and is treated as business
interest expense paid or accrued by the
partner in 2020. X, in computing its
limit under section 163(j), has $25 of
ATI and $30 of business interest
expense. X’s section 163(j) limit is $7.50
($25 × 30 percent). Thus, X has $7.50 of
deductible business interest expense.
X’s $22.50 of business interest expense
not allowed as a deduction is treated as
business interest expense paid or
accrued by X in 2020. Y and Z, in
computing their respective limits under
section 163(j), each have $0 of ATI and
$10 of business interest expense. Thus,
Y and Z each have $10 of business
interest expense not allowed as a
deduction that is treated as business
interest expense paid or accrued in
2020.
(13) Example 13—(i) Facts. X, Y, and
Z are equal partners in partnership PRS.
X, Y, and Z are each individuals subject
to section 163(j). PRS is not subject to
section 163(j) under section 163(j)(3).
PRS has one excepted and one nonexcepted trade or business. In Year 1,
PRS has $200 of income and $10 of
business interest expense from its
excepted trade or business, and $60 of
business interest income and $30 of
business interest expense from its nonexcepted trade or business. PRS
allocates its items of income, gain, loss,
and deduction equally among its
partners. X, Y, and Z each have $10 of
business interest expense from their
respective businesses.
(ii) Partnership-level. PRS is not
subject to section 163(j) by reason of
section 163(j)(3). As a result, none of
PRS’s business interest expense is
subject to the section 163(j) limitation.
(iii) Partner-level allocations. Because
PRS’s business interest expense is not
subject to the section 163(j) limitation,
such business interest expense is not
subject to the section 163(j) limitation at
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56795
the level of either the partnership or
partner. Additionally, pursuant to
§ 1.163(j)–6(m)(1), each partner includes
its share of non-excepted trade or
business items of income, gain, loss, and
deduction (including business interest
expense and business interest income)
of PRS when calculating its ATI.
Therefore, each partner increases its ATI
by $10 (each partner’s share of $20 of
non-excepted income less each partner’s
share of $10 of non-excepted loss).
(iv) Partner-level computations. In
computing its limit under section 163(j),
each partner has $10 of ATI and $10 of
business interest expense. Each
partner’s section 163(j) limit is $3 ($10
× 30 percent). Thus, each partner has $3
of deductible business interest expense.
Each partner has $7 of business interest
expense not allowed as a deduction that
is treated as business interest expense
paid or accrued by the partner in Year
2.
(14) Example 14—(i) Facts. The facts
are the same as in Example 5 in
paragraph (o)(5)(i) of this section, except
in Year 2 Y is not subject to section
163(j) under section 163(j)(3).
(ii) Partnership-level. Same analysis
as Example 5 in paragraph (o)(5)(ii) of
this section.
(iii) Partner-level allocations. Same
analysis as Example 5 in paragraph
(o)(5)(iii) of this section.
(iv) Partner-level computations. For X,
same analysis as Example 5 in
paragraph (o)(5)(iv) of this section. Y is
not subject to section 163(j) under
section 163(j)(3). Thus, all $42 of
business interest expense ($20 from its
sole proprietorship, plus $20 disallowed
business interest expense from Year 1,
plus $2 excess business interest expense
treated as paid or accrued in Year 2) is
not subject to limitation under
§ 1.163(j)–2(d). At the end of Year 2, Y
has $3 of excess business interest
expense from PRS ($5 from Year 1, less
$2 treated as paid or accrued in Year 2).
(15) Example 15—(i) Facts. The facts
are the same as in Example 5 in
paragraph (o)(5)(i) of this section, except
in Year 2 PRS and Y become not subject
to section 163(j) by reason of section
163(j)(3).
(ii) Partnership-level. In Year 2, PRS
is not subject to section 163(j) by reason
of section 163(j)(3). As a result, none of
PRS’s $40 of business interest expense
is subject to the section 163(j) limitation
at the level of either the partnership or
partner.
(iii) Partner-level allocations. Because
PRS is not subject to section 163(j) by
reason of section 163(j)(3), PRS’s $40 of
business interest expense does not
retain its character as business interest
expense for purposes of section 163(j).
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As a result, such business interest
expense is not subject to the section
163(j) limitation at the level of either the
partnership or partner. Additionally,
pursuant to § 1.163(j)–6(m)(1), each
partner includes its share of nonexcepted trade or business items of
income, gain, loss, and deduction
(including business interest expense
and business interest income) of PRS
when calculating its ATI. As a result, X
and Y each increase their ATI by $35.60.
Further, because PRS is not subject to
section 163(j) by reason of section
163(j)(3), the excess business interest
expense from Year 1 is treated as paid
or accrued by the partners pursuant to
§ 1.163(j)–6(m)(3). As a result, X and Y
each treat their $5 of excess business
interest expense from Year 1 as paid or
accrued in Year 2, and increase their
business interest expense by $5.
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $135.60 of ATI ($100 from its sole
proprietorship, plus $35.60 ATI from
PRS) and $25 of business interest
expense ($20 from its sole
proprietorship, plus $5 of excess
business interest expense treated as paid
or accrued in Year 2). X’s section 163(j)
limit is $40.68 ($135.60 × 30 percent).
Thus, $25 of X’s business interest
expense is deductible business interest
expense. Y is not subject to section
163(j) under section 163(j)(3). As a
result, Y’s business interest expense is
not subject to the section 163(j)
limitation. Thus, all $45 of Y’s business
interest expense ($20 from its sole
proprietorship, plus $20 disallowed
from year 1, plus $5 of excess business
interest expense treated as paid or
accrued in Year 2) is not subject to the
section 163(j) limitation.
(16) Example 16—(i) Facts. The facts
are the same as in Example 1 in
paragraph (o)(1)(i) of this section, except
that PRS’s only trade or business is a
real property trade or business for
which PRS does not make the election
provided for in section 163(j)(7)(B). In
Year 2, when PRS’s only trade or
business is still its real property trade or
business, PRS makes the election
provided for in section 163(j)(7)(B).
Further, in Year 2, PRS has $100 of
income and $40 of business interest
expense. PRS allocates its items of
income, gain, deduction, and loss
equally between X and Y. X has $100 of
ATI and $20 of business interest
expense from its sole proprietorship. Y
has $0 of ATI and $20 of business
interest expense from its sole
proprietorship.
(ii) Partnership-level. In Year 2, PRS
is not subject to section 163(j) because
its only trade or business is an excepted
trade or business. As a result, none of
PRS’s $40 of business interest expense
is subject to the section 163(j) limitation
at the level of either the partnership or
partner.
(iii) Partner-level allocations. Because
PRS is not subject to section 163(j),
PRS’s $40 of business interest expense
does not retain its character as business
interest expense for purposes of section
163(j). As a result, such business
interest expense is not subject to the
section 163(j) limitation at the partners’
level. Pursuant to § 1.163(j)–6(m)(1), the
partners do not include their respective
$50 shares of income from PRS when
calculating their own ATI because such
$50 is excepted trade or business
income.
(iv) Partner-level computations. X, in
computing its limit under section 163(j),
has $100 of ATI ($100 from its sole
proprietorship) and $20 of business
interest expense ($20 from its sole
proprietorship). X’s section 163(j) limit
is $30 ($100 × 30 percent). Thus, $20 of
X’s business interest expense is
deductible business interest expense. At
the end of Year 2, X has $5 of excess
business interest expense from PRS ($5
from Year 1). Y, in computing its limit
under section 163(j), has $0 of ATI and
$40 of business interest expense ($20
from its sole proprietorship, plus $20
disallowed business interest expense
from Year 1). Y’s section 163(j) limit is
$0. Thus, Y’s $40 of business interest
expense not allowed as a deduction is
treated as business interest expense paid
or accrued by Y in Year 3. At the end
of Year 2, Y has $5 of excess business
interest expense from PRS ($5 from Year
1).
(17) Example 17: Facts. A (an
individual) and B (a corporation) own
all of the interests in partnership PRS.
At the beginning of Year 1, A and B
each have $100 section 704(b) capital
account and $100 of basis in PRS. In
Year 1, PRS has $100 of ATI, $10 of
investment interest income, $20 of
business interest income (BII), $60 of
business interest expense (BIE), and $10
of floor plan financing interest expense.
PRS’s ATI consists of $100 of gross
income and $0 of gross deductions. PRS
allocates its items comprising ATI $100
to A and $0 to B. PRS allocates its
business interest income $10 to A and
$10 to B. PRS allocates its business
interest expense $30 to A and $30 to B.
PRS allocates all $10 of its investment
interest income and all $10 of its floor
plan financing interest expense to B. A
has ATI from a sole proprietorship,
unrelated to PRS, in the amount of $300.
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section
163(j) limit is 30 percent of its ATI plus
its business interest income, or $50
(($100 × 30 percent) + $20). Thus, PRS
has $0 of excess business interest
income (EBII), $0 of excess taxable
income, $50 of deductible business
interest expense, and $10 of excess
business interest expense. PRS takes its
$10 of floor plan financing into account
in determining its nonseparately stated
taxable income or loss.
(ii) Second, PRS determines each
partner’s allocable share of section
163(j) items used in its own section
163(j) calculation. B’s $10 of investment
interest income is not included in B’s
allocable business interest income
amount because the $10 of investment
interest income was not taken into
account in PRS’s section 163(j)
calculation. B’s $10 of floor plan
financing interest expense is not
included in B’s allocable business
interest expense. The $300 of ATI from
A’s sole proprietorship is not included
in A’s allocable ATI amount because the
$300 was not taken into account in
PRS’s section 163(j) calculation.
TABLE 1 TO PARAGRAPH (o)(17)(ii)
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A
Allocable ATI ................................................................................................................................
Allocable BII .................................................................................................................................
Allocable BIE ...............................................................................................................................
(iii) Third, PRS compares each
partner’s allocable business interest
income to such partner’s allocable
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business interest expense. Because each
partner’s allocable business interest
expense exceeds its allocable business
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B
$100
10
30
Total
$0
10
30
$100
20
60
interest income by $20 ($30¥$10), each
partner has an allocable business
interest income deficit of $20. Thus, the
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total allocable business interest income
deficit is $40 ($20 + $20). No partner
has allocable business interest income
excess because no partner has allocable
business interest income in excess of its
allocable business interest expense.
Thus, the total allocable business
interest income excess is $0.
TABLE 2 TO PARAGRAPH (o)(17)(iii)
A
Allocable BII .................................................................................................................................
Allocable BIE ...............................................................................................................................
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess .....................
If allocable BIE exceeds allocable BII, then such amount = Allocable BII deficit .......................
(iv) Fourth, PRS determines each
partner’s final allocable business
interest income excess. Because no
partner had any allocable business
interest income excess, each partner has
final allocable business interest income
excess of $0.
(v) Fifth, PRS determines each
partner’s remaining business interest
expense. PRS determines A’s remaining
business interest expense by reducing,
but not below $0, A’s allocable business
interest income deficit ($20) by the
product of the total allocable business
interest income excess ($0) and the ratio
of A’s allocable business interest income
deficit to the total business interest
income deficit ($20/$40). Therefore, A’s
allocable business interest income
deficit of $20 is reduced by $0 ($0 × 50
percent). As a result, A’s remaining
business interest expense is $20. PRS
determines B’s remaining business
interest expense by reducing, but not
B
$10
30
0
20
Total
$10
30
0
20
N/A
N/A
$0
40
below $0, B’s allocable business interest
income deficit ($20) by the product of
the total allocable business interest
income excess ($0) and the ratio of B’s
allocable business interest income
deficit to the total business interest
income deficit ($20/$40). Therefore, B’s
allocable business interest income
deficit of $20 is reduced by $0 ($0 × 50
percent). As a result, B’s remaining
business interest expense is $20.
TABLE 3 TO PARAGRAPH (o)(17)(v)
A
Allocable BII deficit ......................................................................................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/Total allocable BII deficit) .................
= Remaining BIE ..........................................................................................................................
(vi) Sixth, PRS determines each
partner’s final allocable ATI. Any
partner with a negative allocable ATI, or
an allocable ATI of $0, has a positive
allocable ATI of $0. Therefore, B has a
positive allocable ATI of $0. Because
A’s allocable ATI is comprised of $100
of income and gain and $0 of deduction
and loss, A has positive allocable ATI of
$100. Thus, the total positive allocable
ATI is $100 ($100 + $0). PRS determines
A’s final allocable ATI by reducing, but
not below $0, A’s positive allocable ATI
($100) by the product of total negative
allocable ATI ($0) and the ratio of A’s
positive allocable ATI to the total
B
$20
0
20
Total
$20
0
20
$40
N/A
40
positive allocable ATI ($100/$100).
Therefore, A’s positive allocable ATI is
reduced by $0 ($0 × 100 percent). As a
result, A’s final allocable ATI is $100.
Because B has a positive allocable ATI
of $0, B’s final allocable ATI is $0.
TABLE 4 TO PARAGRAPH (o)(17)(vi)
A
Allocable ATI ................................................................................................................................
If deduction and loss items comprising allocable ATI exceed income and gain items comprising allocable ATI, then such excess amount = Negative allocable ATI ............................
If income and gain items comprising allocable ATI equal or exceed deduction and loss items
comprising allocable ATI, then such amount = Positive allocable ATI ...................................
B
Total
$100
$0
$100
0
0
0
100
0
100
TABLE 5 TO PARAGRAPH (o)(17)(vi)
A
khammond on DSKJM1Z7X2PROD with RULES2
Positive allocable ATI ..................................................................................................................
Less: (Total negative allocable ATI) × (Positive allocable ATI/Total positive allocable ATI) ......
= Final allocable ATI ....................................................................................................................
(vii) Seventh, PRS compares each
partner’s ATI capacity (ATIC) amount to
such partner’s remaining business
interest expense. A’s ATIC amount is
$30 ($100 × 30 percent) and B’s ATIC
amount is $0 ($0 × 30 percent). Because
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A’s ATIC amount exceeds its remaining
business interest expense by $10
($30¥$20), A has an ATIC excess of
$10. B does not have any ATIC excess.
Thus, the total ATIC excess is $10 ($10
+ $0). A does not have any ATIC deficit.
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B
$100
0
100
Total
$0
0
0
$100
N/A
100
Because B’s remaining business interest
expense exceeds its ATIC amount by
$20 ($20¥$0), B has an ATIC deficit of
$20. Thus, the total ATIC deficit is $20
($0 + $20).
E:\FR\FM\14SER2.SGM
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
TABLE 6 TO PARAGRAPH (o)(17)(vii)
A
ATIC (Final allocable ATI × 30 percent) ......................................................................................
Remaining BIE .............................................................................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC excess ............................................
If remaining BIE exceeds ATIC, then such excess = ATIC deficit .............................................
(viii)(A) Eighth, PRS must perform the
calculations and make the necessary
adjustments described under paragraph
(f)(2)(viii) of this section if, and only if,
PRS has—
(1) An excess business interest
expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI
greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess amount
greater than $0 under paragraph
(f)(2)(vii) of this section.
(B) Because PRS does not meet all
three requirements in paragraph
B
$30
20
10
0
Total
$0
20
0
20
N/A
N/A
$10
20
(o)(17)(viii)(A) of this section, PRS does
not perform the calculations or
adjustments described in paragraph
(f)(2)(viii) of this section. In sum, the
correct amounts to be used in
paragraphs (o)(17)(ix) and (x) of this
section are as follows.
TABLE 7 TO PARAGRAPH (o)(17)(viii)(B)
A
ATIC excess ................................................................................................................................
ATIC deficit ..................................................................................................................................
(ix) Ninth, PRS determines each
partner’s final ATIC excess amount.
Because A has an ATIC excess, PRS
must determine A’s final ATIC excess
amount. A’s final ATIC excess amount
is A’s ATIC excess ($10), reduced, but
not below $0, by the product of the total
ATIC deficit ($20) and the ratio of A’s
B
$10
0
Total
$0
20
$10
20
ATIC excess to the total ATIC excess
($10/$10). Therefore, A has $0 of final
ATIC excess ($10¥($20 × 100 percent)).
TABLE 8 TO PARAGRAPH (o)(17)(ix)
A
ATIC excess ................................................................................................................................
Less: (Total ATIC deficit) × (ATIC excess/Total ATIC excess) ...................................................
= Final ATIC excess ....................................................................................................................
(x) Tenth, PRS determines each
partner’s final ATIC deficit amount.
Because B has an ATIC deficit, PRS
must determine B’s final ATIC deficit
amount. B’s final ATIC deficit amount is
B’s ATIC deficit ($20), reduced, but not
below $0, by the product of the total
ATIC excess ($10) and the ratio of B’s
B
$10
20
0
Total
$0
0
0
N/A
N/A
$0
ATIC deficit to the total ATIC deficit
($20/$20). Therefore, B has $10 of final
ATIC deficit ($20¥($10 × 100 percent)).
TABLE 9 TO PARAGRAPH (o)(17)(x)
A
khammond on DSKJM1Z7X2PROD with RULES2
ATIC deficit ..................................................................................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) .....................................................
= Final ATIC deficit ......................................................................................................................
(xi) Eleventh, PRS allocates
deductible business interest expense
and section 163(j) excess items to the
partners. Pursuant to paragraph (f)(2)(i)
of this section, PRS has $10 of excess
business interest expense. PRS allocates
the excess business interest expense
dollar for dollar to the partners with
final ATIC deficits amounts. Thus, PRS
allocates all $10 of its excess business
interest expense to B. A partner’s
allocable business interest expense is
deductible business interest expense to
the extent it exceeds such partner’s
share of excess business interest
expense. Therefore, A has deductible
business interest expense of $30
($30¥$0) and B has deductible business
B
$0
0
0
Total
$20
10
10
N/A
N/A
$10
interest expense of $20 ($30¥$10). As
a result of its allocations from PRS, A
increases its section 704(b) capital
account and basis in PRS by $80 to
$180. As a result of its allocations from
PRS, B decreases its capital account and
basis in PRS by $20 to $80.
TABLE 10 TO PARAGRAPH (o)(17)(xi)
A
Deductible BIE .............................................................................................................................
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B
$30
14SER2
Total
$20
$50
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
56799
TABLE 10 TO PARAGRAPH (o)(17)(xi)—Continued
A
EBIE allocated .............................................................................................................................
ETI allocated ................................................................................................................................
EBII allocated ...............................................................................................................................
(18) Example 18: Facts. A, B, and C
own all of the interests in partnership
PRS. In Year 1, PRS has $150 of ATI,
$10 of business interest income, and $40
of business interest expense. PRS’s ATI
consists of $200 of gross income and
$50 of gross deductions. PRS allocates
its items comprising ATI ($50) to A,
$200 to B, and $0 to C. PRS allocates its
business interest income $0 to A, $0 to
B, and $10 to C. PRS allocates its
business interest expense $30 to A, $10
to B, and $0 to C.
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section
163(j) limit is 30 percent of its ATI plus
its business interest income, or $55
(($150 × 30 percent) + $10). Thus, PRS
B
0
0
0
Total
10
0
0
10
0
0
has $0 of excess business interest
income, $50 of excess taxable income,
$40 of deductible business interest
expense, and $0 of excess business
interest expense.
(ii) Second, PRS determines each
partner’s allocable share of section
163(j) items used in its own section
163(j) calculation.
TABLE 11 TO PARAGRAPH (o)(18)(ii)
A
Allocable ATI ....................................................................................................
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................
(iii) Third, PRS compares each
partner’s allocable business interest
income to such partner’s allocable
business interest expense. Because A’s
allocable business interest expense
exceeds its allocable business interest
income by $30 ($30¥$0), A has an
allocable business interest income
deficit of $30. Because B’s allocable
B
($50)
0
30
business interest expense exceeds its
allocable business interest income by
$10 ($10¥$0), B has an allocable
business interest income deficit of $10.
C does not have any allocable business
interest income deficit. Thus, the total
allocable business interest income
deficit is $40 ($30 + $10 + $0). A and
B do not have any allocable business
C
$200
0
10
Total
$0
10
0
$150
10
40
interest income excess. Because C’s
allocable business interest income
exceeds its allocable business interest
expense by $10 ($10¥$0), C has an
allocable business interest income
excess of $10. Thus, the total allocable
business interest income excess is $10
($0 + $0 + $10).
TABLE 12 TO PARAGRAPH (o)(18)(iii)
A
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess ..............................................................................................................
If allocable BIE exceeds allocable BII, then such amount = Allocable BII
deficit ............................................................................................................
(iv) Fourth, PRS determines each
partner’s final allocable business
interest income excess. Because A and
B do not have any allocable business
interest income excess, each partner has
final allocable business interest income
excess of $0. PRS determines C’s final
B
C
Total
$0
30
$0
10
$10
0
N/A
N/A
0
0
10
$10
30
10
0
40
allocable business interest income
excess by reducing, but not below $0,
C’s allocable business interest income
excess ($10) by the product of the total
allocable business interest income
deficit ($40) and the ratio of C’s
allocable business interest income
excess to the total allocable business
interest income excess ($10/$10).
Therefore, C’s allocable business
interest income excess of $10 is reduced
by $10 ($40 × 100 percent). As a result,
C’s allocable business interest income
excess is $0.
TABLE 13 TO PARAGRAPH (o)(18)(iv)
khammond on DSKJM1Z7X2PROD with RULES2
A
Allocable BII excess ........................................................................................
Less: (Total allocable BII deficit) × (Allocable BII excess/Total allocable BII
excess) .........................................................................................................
= Final Allocable BII Excess ............................................................................
(v) Fifth, PRS determines each
partner’s remaining business interest
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B
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Total
$0
$0
$10
N/A
0
0
0
0
40
0
N/A
$10
expense. PRS determines A’s remaining
business interest expense by reducing,
PO 00000
C
but not below $0, A’s allocable business
interest income deficit ($30) by the
E:\FR\FM\14SER2.SGM
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
product of the total allocable business
interest income excess ($10) and the
ratio of A’s allocable business interest
income deficit to the total business
interest income deficit ($30/$40).
Therefore, A’s allocable business
interest income deficit of $30 is reduced
by $7.50 ($10 × 75 percent). As a result,
A’s remaining business interest expense
is $22.50. PRS determines B’s remaining
business interest expense by reducing,
but not below $0, B’s allocable business
interest income deficit ($10) by the
product of the total allocable business
interest income excess ($10) and the
ratio of B’s allocable business interest
income deficit to the total business
interest income deficit ($10/$40).
Therefore, B’s allocable business
interest income deficit of $10 is reduced
by $2.50 ($10 × 25 percent). As a result,
B’s remaining business interest expense
is $7.50. Because C does not have any
allocable business interest income
deficit, C’s remaining business interest
expense is $0.
TABLE 14 TO PARAGRAPH (o)(18)(v)
A
Allocable BII deficit ..........................................................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/Total allocable BII
deficit) ...........................................................................................................
= Remaining BIE ..............................................................................................
(vi) Sixth, PRS determines each
partner’s final allocable ATI. Because
A’s allocable ATI is comprised of $50 of
items of deduction and loss and $0 of
income and gain, A has negative
allocable ATI of $50. A is the only
partner with negative allocable ATI.
Thus, the total negative allocable ATI
amount is $50. Any partner with a
negative allocable ATI, or an allocable
B
C
Total
$30
$10
$0
$40
7.50
22.50
2.50
7.50
0
0
N/A
N/A
ATI of $0, has a positive allocable ATI
of $0. Therefore, A and C have a
positive allocable ATI of $0. Because B’s
allocable ATI is comprised of $200 of
items of income and gain and $0 of
deduction and loss, B has positive
allocable ATI of $200. Thus, the total
positive allocable ATI is $200 ($0 +
$200 + $0). PRS determines B’s final
allocable ATI by reducing, but not
below $0, B’s positive allocable ATI
($200) by the product of total negative
allocable ATI ($50) and the ratio of B’s
positive allocable ATI to the total
positive allocable ATI ($200/$200).
Therefore, B’s positive allocable ATI is
reduced by $50 ($50 × 100 percent). As
a result, B’s final allocable ATI is $150.
TABLE 15 TO PARAGRAPH (o)(18)(vi)
A
Allocable ATI ....................................................................................................
If deduction and loss items comprising allocable ATI exceed income and
gain items comprising allocable ATI, then such excess amount = Negative allocable ATI ..........................................................................................
If income and gain items comprising allocable ATI equal or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ..........................................................................................
B
C
Total
($50)
$200
$0
$150
50
0
0
50
0
200
0
200
TABLE 16 TO PARAGRAPH (o)(18)(vi)
A
Positive allocable ATI ......................................................................................
Less: (Total negative allocable ATI) × (Positive allocable ATI/Total positive
allocable ATI) ...............................................................................................
= Final allocable ATI ........................................................................................
(vii) Seventh, PRS compares each
partner’s ATI capacity (ATIC) amount to
such partner’s remaining business
interest expense. A’s ATIC amount is $0
($0 × 30 percent), B’s ATIC amount is
$45 ($150 × 30 percent), and C’s ATIC
amount is $0 ($0 × 30 percent). A does
B
C
Total
$0
$200
$0
$200
0
0
50
150
0
0
N/A
150
not have any ATIC excess. Because B’s
ATIC amount exceeds its remaining
business interest expense by $37.50
($45¥$7.50), B has an ATIC excess
amount of $37.50. C does not have any
ATIC excess. Thus, the total ATIC
excess amount is $37.50 ($0 + $37.50 +
$0). Because A’s remaining business
interest expense exceeds its ATIC
amount by $22.50 ($22.50¥$0), A has
an ATIC deficit of $22.50. B and C do
not have any ATIC deficit. Thus, the
total ATIC deficit is $22.50 ($22.50 + $0
+ $0).
khammond on DSKJM1Z7X2PROD with RULES2
TABLE 17 TO PARAGRAPH (o)(18)(vii)
A
ATIC (Final allocable ATI × 30 percent) ..........................................................
Remaining BIE .................................................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC excess ................
If remaining BIE exceeds ATIC, then such excess = ATIC deficit .................
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B
$0
22.50
0
22.50
E:\FR\FM\14SER2.SGM
C
$45
7.50
37.50
0
14SER2
Total
$0
0
0
0
N/A
N/A
$37.50
22.50
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
(viii)(A) Eighth, PRS must perform the
calculations and make the necessary
adjustments described under paragraph
(f)(2)(viii) of this section if, and only if,
PRS has—
(1) An excess business interest
expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI
greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess amount
greater than $0 under paragraph
(f)(2)(vii) of this section.
(B) Because PRS does not meet all
three requirements in paragraph
56801
(o)(18)(viii)(A) of this section, PRS does
not perform the calculations or
adjustments described in paragraph
(f)(2)(viii) of this section. In sum, the
correct amounts to be used in
paragraphs (o)(18)(ix) and (x) of this
section are as follows.
TABLE 18 TO PARAGRAPH (o)(18)(viii)(B)
A
ATIC excess ....................................................................................................
ATIC deficit ......................................................................................................
(ix) Ninth, PRS determines each
partner’s final ATIC excess amount.
Because B has ATIC excess, PRS must
determine B’s final ATIC excess
B
$0
22.50
amount. B’s final ATIC excess amount is
B’s ATIC excess ($37.50), reduced, but
not below $0, by the product of the total
ATIC deficit ($22.50) and the ratio of B’s
C
$37.50
0
Total
$0
0
$37.50
22.50
ATIC excess to the total ATIC excess
($37.50/$37.50). Therefore, B has $15 of
final ATIC excess ($37.50¥($22.50 ×
100 percent)).
TABLE 19 TO PARAGRAPH (o)(18)(ix)
A
ATIC excess ....................................................................................................
Less: (Total ATIC deficit) × (ATIC excess/Total ATIC excess) .......................
= Final ATIC excess ........................................................................................
(x) Tenth, PRS determines each
partner’s final ATIC deficit amount.
Because A has an ATIC deficit, PRS
must determine A’s final ATIC deficit
B
$0
0
0
amount. A’s final ATIC deficit amount
is A’s ATIC deficit ($22.50), reduced,
but not below $0, by the product of the
total ATIC excess ($37.50) and the ratio
C
$37.50
22.50
15
Total
$0
0
0
N/A
N/A
$15
of A’s ATIC deficit to the total ATIC
deficit ($22.50/$22.50). Therefore, A has
$0 of final ATIC deficit ($22.50¥($37.50
× 100 percent)).
TABLE 20 TO PARAGRAPH (o)(18)(x)
A
ATIC deficit ......................................................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) .........................
= Final ATIC deficit ..........................................................................................
(xi) Eleventh, PRS allocates
deductible business interest expense
and section 163(j) excess items to the
partners. Pursuant to paragraph (f)(2)(i)
of this section, PRS has $50 of excess
taxable income and $40 of deductible
business interest expense. After grossing
up each partner’s final ATIC excess
B
$22.50
37.50
0
amounts by ten-thirds, excess taxable
income is allocated dollar for dollar to
partners with final ATIC excess
amounts. Thus, PRS allocates its excess
taxable income $50 to B. A partner’s
allocable business interest expense is
deductible business interest expense to
the extent it exceeds such partner’s
C
$0
0
0
Total
$0
0
0
N/A
N/A
0
share of excess business interest
expense. Therefore, A has deductible
business interest expense of $30
($30¥$0), B has deductible business
interest expense of $10 ($10¥$0), and C
has deductible business interest expense
of $0 ($0¥$0).
TABLE 21 TO PARAGRAPH (o)(18)(xi)
A
khammond on DSKJM1Z7X2PROD with RULES2
Deductible BIE .................................................................................................
EBIE allocated .................................................................................................
ETI allocated ....................................................................................................
EBII allocated ...................................................................................................
(19) Example 19: Facts. A, B, and C
own all of the interests in partnership
PRS. In Year 1, PRS has $100 of ATI, $0
of business interest income, and $50 of
business interest expense. PRS’s ATI
consists of $200 of gross income and
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B
$30
0
0
0
$100 of gross deductions. PRS allocates
its items comprising ATI $100 to A,
$100 to B, and ($100) to C. PRS allocates
its business interest expense $0 to A,
$25 to B, and $25 to C.
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C
$10
0
50
0
Total
$0
0
0
0
$40
0
50
0
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section
163(j) limit is 30 percent of its ATI plus
its business interest income, or $30
($100 × 30 percent). Thus, PRS has $30
of deductible business interest expense
E:\FR\FM\14SER2.SGM
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
and $20 of excess business interest
expense.
(ii) Second, PRS determines each
partner’s allocable share of section
163(j) items used in its own section
163(j) calculation.
TABLE 22 TO PARAGRAPH (o)(19)(ii)
A
Allocable ATI ....................................................................................................
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................
(iii) Third, PRS compares each
partner’s allocable business interest
income to such partner’s allocable
business interest expense. No partner
has allocable business interest income.
Consequently, each partner’s allocable
business interest income deficit is equal
B
$100
0
0
to such partner’s allocable business
interest expense. Thus, A’s allocable
business interest income deficit is $0,
B’s allocable business interest income
deficit is $25, and C’s allocable business
interest income deficit is $25. The total
allocable business interest income
C
$100
0
25
Total
($100)
0
25
$100
0
50
deficit is $50 ($0 + $25 + $25). No
partner has allocable business interest
income excess because no partner has
allocable business interest income in
excess of its allocable business interest
expense. Thus, the total allocable
business interest income excess is $0.
TABLE 23 TO PARAGRAPH (o)(19)(iii)
A
Allocable BII .....................................................................................................
Allocable BIE ...................................................................................................
If allocable BII exceeds allocable BIE, then such amount = Allocable BII excess ..............................................................................................................
If allocable BIE exceeds allocable BII, then such amount = Allocable BII
deficit ............................................................................................................
(iv) Fourth, PRS determines each
partner’s final allocable business
interest income excess. Because no
partner had any allocable business
interest income excess, each partner has
final allocable business interest income
excess of $0.
B
C
Total
$0
0
$0
25
$0
25
N/A
N/A
0
0
0
$0
0
25
25
50
deficit. Thus, A’s remaining business
interest expense is $0, B’s remaining
business interest expense is $25, and C’s
remaining business interest expense is
$25.
(v) Fifth, PRS determines each
partner’s remaining business interest
expense. Because no partner has any
allocable business interest income
excess, each partner’s remaining
business interest expense equals its
allocable business interest income
TABLE 24 TO PARAGRAPH (o)(19)(v)
A
khammond on DSKJM1Z7X2PROD with RULES2
Allocable BII deficit ..........................................................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/Total allocable BII
deficit) ...........................................................................................................
= Remaining BIE ..............................................................................................
(vi) Sixth, PRS determines each
partner’s final allocable ATI. Because
C’s allocable ATI is comprised of $100
of items of deduction and loss and $0
of income and gain, C has negative
allocable ATI of $100. C is the only
partner with negative allocable ATI.
Thus, the total negative allocable ATI
amount is $100. Any partner with a
negative allocable ATI, or an allocable
ATI of $0, has a positive allocable ATI
of $0. Therefore, C has a positive
allocable ATI of $0. Because A’s
allocable ATI is comprised of $100 of
items of income and gain and $0 of
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B
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Total
$0
$25
$25
$50
0
0
0
25
0
25
N/A
N/A
deduction and loss, A has positive
allocable ATI of $100. Because B’s
allocable ATI is comprised of $100 of
items of income and gain and $0 of
deduction and loss, B has positive
allocable ATI of $100. Thus, the total
positive allocable ATI is $200 ($100 +
$100 + $0). PRS determines A’s final
allocable ATI by reducing, but not
below $0, A’s positive allocable ATI
($100) by the product of total negative
allocable ATI ($100) and the ratio of A’s
positive allocable ATI to the total
positive allocable ATI ($100/$200).
Therefore, A’s positive allocable ATI is
PO 00000
C
reduced by $50 ($100 × 50 percent). As
a result, A’s final allocable ATI is $50.
PRS determines B’s final allocable ATI
by reducing, but not below $0, B’s
positive allocable ATI ($100) by the
product of total negative allocable ATI
($100) and the ratio of B’s positive
allocable ATI to the total positive
allocable ATI ($100/$200). Therefore,
B’s positive allocable ATI is reduced by
$50 ($100 × 50 percent). As a result, B’s
final allocable ATI is $50. Because C has
a positive allocable ATI of $0, C’s final
allocable ATI is $0.
E:\FR\FM\14SER2.SGM
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56803
TABLE 25 TO PARAGRAPH (o)(19)(vi)
A
Allocable ATI ....................................................................................................
If deduction and loss items comprising allocable ATI exceed income and
gain items comprising allocable ATI, then such excess amount = Negative allocable ATI ..........................................................................................
If income and gain items comprising allocable ATI equal or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ..........................................................................................
B
C
Total
$100
$100
($100)
$100
0
0
100
100
100
100
0
200
TABLE 26 TO PARAGRAPH (o)(19)(vi)
A
Positive allocable ATI ......................................................................................
Less: (Total negative allocable ATI) × (Positive allocable ATI/Total positive
allocable ATI) ...............................................................................................
= Final allocable ATI ........................................................................................
(vii) Seventh, PRS compares each
partner’s ATI capacity (ATIC) amount to
such partner’s remaining business
interest expense. A’s ATIC amount is
$15 ($50 × 30 percent), B’s ATIC amount
is $15 ($50 × 30 percent), and C’s ATIC
amount is $0 ($0 × 30 percent). Because
A’s ATIC amount exceeds its remaining
B
C
Total
$100
$100
$0
$200
50
50
50
50
0
0
N/A
100
business interest expense by $15
($15¥$0), A has an ATIC excess of $15.
B and C do not have any ATIC excess.
Thus, the total ATIC excess is $15 ($15
+ $0 + $0). A does not have any ATIC
deficit. Because B’s remaining business
interest expense exceeds its ATIC
amount by $10 ($25¥$15), B has an
ATIC deficit of $10. Because C’s
remaining business interest expense
exceeds its ATIC amount by $25
($25¥$0), C has an ATIC deficit of $25.
Thus, the total ATIC deficit is $35 ($0
+ $10 + $25).
TABLE 27 TO PARAGRAPH (o)(19)(vii)
A
ATIC (Final allocable ATI × 30 percent) ..........................................................
Remaining BIE .................................................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC excess ................
If remaining BIE exceeds ATIC, then such excess = ATIC deficit .................
(viii)(A) Eighth, PRS must perform the
calculations and make the necessary
adjustments described under paragraph
(f)(2)(viii) of this section if, and only if,
PRS has—
(1) An excess business interest
expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI
greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess greater than $0
under paragraph (f)(2)(vii) of this
section. Because PRS satisfies each of
these three requirements, PRS must
perform the calculations and make the
necessary adjustments described under
B
$15
0
15
0
paragraphs (f)(2)(viii)(B) and (C) or (D)
of this section.
(B) PRS must determine each
partner’s priority amount and usable
priority amount. Only partners with an
ATIC deficit under paragraph (f)(2)(vii)
of this section can have a priority
amount greater than $0. Thus, only
partners B and C can have a priority
amount greater than $0. PRS determines
a partner’s priority amount as 30
percent of the amount by which such
partner’s allocable positive ATI exceeds
its final allocable ATI. Therefore, A’s
priority amount is $0, B’s priority
amount is $15 (($100¥$50) × 30
percent), and C’s priority amount is $0
(($0¥$0) × 30 percent). Thus, the total
C
$15
25
0
10
Total
$0
25
0
25
N/A
N/A
$15
35
priority amount is $15 ($0 + $15 + $0).
Next, PRS must determine each
partner’s usable priority amount. Each
partner’s usable priority amount is the
lesser of such partner’s priority amount
or ATIC deficit. Thus, A has a usable
priority amount of $0, B has a usable
priority amount of $10, and C has a
usable priority amount of $0. As a
result, the total usable priority amount
is $10 ($0 + $10 + $0). Because the total
ATIC excess under paragraph (f)(2)(vii)
of this section ($15) is greater than the
total usable priority amount ($10), PRS
must perform the adjustments described
in paragraph (f)(2)(viii)(C) of this
section.
khammond on DSKJM1Z7X2PROD with RULES2
TABLE 28 TO PARAGRAPH (o)(19)(viii)(B)
A
(Positive allocable ATI—Final allocable ATI) ..................................................
Multiplied by 30 percent ..................................................................................
= Priority amount .............................................................................................
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B
$0
30%
$0
E:\FR\FM\14SER2.SGM
C
$50
30%
$15
14SER2
Total
$0
30%
$0
N/A
N/A
$15
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
TABLE 29 TO PARAGRAPH (o)(19)(viii)(B)
A
Priority amount .................................................................................................
ATIC deficit ......................................................................................................
Lesser of priority amount or ATIC deficit = Usable priority amount ................
(C) For purposes of paragraph
(f)(2)(ix) of this section, each partner’s
final ATIC excess is $0. For purposes of
paragraph (f)(2)(x) of this section, the
following terms have the following
meanings. Each partner’s ATIC deficit is
such partner’s ATIC deficit as
determined pursuant to paragraph
B
$0
0
0
(f)(2)(vii) of this section reduced by such
partner’s usable priority amount. Thus,
A’s ATIC deficit is $0 ($0¥$0), B’s
ATIC deficit is $0 ($10¥$10), and C’s
ATIC deficit is $25 ($25¥$0). The total
ATIC deficit is the total ATIC deficit
determined pursuant to paragraph
(f)(2)(vii) ($35) reduced by the total
C
$15
10
10
Total
$0
25
0
N/A
N/A
$10
usable priority amount ($10). Thus, the
total ATIC deficit is $25 ($35¥$10). The
total ATIC excess is the total ATIC
excess determined pursuant to
paragraph (f)(2)(vii) of this section ($15)
reduced by the total usable priority
amount ($10). Thus, the total ATIC
excess is $5 ($15¥$5).
TABLE 30 TO PARAGRAPH (o)(19)(viii)(C)
A
ATIC deficit ......................................................................................................
Less: Usable priority amount ...........................................................................
= ATIC deficit for purposes of paragraph (f)(2)(x) of this section ...................
(D)(1) In light of the fact that the total
ATIC excess was greater than the total
usable priority amount under paragraph
B
$0
0
0
(f)(2)(viii)(B) of this section, paragraph
(f)(2)(viii)(D) of this section does not
apply.
C
$10
10
0
Total
$25
0
25
N/A
N/A
$25
(2) In sum, the correct amounts to be
used in paragraphs (o)(19)(ix) and (x) of
this section are as follows.
TABLE 31 TO PARAGRAPH (o)(19)(viii)(D)(2)
A
ATIC excess ....................................................................................................
ATIC deficit ......................................................................................................
(ix) Ninth, PRS determines each
partner’s final ATIC excess amount.
Pursuant to paragraph (f)(2)(viii)(C) of
this section, each partner’s final ATIC
excess amount is $0.
B
$5
0
(x) Tenth, PRS determines each
partner’s final ATIC deficit amount.
Because C has an ATIC deficit, PRS
must determine C’s final ATIC deficit
amount. C’s final ATIC deficit amount is
C’s ATIC deficit ($25), reduced, but not
C
$0
0
Total
$0
25
$5
25
below $0, by the product of the total
ATIC excess ($5) and the ratio of C’s
ATIC deficit to the total ATIC deficit
($25/$25). Therefore, C has $20 of final
ATIC deficit ($25¥($5 × 100 percent)).
TABLE 32 TO PARAGRAPH (o)(19)(x)
A
khammond on DSKJM1Z7X2PROD with RULES2
ATIC deficit ......................................................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) .........................
= Final ATIC deficit ..........................................................................................
(xi) Eleventh, PRS allocates
deductible business interest expense
and section 163(j) excess items to the
partners. Pursuant to paragraph (f)(2)(i)
of this section, PRS has $20 of excess
business interest expense. PRS allocates
the excess business interest expense
B
$0
0
0
dollar for dollar to the partners with
final ATIC deficits. Thus, PRS allocates
its excess business interest expense $20
to C. A partner’s allocable business
interest expense is deductible business
interest expense to the extent it exceeds
such partner’s share of excess business
C
$0
0
0
Total
$25
5
20
N/A
N/A
$20
interest expense. Therefore, A has
deductible business interest expense of
$0 ($0¥$0), B has deductible business
interest expense of $25 ($25¥$0), and C
has deductible business interest expense
of $5 ($25¥$20).
TABLE 33 TO PARAGRAPH (o)(19)(xi)
A
Deductible BIE .................................................................................................
EBIE allocated .................................................................................................
ETI allocated ....................................................................................................
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B
$0
0
0
E:\FR\FM\14SER2.SGM
C
$25
0
0
14SER2
Total
$5
20
0
$30
20
0
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
56805
TABLE 33 TO PARAGRAPH (o)(19)(xi)—Continued
A
B
EBII allocated ...................................................................................................
(20) Example 20: Facts. A, B, C, and
D own all of the interests in partnership
PRS. In Year 1, PRS has $200 of ATI, $0
of business interest income, and $140 of
business interest expense. PRS’s ATI
consists of $600 of gross income and
$400 of gross deductions. PRS allocates
its items comprising ATI $100 to A,
0
$100 to B, $400 to C, and ($400) to D.
PRS allocates its business interest
expense $0 to A, $40 to B, $60 to C, and
$40 to D.
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section
163(j) limit is 30 percent of its ATI plus
its business interest income, or $60
C
0
Total
0
0
($200 × 30 percent). Thus, PRS has $60
of deductible business interest expense
and $80 of excess business interest
expense.
(ii) Second, PRS determines each
partner’s allocable share of section
163(j) items used in its own section
163(j) calculation.
TABLE 34 TO PARAGRAPH (o)(20)(ii)
A
Allocable ATI ........................................................................
Allocable BII .........................................................................
Allocable BIE ........................................................................
(iii) Third, PRS compares each
partner’s allocable business interest
income to such partner’s allocable
business interest expense. No partner
has allocable business interest income.
Consequently, each partner’s allocable
business interest income deficit is equal
to such partner’s allocable business
B
$100
0
0
C
$100
0
40
interest expense. Thus, A’s allocable
business interest income deficit is $0,
B’s allocable business interest income
deficit is $40, C’s allocable business
interest income deficit is $60, and D’s
allocable business interest income
deficit is $40. The total allocable
business interest income deficit is $140
D
$400
0
60
Total
($400)
0
40
$200
0
140
($0 + $40 + $60 + $40). No partner has
allocable business interest income
excess because no partner has allocable
business interest income in excess of its
allocable business interest expense.
Thus, the total allocable business
interest income excess is $0.
TABLE 35 TO PARAGRAPH (o)(20)(iii)
A
Allocable BII .........................................................................
Allocable BIE ........................................................................
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess .........................................................
If allocable BIE exceeds allocable BII, then such amount =
Allocable BII deficit ...........................................................
(iv) Fourth, PRS determines each
partner’s final allocable business
interest income excess. Because no
partner has any allocable business
interest income excess, each partner has
final allocable business interest income
excess of $0.
B
C
D
Total
$0
0
$0
40
$0
60
$0
40
N/A
N/A
0
0
0
0
$0
0
40
60
40
140
(v) Fifth, PRS determines each
partner’s remaining business interest
expense. Because no partner has any
allocable business interest income
excess, each partner’s remaining
business interest expense equals its
allocable business interest income
deficit. Thus, A’s remaining business
interest expense is $0, B’s remaining
business interest expense is $40, C’s
remaining business interest expense is
$60, and D’s remaining business interest
expense is $40.
TABLE 36 TO PARAGRAPH (o)(20)(v)
A
khammond on DSKJM1Z7X2PROD with RULES2
Allocable BII deficit ..............................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/
Total allocable BII deficit) .................................................
= Remaining BIE ..................................................................
(vi) Sixth, PRS determines each
partner’s final allocable ATI. Because
D’s allocable ATI is comprised of $400
of items of deduction and loss and $0
of income and gain, D has negative
allocable ATI of $400. D is the only
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18:00 Sep 11, 2020
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C
Frm 00121
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Total
$0
$40
$60
$40
$140
0
0
0
40
0
60
0
40
N/A
N/A
partner with negative allocable ATI.
Thus, the total negative allocable ATI
amount is $400. Any partner with a
negative allocable ATI, or an allocable
ATI of $0, has a positive allocable ATI
of $0. Therefore, D has a positive
PO 00000
D
Sfmt 4700
allocable ATI of $0. PRS determines A’s
final allocable ATI by reducing, but not
below $0, A’s positive allocable ATI
($100) by the product of total negative
allocable ATI ($400) and the ratio of A’s
positive allocable ATI to the total
E:\FR\FM\14SER2.SGM
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
positive allocable ATI ($100/$600).
Therefore, A’s positive allocable ATI is
reduced by $66.67 ($400 × 16.67
percent). As a result, A’s final allocable
ATI is $33.33. PRS determines B’s final
allocable ATI by reducing, but not
below $0, B’s positive allocable ATI
($100) by the product of total negative
allocable ATI ($400) and the ratio of B’s
positive allocable ATI to the total
positive allocable ATI ($100/$600).
Therefore, B’s positive allocable ATI is
reduced by $66.67 ($400 × 16.67
percent). As a result, B’s final allocable
ATI is $33.33. PRS determines C’s final
allocable ATI by reducing, but not
below $0, C’s positive allocable ATI
($400) by the product of total negative
allocable ATI ($400) and the ratio of C’s
positive allocable ATI to the total
positive allocable ATI ($400/$600).
Therefore, C’s positive allocable ATI is
reduced by $266.67 ($400 × 66.67
percent). As a result, C’s final allocable
ATI is $133.33. Because D has a positive
allocable ATI of $0, D’s final allocable
ATI is $0.
TABLE 37 TO PARAGRAPH (o)(20)(vi)
A
Allocable ATI ........................................................................
If deduction and loss items comprising allocable ATI exceed income and gain items comprising allocable ATI,
then such excess amount = Negative allocable ATI .......
If income and gain items comprising allocable ATI equal
or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ....
B
C
D
Total
$100
$100
$400
($400)
$200
0
0
0
400
400
100
100
400
0
600
TABLE 38 TO PARAGRAPH (o)(20)(vi)
A
Positive allocable ATI ..........................................................
Less: (Total negative allocable ATI) × (Positive allocable
ATI/Total positive allocable ATI) ......................................
= Final allocable ATI ............................................................
(vii) Seventh, PRS compares each
partner’s ATI capacity (ATIC) amount to
such partner’s remaining business
interest expense. A’s ATIC amount is
$10 ($33.33 × 30 percent), B’s ATIC
amount is $10 ($33.33 × 30 percent), C’s
ATIC amount is $40 ($133.33 × 30
percent), and D’s ATIC amount is $0 ($0
× 30 percent). Because A’s ATIC amount
B
C
D
Total
$100
$100
$400
$0
$600
66.67
33.33
66.67
33.33
266.67
133.33
0
0
N/A
200
exceeds its remaining business interest
expense by $10 ($10¥$0), A has an
ATIC excess of $10. B, C, and D do not
have any ATIC excess. Thus, the total
ATIC excess is $10 ($10 + $0 + $0 + $0).
A does not have any ATIC deficit.
Because B’s remaining business interest
expense exceeds its ATIC amount by
$30 ($40¥$10), B has an ATIC deficit of
$30. Because C’s remaining business
interest expense exceeds its ATIC
amount by $20 ($60¥$40), C has an
ATIC deficit of $20. Because D’s
remaining business interest expense
exceeds its ATIC amount by $40
($40¥$0), D has an ATIC deficit of $40.
Thus, the total ATIC deficit is $90 ($0
+ $30 + $20 + $40).
TABLE 39 TO PARAGRAPH (o)(20)(vii)
l
A
khammond on DSKJM1Z7X2PROD with RULES2
ATIC (Final allocable ATI × 30 percent) ..............................
Remaining BIE .....................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC
excess ..............................................................................
If remaining BIE exceeds ATIC, then such excess = ATIC
deficit ................................................................................
(viii)(A) Eighth, PRS must perform the
calculations and make the necessary
adjustments described under paragraph
(f)(2)(viii) of this section if, and only if,
PRS has (1) an excess business interest
expense greater than $0 under
paragraph (f)(2)(i) of this section, (2) a
total negative allocable ATI greater than
$0 under paragraph (f)(2)(vi) of this
section, and (3) a total ATIC excess
amount greater than $0 under paragraph
(f)(2)(vii) of this section. Because PRS
satisfies each of these three
requirements, PRS must perform the
calculations and make the necessary
adjustments described under paragraphs
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B
C
Frm 00122
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Total
$10
0
$10
40
$40
60
$0
40
N/A
N/A
10
0
0
0
$10
0
30
20
40
90
(f)(2)(viii)(B) and (C) or paragraph
(f)(2)(viii)(D) of this section.
(B) PRS must determine each
partner’s priority amount and usable
priority amount. Only partners with an
ATIC deficit under paragraph (f)(2)(vii)
of this section can have a priority
amount greater than $0. Thus, only
partners B, C, and D can have a priority
amount greater than $0. PRS determines
a partner’s priority amount as 30
percent of the amount by which such
partner’s allocable positive ATI exceeds
its final allocable ATI. Therefore, B’s
priority amount is $20 (($100¥$33.33)
× 30 percent), C’s priority amount is $80
PO 00000
D
Sfmt 4700
(($400¥$133.33) × 30 percent), and D’s
priority amount is $0 (($0¥$0) × 30
percent). Thus, the total priority amount
is $100 ($0 + $20 + $80 + $0). Next, PRS
must determine each partner’s usable
priority amount. Each partner’s usable
priority amount is the lesser of such
partner’s priority amount or ATIC
deficit. Thus, A has a usable priority
amount of $0, B has a usable priority
amount of $20, C has a usable priority
amount of $20, and D has a usable
priority amount of $0. As a result, the
total usable priority amount is $40 ($0
+ $20 + $20 + $0). Because the total
usable priority amount ($40) is greater
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than the total ATIC excess under
paragraph (f)(2)(vii) of this section ($10),
PRS must perform the adjustments
56807
described in paragraph (f)(2)(viii)(D) of
this section.
TABLE 40 TO PARAGRAPH (o)(20)(viii)(B)
A
(Positive allocable ATI—Final allocable ATI) ......................
Multiplied by 30 percent .......................................................
= Priority amount .................................................................
B
$0
30%
0
C
$66.67
30%
20
D
$266.67
30%
80
Total
$0
30%
0
N/A
N/A
$100
TABLE 41 TO PARAGRAPH (o)(20)(viii)(B)
A
Priority amount .....................................................................
ATIC deficit ..........................................................................
Lesser of priority amount or ATIC deficit = Usable priority
amount ..............................................................................
(C) In light of the fact that the total
usable priority amount is greater than
the total ATIC excess under paragraph
(f)(2)(viii)(B) of this section, paragraph
(f)(2)(viii)(C) of this section does not
apply.
(D)(1) Because B and C are the only
partners with priority amounts greater
than $0, B and C are priority partners,
while A and D are non-priority partners.
For purposes of paragraph (f)(2)(ix) of
this section, each partner’s final ATIC
excess amount is $0. For purposes of
paragraph (f)(2)(x) of this section, each
non-priority partner’s final ATIC deficit
amount is such partner’s ATIC deficit
determined pursuant to paragraph
(f)(2)(vii) of this section. Therefore, A
B
C
D
Total
$0
0
$20
30
$80
20
$0
40
N/A
N/A
0
20
20
0
$40
has a final ATIC deficit of $0 and D has
a final ATIC deficit of $40. Additionally,
for purposes of paragraph (f)(2)(x) of this
section, PRS must determine each
priority partner’s step eight excess
share. A priority partner’s step eight
excess share is the product of the total
ATIC excess and the ratio of the
partner’s priority amount to the total
priority amount. Thus, B’s step eight
excess share is $2 ($10 × ($20/$100))
and C’s step eight excess share is $8
($10 × ($80/$100)). To the extent a
priority partner’s step eight excess share
exceeds its ATIC deficit, the excess will
be the partner’s ATIC excess for
purposes of paragraph (f)(2)(x) of this
section. Thus, B and C each have an
ATIC excess of $0, resulting in a total
ATIC excess is $0. To the extent a
priority partner’s ATIC deficit exceeds
its step eight excess share, the excess
will be the partner’s ATIC deficit for
purposes of paragraph (f)(2)(x) of this
section. Because B’s ATIC deficit ($30)
exceeds its step eight excess share ($2),
B’s ATIC deficit for purposes of
paragraph (f)(2)(x) of this section is $28
($30¥$2). Because C’s ATIC deficit
($20) exceeds its step eight excess share
($8), C’s ATIC deficit for purposes of
paragraph (f)(2)(x) of this section is $12
($20¥$8). Thus, the total ATIC deficit
is $40 ($28 + $12).
TABLE 42 TO PARAGRAPH (o)(20)(viii)(D)(1)
A
Non-priority partners ATIC deficit in paragraph (f)(2)(vii) =
Final ATIC deficit for purposes of paragraph (f)(2)(x) of
this section .......................................................................
B
$0
C
N/A
D
N/A
Total
$40
N/A
TABLE 43 TO PARAGRAPH (o)(20)(viii)(D)(1)
khammond on DSKJM1Z7X2PROD with RULES2
A
Priority partners step eight excess share = (Total ATIC excess) × (Priority/Total priority) ..........................................
ATIC deficit ..........................................................................
If step eight excess share exceeds ATIC deficit, then such
excess = ATIC excess for purposes of paragraph
(f)(2)(x) of this section ......................................................
If ATIC deficit exceeds step eight excess share, then such
excess = ATIC deficit for purposes of paragraph (f)(2)(x)
of this section ...................................................................
B
C
D
N/A
N/A
$2
30
$8
20
N/A
N/A
N/A
N/A
N/A
0
0
N/A
0
N/A
28
12
N/A
40
(2) In sum, the correct amounts to be
used in paragraphs (o)(20)(ix) and (x) of
this section are as follows.
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TABLE 44 TO PARAGRAPH (o)(20)(viii)(D)(2)
A
ATIC excess .........................................................................
ATIC deficit ..........................................................................
Non-priority partner final ATIC deficit ..................................
B
$0
0
0
C
$0
28
0
amount. B’s final ATIC deficit amount is
B’s ATIC deficit ($28), reduced, but not
below $0, by the product of the total
ATIC excess ($0) and the ratio of B’s
ATIC deficit to the total ATIC deficit
($28/$40). Therefore, B has $28 of final
ATIC deficit ($28¥($0 × 70 percent)).
Because C has an ATIC deficit, PRS
must determine C’s final ATIC deficit
amount. C’s final ATIC deficit amount is
(ix) Ninth, PRS determines each
partner’s final ATIC excess amount.
Pursuant to paragraph (f)(2)(viii)(D) of
this section, each priority and nonpriority partner’s final ATIC excess
amount is $0.
(x) Tenth, PRS determines each
partner’s final ATIC deficit amount.
Because B has an ATIC deficit, PRS
must determine B’s final ATIC deficit
D
$0
12
0
Total
$0
0
0
$0
40
N/A
C’s ATIC deficit ($12), reduced, but not
below $0, by the product of the total
ATIC excess ($0) and the ratio of C’s
ATIC deficit to the total ATIC deficit
($12/$40). Therefore, C has $12 of final
ATIC deficit ($12¥($0 × 30 percent)).
Pursuant to paragraph (f)(2)(viii)(D) of
this section, D’s final ATIC deficit
amount is $40.
TABLE 45 TO PARAGRAPH (o)(20)(x)
A
ATIC deficit ..........................................................................
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) ....................................................................................
= Final ATIC deficit ..............................................................
(xi) Eleventh, PRS allocates
deductible business interest expense
and section 163(j) excess items to the
partners. Pursuant to paragraph (f)(2)(i)
of this section, PRS has $80 of excess
business interest expense. PRS allocates
the excess business interest expense
dollar for dollar to the partners with
B
C
D
Total
N/A
$28
$12
N/A
N/A
N/A
$0
0
28
0
12
N/A
$40
N/A
$80
final ATIC deficits. Thus, PRS allocates
its excess business interest expense $28
to B, $12 to C, and $40 to D. A partner’s
allocable business interest expense is
deductible business interest expense to
the extent it exceeds such partner’s
share of excess business interest
expense. Therefore, A has deductible
business interest expense of $0 ($0¥$0),
B has deductible business interest
expense of $12 ($40¥$28), C has
deductible business interest expense of
$48 ($60¥$12), and D has deductible
business interest expense of $0
($40¥$40).
TABLE 46 TO PARAGRAPH (o)(20)(xi)
A
Deductible BIE .....................................................................
EBIE allocated .....................................................................
ETI allocated ........................................................................
EBII allocated .......................................................................
(21) Example 21: Facts. A, B, C, and
D own all of the interests in partnership
PRS. In Year 1, PRS has $200 of ATI, $0
of business interest income, and $150 of
business interest expense. PRS’s ATI
consists of $500 of gross income and
$300 of gross deductions. PRS allocates
its items comprising ATI $50 to A, $50
B
$0
0
0
0
C
$12
28
0
0
to B, $400 to C, and ($300) to D. PRS
allocates its business interest expense
$0 to A, $50 to B, $50 to C, and $50
to D.
(i) First, PRS determines its limitation
pursuant to § 1.163(j)–2. PRS’s section
163(j) limit is 30 percent of its ATI plus
its business interest income, or $60
D
$48
12
0
0
Total
$0
40
0
0
$60
80
0
0
($200 × 30 percent). Thus, PRS has $60
of deductible business interest expense,
and $90 of excess business interest
expense.
(ii) Second, PRS determines each
partner’s allocable share of section
163(j) items used in its own section
163(j) calculation.
TABLE 47 TO PARAGRAPH (o)(21)(ii)
khammond on DSKJM1Z7X2PROD with RULES2
A
Allocable ATI ........................................................................
Allocable BII .........................................................................
Allocable BIE ........................................................................
(iii) Third, PRS compares each
partner’s allocable business interest
income to such partner’s allocable
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B
$50
0
0
C
$50
0
50
business interest expense. No partner
has allocable business interest income.
Consequently, each partner’s allocable
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D
$400
0
50
Total
($300)
0
50
$200
0
150
business interest income deficit is equal
to such partner’s allocable business
interest expense. Thus, A’s allocable
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business interest income deficit is $0,
B’s allocable business interest income
deficit is $50, C’s allocable business
interest income deficit is $50, and D’s
allocable business interest income
deficit is $50. The total allocable
business interest income deficit is $150
($0 + $50 + $50 + $50). No partner has
allocable business interest income
excess because no partner has allocable
56809
business interest income in excess of its
allocable business interest expense.
Thus, the total allocable business
interest income excess is $0.
TABLE 48 TO PARAGRAPH (o)(21)(iii)
A
Allocable BII .........................................................................
Allocable BIE ........................................................................
If allocable BII exceeds allocable BIE, then such amount =
Allocable BII excess .........................................................
If allocable BIE exceeds allocable BII, then such amount =
Allocable BII deficit ...........................................................
(iv) Fourth, PRS determines each
partner’s final allocable business
interest income excess. Because no
partner has any allocable business
interest income excess, each partner has
final allocable business interest income
excess of $0.
B
C
D
Total
$0
0
$0
50
$0
50
$0
50
N/A
N/A
0
0
0
0
0
0
50
50
50
150
deficit. Thus, A’s remaining business
interest expense is $0, B’s remaining
business interest expense is $50, C’s
remaining business interest expense is
$50, and D’s remaining business interest
expense is $50.
(v) Fifth, PRS determines each
partner’s remaining business interest
expense. Because no partner has any
allocable business interest income
excess, each partner’s remaining
business interest expense equals its
allocable business interest income
TABLE 49 TO PARAGRAPH (o)(21)(v)
A
Allocable BII deficit ..............................................................
Less: (Total allocable BII excess) × (Allocable BII deficit/
Total allocable BII deficit) .................................................
= Remaining BIE ..................................................................
(vi) Sixth, PRS determines each
partner’s final allocable ATI. Because
D’s allocable ATI is comprised of $300
of items of deduction and loss and $0
of income and gain, D has negative
allocable ATI of $300. D is the only
partner with negative allocable ATI.
Thus, the total negative allocable ATI
amount is $300. Any partner with a
negative allocable ATI, or an allocable
ATI of $0, has a positive allocable ATI
of $0. Therefore, D has a positive
allocable ATI of $0. PRS determines A’s
final allocable ATI by reducing, but not
below $0, A’s positive allocable ATI
B
C
D
Total
$0
$50
$50
$50
$150
0
0
0
50
0
50
0
50
N/A
N/A
($50) by the product of total negative
allocable ATI ($300) and the ratio of A’s
positive allocable ATI to the total
positive allocable ATI ($50/$500).
Therefore, A’s positive allocable ATI is
reduced by $30 ($300 × 10 percent). As
a result, A’s final allocable ATI is $20.
PRS determines B’s final allocable ATI
by reducing, but not below $0, B’s
positive allocable ATI ($50) by the
product of total negative allocable ATI
($300) and the ratio of B’s positive
allocable ATI to the total positive
allocable ATI ($50/$500). Therefore, B’s
positive allocable ATI is reduced by $30
($300 × 10 percent). As a result, B’s final
allocable ATI is $20. PRS determines C’s
final allocable ATI by reducing, but not
below $0, C’s positive allocable ATI
($400) by the product of total negative
allocable ATI ($300) and the ratio of C’s
positive allocable ATI to the total
positive allocable ATI ($400/$500).
Therefore, C’s positive allocable ATI is
reduced by $240 ($300 × 80 percent). As
a result, C’s final allocable ATI is $160.
Because D has a positive allocable ATI
of $0, D’s final allocable ATI is $0.
TABLE 50 TO PARAGRAPH (o)(21)(vi)
khammond on DSKJM1Z7X2PROD with RULES2
A
Allocable ATI ........................................................................
If deduction and loss items comprising allocable ATI exceed income and gain items comprising allocable ATI,
then such excess amount = Negative allocable ATI .......
If income and gain items comprising allocable ATI equal
or exceed deduction and loss items comprising allocable ATI, then such amount = Positive allocable ATI ....
B
C
D
Total
$50
$50
$400
($300)
$200
0
0
0
300
300
50
50
400
0
500
TABLE 51 TO PARAGRAPH (o)(21)(vi)
A
Positive allocable ATI ..........................................................
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$50
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$400
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$0
$500
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TABLE 51 TO PARAGRAPH (o)(21)(vi)—Continued
A
B
Less: (Total negative allocable ATI) × (Positive allocable
ATI/Total positive allocable ATI) ......................................
= Final allocable ATI ............................................................
(vii) Seventh, PRS compares each
partner’s ATI capacity (ATIC) amount to
such partner’s remaining business
interest expense. A’s ATIC amount is $6
($20 × 30 percent), B’s ATIC amount is
$6 ($20 × 30 percent), C’s ATIC amount
is $48 ($160 × 30 percent), and D’s ATIC
amount is $0 ($0 × 30 percent). Because
A’s ATIC amount exceeds its remaining
30
20
C
30
20
business interest expense by $6
($6¥$0), A has an ATIC excess of $6.
B, C, and D do not have any ATIC
excess. Thus, the total ATIC excess
amount is $6 ($6 + $0 + $0 + $0). A does
not have any ATIC deficit. Because B’s
remaining business interest expense
exceeds its ATIC amount by $44
($50¥$6), B has an ATIC deficit of $44.
D
240
160
Total
0
0
N/A
200
Because C’s remaining business interest
expense exceeds its ATIC amount by $2
($50¥$48), C has an ATIC deficit of $2.
Because D’s remaining business interest
expense exceeds its ATIC amount by
$50 ($50¥$0), D has an ATIC deficit of
$50. Thus, the total ATIC deficit is $96
($0 + $44 + $2 + $50).
TABLE 52 TO PARAGRAPH (o)(21)(vii)
A
B
ATIC (Final allocable ATI × 30 percent) ..............................
Remaining BIE .....................................................................
If ATIC exceeds remaining BIE, then such excess = ATIC
excess ..............................................................................
If remaining BIE exceeds ATIC, then such excess = ATIC
deficit ................................................................................
(viii)(A) Eighth, PRS must perform the
calculations and make the necessary
adjustments described under paragraph
(f)(2)(viii) of this section if, and only if,
PRS has—
(1) An excess business interest
expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI
greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess amount
greater than $0 under paragraph
(f)(2)(vii) of this section. Because PRS
satisfies each of these three
requirements, PRS must perform the
calculations and make the necessary
C
D
Total
$6
0
$6
50
$48
50
$0
50
N/A
N/A
6
0
0
0
$6
0
44
2
50
96
adjustments described under paragraph
(f)(2)(viii) of this section.
(B) PRS must determine each
partner’s priority amount and usable
priority amount. Only partners with an
ATIC deficit under paragraph (f)(2)(vii)
of this section of this section can have
a priority amount greater than $0. Thus,
only partners B, C, and D can have a
priority amount greater than $0. PRS
determines a partner’s priority amount
as 30 percent of the amount by which
such partner’s allocable positive ATI
exceeds its final allocable ATI.
Therefore, B’s priority amount is $9
(($50¥$20) × 30 percent), C’s priority
amount is $72 (($400¥$160) × 30
percent), and D’s priority amount is $0
(($0¥$0) × 30 percent). Thus, the total
priority amount is $81 ($0 + $9 + $72
+ $0). Next, PRS must determine each
partner’s usable priority amount. Each
partner’s usable priority amount is the
lesser of such partner’s priority amount
or ATIC deficit. Thus, B has a usable
priority amount of $9, C has a usable
priority amount of $2, and D has a
usable priority amount of $0. As a
result, the total usable priority amount
is $11 ($0 + $9 + $2 + $0). Because the
total usable priority amount ($11) is
greater than the total ATIC excess ($6)
under paragraph (f)(2)(vii) of this
section, PRS must perform the
adjustments described in paragraph
(f)(2)(viii)(D) of this section.
TABLE 53 TO PARAGRAPH (o)(21)(viii)(B)
A
(Positive allocable ATI¥Final allocable ATI) ......................
Multiplied by 30 percent .......................................................
= Priority amount .................................................................
B
$0
30%
$0
C
$30
30%
$9
D
$240
30%
$72
Total
$0
30%
$0
N/A
N/A
$81
TABLE 54 TO PARAGRAPH (o)(21)(viii)(B)
khammond on DSKJM1Z7X2PROD with RULES2
A
Priority amount .....................................................................
ATIC deficit ..........................................................................
Lesser of priority amount or ATIC deficit = Usable priority
amount ..............................................................................
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B
C
D
Total
$0
0
$9
44
$72
2
$0
50
N/A
N/A
0
9
2
0
$11
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(C) In light of the fact that the total
usable priority amount is greater than
the total ATIC excess under paragraph
(f)(2)(viii)(B) of this section, paragraph
(f)(2)(viii)(C) of this section does not
apply.
(D)(1) Because B and C are the only
partners with priority amounts greater
than $0, B and C are priority partners,
while A and D are non-priority partners.
For purposes of paragraph (f)(2)(ix) of
this section, each partner’s final ATIC
excess amount is $0. For purposes of
paragraph (f)(2)(x) of this section, each
non-priority partner’s final ATIC deficit
amount is such partner’s ATIC deficit
determined pursuant to paragraph
(f)(2)(vii) of this section. Therefore, A
has a final ATIC deficit of $0 and D has
a final ATIC deficit of $50. Additionally,
for purposes of paragraph (f)(2)(x) of this
section, PRS must determine each
priority partner’s step eight excess
share. A priority partner’s step eight
excess share is the product of the total
ATIC excess and the ratio of the
partner’s priority amount to the total
priority amount. Thus, B’s step eight
excess share is $0.67 ($6 × ($9/$81)) and
C’s step eight excess share is $5.33 ($6
× ($72/$81)). To the extent a priority
partner’s step eight excess share exceeds
its ATIC deficit, the excess will be the
partner’s ATIC excess for purposes of
paragraph (f)(2)(x) of this section. B’s
step eight excess share does not exceed
its ATIC deficit. Because C’s step eight
excess share ($5.33) exceeds its ATIC
56811
deficit ($2), C’s ATIC excess for
purposes of paragraph (f)(2)(x) of this
section is $3.33 ($5.33¥$2). Thus, the
total ATIC excess for purposes of
paragraph (f)(2)(x) of this section is
$3.33 ($0 + $3.33). To the extent a
priority partner’s ATIC deficit exceeds
its step eight excess share, the excess
will be the partner’s ATIC deficit for
purposes of paragraph (f)(2)(x) of this
section. Because B’s ATIC deficit ($44)
exceeds its step eight excess share
($0.67), B’s ATIC deficit for purposes of
paragraph (f)(2)(x) of this section is
$43.33 ($44¥$0.67). C’s ATIC deficit
does not exceed its step eight excess
share. Thus, the total ATIC deficit for
purposes of paragraph (f)(2)(x) of this
section is $43.33 ($43.33 + $0).
TABLE 55 TO PARAGRAPH (o)(21)(viii)(D)(1)
A
Non-priority partners ATIC deficit in paragraph (f)(2)(vii) =
Final ATIC deficit for purposes of paragraph (f)(2)(x) of
this section .......................................................................
B
$0
C
N/A
D
N/A
Total
$50
N/A
TABLE 56 TO PARAGRAPH (o)(21)(viii)(D)(1)
A
Priority partners step eight excess share = (Total ATIC excess) × (Priority/Total priority) ..........................................
ATIC deficit ..........................................................................
If step eight excess share exceeds ATIC deficit, then such
excess = ATIC excess for purposes of paragraph
(f)(2)(x) of this section ......................................................
If ATIC deficit exceeds step eight excess share, then such
excess = ATIC deficit for purposes of paragraph (f)(2)(x)
of this section ...................................................................
B
C
D
Total
N/A
N/A
$0.67
44
$5.33
2
N/A
N/A
N/A
N/A
N/A
0
3.33
N/A
$3.33
N/A
43.33
0
N/A
43.33
(2) In sum, the correct amounts to be
used in paragraphs (o)(21)(ix) and (x) of
this section are as follows.
TABLE 57 TO PARAGRAPH (o)(21)(viii)(D)(2)
A
khammond on DSKJM1Z7X2PROD with RULES2
ATIC excess .........................................................................
ATIC deficit ..........................................................................
Non-priority partner final ATIC deficit ..................................
(ix) Ninth, PRS determines each
partner’s final ATIC excess amount.
Pursuant to paragraph (f)(2)(viii)(D) of
this section, each priority and nonpriority partner’s final ATIC excess
amount is $0.
B
$0
0
0
C
$0
43.33
0
(x) Tenth, PRS determines each
partner’s final ATIC deficit amount.
Because B has an ATIC deficit, PRS
must determine B’s final ATIC deficit
amount. B’s final ATIC deficit amount is
B’s ATIC deficit ($43.33), reduced, but
not below $0, by the product of the total
D
$3.33
0
0
Total
$0
0
50
$3.33
43.33
N/A
ATIC excess ($3.33) and the ratio of B’s
ATIC deficit to the total ATIC deficit
($43.33/$43.33). Therefore, B has $40 of
final ATIC deficit ($43.33¥($3.33 × 100
percent)). Pursuant to paragraph
(f)(2)(viii)(D) of this section, D’s final
ATIC deficit amount is $40.
TABLE 58 TO PARAGRAPH (o)(21)(x)
A
ATIC deficit ..........................................................................
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C
$43.33
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D
$0
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N/A
N/A
56812
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
TABLE 58 TO PARAGRAPH (o)(21)(x)—Continued
A
Less: (Total ATIC excess) × (ATIC deficit/Total ATIC deficit) ....................................................................................
= Final ATIC deficit ..............................................................
(xi) Eleventh, PRS allocates
deductible business interest expense
and section 163(j) excess items to the
partners. Pursuant to paragraph (f)(2)(i)
of this section, PRS has $90 of excess
business interest expense. PRS allocates
the excess business interest expense
dollar for dollar to the partners with
B
0
0
C
3.33
40
final ATIC deficits. Thus, PRS allocates
its excess business interest expense $40
to B and $50 to D. A partner’s allocable
business interest expense is deductible
business interest expense to the extent
it exceeds such partner’s share of excess
business interest expense. Therefore, A
has deductible business interest expense
D
0
0
Total
N/A
$50
N/A
$90
of $0 ($0¥$0), B has deductible
business interest expense of $10
($50¥$40), C has deductible business
interest expense of $50 ($50¥$0), and D
has deductible business interest expense
of $0 ($50¥$50).
TABLE 59 TO PARAGRAPH (o)(21)(xi)
A
khammond on DSKJM1Z7X2PROD with RULES2
Deductible BIE .....................................................................
EBIE allocated .....................................................................
ETI allocated ........................................................................
EBII allocated .......................................................................
(22) Example 22—(i) Facts. A and B
are equal shareholders in X, a
subchapter S corporation. In Year 1, X
has $100 of ATI and $40 of business
interest expense. A has $100 of ATI and
$20 of business interest expense from its
sole proprietorship. B has $0 of ATI and
$20 of business interest expense from its
sole proprietorship.
(ii) S corporation-level. In Year 1, X’s
section 163(j) limit is 30 percent of its
ATI, or $30 ($100 × 30 percent). Thus,
X has $30 of deductible business
interest expense and $10 of disallowed
business interest expense. Such $30 of
deductible business interest expense is
includable in X’s nonseparately stated
income or loss, and is not subject to
further limitation under section 163(j).
X carries forward the $10 of disallowed
business interest expense to Year 2 as a
disallowed business interest expense
carryforward under § 1.163(j)–2(c). X
may not currently deduct all $40 of its
business interest expense in Year 1. X
only reduces its accumulated
adjustments account in Year 1 by the
$30 of deductible business interest
expense in Year 1 under § 1.163(j)–
6(l)(7).
(iii) Shareholder allocations. A and B
are each allocated $35 of nonseparately
stated taxable income ($50 items of
income or gain, less $15 of deductible
business interest expense) from X. A
and B do not reduce their basis in X by
the $10 of disallowed business interest
expense.
(iv) Shareholder-level computations.
A, in computing its limit under section
163(j), has $100 of ATI and $20 of
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18:00 Sep 11, 2020
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B
$0
0
0
0
C
$10
40
0
0
business interest expense from its sole
proprietorship. A’s section 163(j) limit
is $30 ($100 × 30 percent). Thus, A’s
$20 of business interest expense is
deductible business interest expense. B,
in computing its limit under section
163(j), has $20 of business interest
expense from its sole proprietorship. B’s
section 163(j) limit is $0 ($0 × 30
percent). Thus, B’s $20 of business
interest expense is not allowed as a
deduction and is treated as business
interest expense paid or accrued by B in
Year 2.
(23) Example 23—(i) Facts. The facts
are the same as in Example 22 in
paragraph (o)(22)(i) of this section. In
Year 2, X has $233.33 of ATI, $0 of
business interest income, and $30 of
business interest expense. A has $100 of
ATI and $20 of business interest
expense from its sole proprietorship. B
has $0 of ATI and $20 of business
interest expense from its sole
proprietorship.
(ii) S corporation-level. In Year 2, X’s
section 163(j) limit is 30 percent of its
ATI plus its business interest income, or
$70 ($233.33 × 30 percent). Because X’s
section 163(j) limit exceeds X’s $40 of
business interest expense ($30 from
Year 2, plus the $10 disallowed
business interest expense carryforwards
from Year 1), X may deduct all $40 of
business interest expense in Year 2.
Such $40 of deductible business interest
expense is includable in X’s
nonseparately stated income or loss, and
is not subject to further limitation under
section 163(j). Pursuant to § 1.163(j)–
6(l)(7), X must reduce its accumulated
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D
$50
0
0
0
Total
$0
50
0
0
$60
90
0
0
adjustments account by $40.
Additionally, X has $100 of excess
taxable income under § 1.163(j)–
1(b)(17).
(iii) Shareholder allocations. A and B
are each allocated $96.67 of
nonseparately stated taxable income
($116.67 items of income or gain, less
$20 of deductible business interest
expense) from X. Additionally, A and B
are each allocated $50 of excess taxable
income under § 1.163(j)–6(l)(4). As a
result, A and B each increase their ATI
by $50.
(iv) Shareholder-level computations.
A, in computing its limit under section
163(j), has $150 of ATI ($100 from its
sole proprietorship, plus $50 excess
taxable income) and $20 of business
interest expense (from its sole
proprietorship). A’s section 163(j) limit
is $45 ($150 × 30 percent). Thus, A’s
$20 of business interest expense is
deductible business interest expense. B,
in computing its limit under section
163(j), has $50 of ATI ($0 from its sole
proprietorship, plus $50 excess taxable
income) and $40 of business interest
expense ($20 from its sole
proprietorship, plus $20 disallowed
business interest expense from its sole
proprietorship in Year 1). B’s section
163(j) limit is $15 ($50 × 30 percent).
Thus, $15 of B’s business interest
expense is deductible business interest
expense. The $25 of B’s business
interest expense not allowed as a
deduction ($40 business interest
expense, less $15 section 163(j) limit) is
treated as business interest expense paid
or accrued by B in Year 3.
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(p) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
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§ 1.163(j)–7 Application of the section
163(j) limitation to foreign corporations and
United States shareholders.
(a) Overview. This section provides
rules for the application of section 163(j)
to relevant foreign corporations with
shareholders that are United States
persons. Paragraph (b) of this section
describes the general rule regarding the
application of section 163(j) to relevant
foreign corporations. Paragraphs (c)
through (f) of this section are reserved.
Paragraph (g) of this section provides
rules concerning the computation of
ATI of a relevant foreign corporation.
Paragraphs (h) through (k) of this
section are reserved.
(b) General rule regarding the
application of section 163(j) to relevant
foreign corporations. Except as
otherwise provided in this section,
section 163(j) and the section 163(j)
regulations apply to determine the
deductibility of a relevant foreign
corporation’s business interest expense
for purposes of computing its taxable
income for U.S. income tax purposes (if
any) in the same manner as those
provisions apply to determine the
deductibility of a domestic C
corporation’s business interest expense
for purposes of computing its taxable
income. See also § 1.952–2. If a relevant
foreign corporation is a direct or
indirect partner in a partnership, see
§ 1.163(j)–6 (concerning the application
of section 163(j) to partnerships).
(c)–(f) [Reserved]
(g) Rules concerning the computation
of adjusted taxable income of a relevant
foreign corporation—(1) Tentative
taxable income. For purposes of
computing the tentative taxable income
of a relevant foreign corporation for a
taxable year, the relevant foreign
corporation’s gross income and
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allowable deductions are determined
under the principles of § 1.952–2 or
under the rules of section 882 for
determining income that is, or
deductions that are allocable to,
effectively connected income, as
applicable.
(2) Treatment of certain dividends.
For purposes of computing the ATI of a
relevant foreign corporation for a
taxable year, any dividend included in
gross income that is received from a
related person, within the meaning of
section 954(d)(3), with respect to the
distributee is subtracted from tentative
taxable income.
(h)–(l) [Reserved]
(m) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
§ 1.163(j)–8.
[Reserved]
§ 1.163(j)–9 Elections for excepted trades
or businesses; safe harbor for certain
REITs.
(a) Overview. The limitation in section
163(j) applies to business interest,
which is defined under section 163(j)(5)
as interest properly allocable to a trade
or business. The term trade or business
does not include any electing real
property trade or business or any
electing farming business. See section
163(j)(7). This section provides the rules
and procedures for taxpayers to follow
in making an election under section
163(j)(7)(B) for a trade or business to be
an electing real property trade or
business and an election under section
163(j)(7)(C) for a trade or business to be
an electing farming business.
(b) Availability of election—(1) In
general. An election under section
163(j)(7)(B) for a real property trade or
business to be an electing real property
trade or business is available to any
trade or business that is described in
§ 1.163(j)–1(b)(14)(i), (ii), or (iii), and an
election under section 163(j)(7)(C) for a
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farming business to be an electing
farming business is available to any
trade or business that is described in
§ 1.163(j)–1(b)(13)(i), (ii), or (iii).
(2) Special rules—(i) Exempt small
businesses. An election described in
paragraph (b)(1) of this section is
available regardless of whether the real
property trade or business or farming
business making the election also meets
the requirements of the small business
exemption in section 163(j)(3) and
§ 1.163(j)–2(d). See paragraph (c)(2) of
this section for the effect of the election
relating to depreciation.
(ii) Section 162 trade or business not
required for electing real property trade
or business. An election described in
paragraph (b)(1) of this section to be an
electing real property trade or business
is available regardless of whether the
trade or business with respect to which
the election is made is a trade or
business under section 162. For
example, a taxpayer engaged in
activities described in section
469(c)(7)(C) and § 1.469–9(b)(2), as
required in § 1.163(j)–1(b)(14)(i), may
make an election for a trade or business
to be an electing real property trade or
business, regardless of whether its
activities rise to the level of a section
162 trade or business.
(c) Scope and effect of election—(1) In
general. An election under this section
is made with respect to each eligible
trade or business of the taxpayer and
applies only to such trade or business
for which the election is made. An
election under this section applies to
the taxable year in which the election is
made and to all subsequent taxable
years. See paragraph (e) of this section
for terminations of elections.
(2) Irrevocability. An election under
this section is irrevocable.
(3) Depreciation. Taxpayers making
an election under this section are
required to use the alternative
depreciation system for certain types of
property under section 163(j)(11) and
cannot claim the additional first-year
depreciation deduction under section
168(k) for those types of property.
(d) Time and manner of making
election—(1) In general. Subject to
paragraph (f) of this section, a taxpayer
makes an election under this section by
attaching an election statement to the
taxpayer’s timely filed original Federal
income tax return, including extensions.
A taxpayer may make elections for
multiple trades or businesses on a single
election statement.
(2) Election statement contents. The
election statement should be titled
‘‘Section 1.163(j)–9 Election’’ and must
contain the following information for
each trade or business:
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(i) The taxpayer’s name;
(ii) The taxpayer’s address;
(iii) The taxpayer’s social security
number (SSN) or employer
identification number (EIN);
(iv) A description of the taxpayer’s
electing trade or business sufficient to
demonstrate qualification for an election
under this section, including the
principal business activity code; and
(v) A statement that the taxpayer is
making an election under section
163(j)(7)(B) or (C), as applicable.
(3) Consolidated group’s trade or
business. For a consolidated group’s
trade or business, the election under
this section is made by the agent for the
group, as defined in § 1.1502–77, on
behalf of itself and members of the
consolidated group. Only the name and
taxpayer identification number (TIN) of
the agent for the group, as defined in
§ 1.1502–77, must be provided on the
election statement.
(4) Partnership’s trade or business. An
election for a partnership must be made
on the partnership’s return for a trade or
business that the partnership conducts.
An election by a partnership does not
apply to a trade or business conducted
by a partner outside the partnership.
(e) Termination of election—(1) In
general. An election under this section
automatically terminates if a taxpayer
ceases to engage in the electing trade or
business. A taxpayer is considered to
cease to engage in an electing trade or
business if the taxpayer sells or transfers
substantially all of the assets of the
electing trade or business to an acquirer
that is not a related party in a taxable
asset transfer. A taxpayer is also
considered to cease to engage in an
electing trade or business if the taxpayer
terminates its existence for Federal
income tax purposes or ceases operation
of the electing trade or business, except
to the extent that such termination or
cessation results in the sale or transfer
of substantially all of the assets of the
electing trade or business to an acquirer
that is a related party, or in a transaction
that is not a taxable asset transfer.
(2) Taxable asset transfer defined. For
purposes of this paragraph (e), the term
taxable asset transfer means a transfer
in which the acquirer’s basis or adjusted
basis in the assets is not determined,
directly or indirectly, in whole or in
part, by reference to the transferor’s
basis in the assets.
(3) Related party defined. For
purposes of this paragraph (e), the term
related party means any person who
bears a relationship to the taxpayer
which is described in section 267(b) or
707(b)(1).
(4) Anti-abuse rule. If, within 60
months of a sale or transfer of assets
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described in paragraph (e)(1) of this
section, the taxpayer or a related party
reacquires substantially all of the assets
that were used in the taxpayer’s prior
electing trade or business, or
substantially similar assets, and resumes
conducting such prior electing trade or
business, the taxpayer’s previously
terminated election under this section is
reinstated and is effective on the date
the prior electing trade or business is
reacquired.
(f) Additional guidance. The rules and
procedures regarding the time and
manner of making an election under this
section and the election statement
contents in paragraph (d) of this section
may be modified through other
guidance (see §§ 601.601(d) and 601.602
of this chapter). Additional situations in
which an election may terminate under
paragraph (e) of this section may be
provided through guidance published in
the Federal Register or in the Internal
Revenue Bulletin (see § 601.601(d) of
this chapter).
(g) Examples. The examples in this
paragraph (g) illustrate the application
of this section. Unless otherwise
indicated, X and Y are domestic C
corporations; D and E are U.S. resident
individuals not subject to any foreign
income tax; and the exemption for
certain small businesses in § 1.163(j)–
2(d) does not apply.
(1) Example 1: Scope of election—(i)
Facts. For the taxable year ending
December 31, 2021, D, a sole proprietor,
owned and operated a dairy farm and an
orchard as separate farming businesses
described in section 263A(e)(4). D filed
an original Federal income tax return for
the 2021 taxable year on August 1, 2022,
and included with the return an election
statement meeting the requirements of
paragraph (d)(2) of this section. The
election statement identified D’s dairy
farm business as an electing trade or
business under this section. On March
1, 2023, D sold some but not all or
substantially all of the assets from D’s
dairy farm business to D’s neighbor, E,
who is unrelated to D. After the sale, D
continued to operate the dairy farm
trade or business.
(ii) Analysis. D’s election under this
section was properly made and is
effective for the 2021 taxable year and
subsequent years. D’s dairy farm
business is an excepted trade or
business because D made the election
with D’s timely filed Federal income tax
return. D’s orchard business is a nonexcepted trade or business, because D
did not make an election for the orchard
business to be an excepted trade or
business. The sale of some but not all
or substantially all of the assets from D’s
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dairy farm business does not affect D’s
election under this section.
(2) Example 2: Availability of
election—(i) Facts. E, an individual,
operates a dairy business that is a
farming business under section 263A
and also owns real property that is not
part of E’s dairy business that E leases
to an unrelated party through a triple
net lease. E’s average gross receipts,
excluding inherently personal amounts,
for the three years prior to 2021 are
approximately $25 million, but E is
unsure of the exact amount.
(ii) Analysis. Under paragraph (b)(2)(i)
of this section, E may make an election
under this section for the dairy business
to be an electing farming business, even
though E is unsure whether the small
business exemption of § 1.163(j)–2(d)
applies. Additionally, under paragraph
(b)(2)(ii) of this section, assuming the
requirements of section 163(j)(7)(C) and
this section are otherwise satisfied, E
may make an election under this section
for its triple net lease property to be an
electing real property trade or business,
even though E may not be engaged in a
trade or business under section 162 with
respect to the real property.
(3) Example 3: Cessation of entire
trade or business—(i) Facts. X has a real
property trade or business for which X
made an election under this section by
attaching an election statement to A’s
2021 Federal income tax return. On
March 1, 2022, X sold all of the assets
used in its real property trade or
business to Y, an unrelated party, and
ceased to engage in the electing trade or
business. On June 1, 2027, X started a
new real property trade or business that
was substantially similar to X’s prior
electing trade or business.
(ii) Analysis. X’s election under this
section terminated on March 1, 2022,
under paragraph (e)(1) of this section. X
may choose whether to make an election
under this section for X’s new real
property trade or business that A started
in 2027.
(4) Example 4: Anti-abuse rule—(i)
Facts. The facts are the same as in
Example 3 in paragraph (g)(3)(i) of this
section, except that X re-started its
previous real property trade or business
on February 1, 2023, when X reacquired
substantially all of the assets that X had
sold on March 1, 2022.
(ii) Analysis. X’s election under this
section terminated on March, 1, 2022,
under paragraph (e)(1) of this section.
On February 1, 2023, X’s election was
reinstated under paragraph (e)(4) of this
section. X’s new real property trade or
business is treated as a resumption of
X’s prior electing trade or business and
is therefore treated as an electing real
property trade or business.
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(5) Example 5: Trade or business
continuing after acquisition—(i) Facts.
X has a farming business for which X
made an election under this section by
attaching an election statement to X’s
timely filed 2021 Federal income tax
return. Y, unrelated to X, also has a
farming business, but Y has not made an
election under this section. On July 1,
2022, X transferred all of its assets to Y
in a transaction described in section
368(a)(1)(D). After the transfer, Y
continues to operate the farming trade
or business acquired from X.
(ii) Analysis. Under paragraph (e)(1)
of this section, Y is subject to X’s
election under this section for the trade
or business that uses X’s assets because
the sale or transfer was not in a taxable
transaction. Y cannot revoke X’s
election, but X’s election has no effect
on Y’s existing farming business for
which Y has not made an election under
this section.
(6) Example 6: Trade or business
merged after acquisition—(i) Facts. The
facts are the same as in Example 5 in
paragraph (g)(5)(i) of this section, except
that Y uses the assets acquired from X
in a trade or business that is neither a
farming business (as defined in section
263A(e)(4) or § 1.263A–4(a)(4)) nor a
trade or business of a specified
agricultural or horticultural cooperative
(as defined in section 199A(g)(4)).
(ii) Analysis. Y is not subject to X’s
election for Y’s farming business
because the farming trade or business
ceased to exist after the acquisition.
(h) Safe harbor for REITs—(1) In
general. If a REIT holds real property, as
defined in § 1.856–10, interests in one
or more partnerships directly or
indirectly holding real property
(through interests in other partnerships
or shares in other REITs), as defined in
§ 1.856–10, or shares in one or more
other REITs directly or indirectly
holding real property (through interests
in partnerships or shares in other
REITs), as defined in § 1.856–10, the
REIT is eligible to make the election
described in paragraph (b)(1) of this
section to be an electing real property
trade or business for purposes of
sections 163(j)(7)(B) and 168(g)(1)(F) for
all or part of its assets. The portion of
the REIT’s assets eligible for this
election is determined under paragraph
(h)(2) or (3) of this section.
(2) REITs that do not significantly
invest in real property financing assets.
If a REIT makes the election under
paragraph (h)(1) of this section and the
value of the REIT’s real property
financing assets, as defined in
paragraphs (h)(5) and (6) of this section,
at the close of the taxable year is 10
percent or less of the value of the REIT’s
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total assets at the close of the taxable
year, as determined under section
856(c)(4)(A), then all of the REIT’s assets
are treated as assets of an excepted trade
or business.
(3) REITs that significantly invest in
real property financing assets. If a REIT
makes the election under paragraph
(h)(1) of this section and the value of the
REIT’s real property financing assets, as
defined in paragraphs (h)(5) and (6) of
this section, at the close of the taxable
year is more than 10 percent of the
value of the REIT’s total assets at the
close of the taxable year, as determined
under section 856(c)(4)(A), then for the
allocation of interest expense, interest
income, and other items of expense and
gross income to excepted and nonexcepted trades or businesses, the REIT
must apply the rules set forth in
§ 1.163(j)–10 as modified by paragraph
(h)(4) of this section.
(4) REIT real property assets, interests
in partnerships, and shares in other
REITs—(i) Real property assets. Assets
held by a REIT described in paragraph
(h)(3) of this section that meet the
definition of real property under
§ 1.856–10 are treated as assets of an
excepted trade or business.
(ii) Partnership interests. If a REIT
described in paragraph (h)(3) of this
section holds an interest in a
partnership, in applying the partnership
look-through rule described in
§ 1.163(j)–10(c)(5)(ii)(A)(2), the REIT
treats assets of the partnership that meet
the definition of real property under
§ 1.856–10 as assets of an excepted trade
or business. This application of the
definition of real property under
§ 1.856–10 does not affect the
characterization of the partnership’s
assets at the partnership level or for any
non-REIT partner. However, no portion
of the adjusted basis of the REIT’s
interest in the partnership is allocated to
a non-excepted trade or business if the
partnership makes an election under
paragraph (h)(7) of this section and if all
of the partnership’s assets are treated as
assets of an excepted trade or business
under paragraph (h)(2) of this section.
(iii) Shares in other REITs—(A) In
general. If a REIT (shareholder REIT)
described in paragraph (h)(3) of this
section holds an interest in another
REIT, then for purposes of applying the
allocation rules in § 1.163(j)–10, the
partnership look-through rule described
in § 1.163(j)–10(c)(5)(ii)(A)(2), as
modified by paragraph (h)(4)(ii) of this
section, applies to the assets of the other
REIT (as if the other REIT were a
partnership) in determining the portion
of shareholder REIT’s adjusted basis in
the shares of the other REIT that is
allocable to an excepted or non-
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56815
excepted trade or business of
shareholder REIT. However, no portion
of the adjusted basis of shareholder
REIT’s shares in the other REIT is
allocated to a non-excepted trade or
business if all of the other REIT’s assets
are treated as assets of an excepted trade
or business under paragraph (h)(2) of
this section.
(B) Information necessary. If
shareholder REIT does not receive,
either directly from the other REIT or
indirectly through the analysis of an
applicable financial statement (within
the meaning of section 451(b)(3)) of the
other REIT, the information necessary to
determine whether and to what extent
the assets of the other REIT are
investments in real property financing
assets, then shareholder REIT’s shares in
the other REIT are treated as assets of a
non-excepted trade or business under
§ 1.163(j)–10(c).
(iv) Tiered entities. In applying
§ 1.163(j)–10(c)(5)(ii)(E), the rules in
paragraphs (h)(4)(ii) and (h)(4)(iii)(A)
and (B) of this section apply to any
partnerships and other REITs within the
tier.
(5) Value of shares in other REITs—
(i) In general. If a REIT (shareholder
REIT) holds shares in another REIT,
then solely for purposes of applying the
value tests under paragraphs (h)(2) and
(3) of this section, the value of
shareholder REIT’s real property
financing assets includes the portion of
the value of shareholder REIT’s shares
in the other REIT that is attributable to
the other REIT’s investments in real
property financing assets. However, no
portion of the value of shareholder
REIT’s shares in the other REIT is
included in the value of shareholder
REIT’s real property financing assets if
all of the other REIT’s assets are treated
as assets of an excepted trade or
business under paragraph (h)(2) of this
section.
(ii) Information necessary. If
shareholder REIT does not receive,
either directly from the other REIT or
indirectly through the analysis of an
applicable financial statement (within
the meaning of section 451(b)(3)) of the
other REIT, the information necessary to
determine whether and to what extent
the assets of the other REIT are
investments in real property financing
assets, then shareholder REIT’s shares in
the other REIT are treated as real
property financing assets for purposes of
paragraphs (h)(2) and (3) of this section.
(iii) Tiered REITs. The rules in
paragraphs (h)(5)(i) and (ii) of this
section apply successively to the extent
that the other REIT, and any other REIT
in the tier, holds shares in another REIT.
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(6) Real property financing assets. For
purposes of this paragraph (h), real
property financing assets include
interests, including participation
interests, in the following: Mortgages,
deeds of trust, and installment land
contracts; mortgage pass-through
certificates guaranteed by Government
National Mortgage Association (GNMA),
Federal National Mortgage Association
(FNMA), Federal Home Loan Mortgage
Corporation (FHLMC), or Canada
Mortgage and Housing Corporation
(CMHC); REMIC regular interests; other
interests in investment trusts classified
as trusts under § 301.7701–4(c) of this
chapter that represent undivided
beneficial ownership in a pool of
obligations principally secured by
interests in real property and related
assets that would be permitted
investments if the investment trust were
a REMIC; obligations secured by
manufactured housing treated as single
family residences under section
25(e)(10), without regard to the
treatment of the obligations or the
properties under state law; and debt
instruments issued by publicly offered
REITs.
(7) Application of safe harbor for
partnerships controlled by REITs. A
partnership is eligible to make the
election under paragraph (h)(1) of this
section if one or more REITs own
directly or indirectly at least 50 percent
of the partnership’s capital and profits,
the partnership meets the requirements
of section 856(c)(2), (3), and (4) as if the
partnership were a REIT, and the
partnership satisfies the requirements
described in paragraph (h)(1) of this
section as if the partnership were a
REIT. The portion of the partnership’s
assets eligible for this election is
determined under paragraph (h)(2) or (3)
of this section, treating the partnership
as if it were a REIT.
(8) REITs or partnerships controlled
by REITs that do not apply the safe
harbor. A REIT or a partnership that is
eligible but chooses not to apply the safe
harbor provisions of paragraph (h)(1) or
(7) of this section, respectively, may still
elect, under paragraph (b)(1) of this
section, for one or more of its trades or
businesses to be an electing real
property trade or business, provided
that such trade or business is otherwise
eligible to elect under paragraph (b)(1)
of this section. A REIT or partnership
that makes the election under paragraph
(b)(1) of this section without utilizing
the safe harbor provisions of paragraph
(h) of this section may not rely on any
portion of paragraphs (h)(1) through (7)
of this section.
(i) [Reserved]
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(j) Special anti-abuse rule for certain
real property trades or businesses—(1)
In general. Except as provided in
paragraph (j)(2) of this section, a trade
or business (lessor) does not constitute
a trade or business eligible for an
election described in paragraph (b)(1) of
this section to be an electing real
property trade or business if at least 80
percent, determined by fair market
rental value, of the real property used in
the business is leased to a trade or
business (lessee) under common control
with the lessor, regardless of whether
the arrangement is pursuant to a written
lease or pursuant to a service contract or
another agreement that is not
denominated as a lease. For purposes of
this paragraph (j), fair market rental
value is the amount of rent that a
prospective lessee that is unrelated to
the lessor would be willing to pay for
a rental interest in real property, taking
into account the geographic location,
size, and type of the real property. For
purposes of this paragraph (j), two
trades or businesses are under common
control if 50 percent of the direct and
indirect ownership of both businesses
are held by related parties within the
meaning of sections 267(b) and 707(b).
(2) Exceptions—(i) De minimis
exception. The limitation in paragraph
(j)(1) of this section does not apply, and
the lessor is eligible to make an election
under paragraph (b)(1) of this section, if
the lessor leases, regardless of whether
the arrangement is pursuant to a written
lease or pursuant to a service contract or
another agreement that is not
denominated as a lease, at least 90
percent of the lessor’s real property,
determined by fair market rental value,
to one or more of the following:
(A) A party not under common
control with the lessor or lessee;
(B) A party under common control
with the lessor or lessee that has made
an election described in paragraph (b)(1)
of this section for a trade or business to
be an electing real property trade or
business or electing farming business,
but only to the extent that the real
property is used as part of its electing
real property trade or business or
electing farming business; or
(C) A party under common control
with the lessor or lessee that is an
excepted regulated utility trade or
business, but only to the extent that the
real property is used as part of its
excepted regulated utility trade or
business.
(ii) Look-through exception. If the de
minimis exception in paragraph (j)(2)(i)
of this section does not apply because
less than 90 percent of the lessor’s real
property is leased to parties described in
paragraphs (j)(2)(i)(A), (B), and (C), the
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lessor is eligible to make the election
under paragraph (b)(1) of this section to
the extent that the lessor leases the real
property to parties described in
paragraph (j)(2)(A), (B), or (C), and to the
extent that the lessee subleases (or
lessees ultimately sublease) the real
property to:
(A) A party not under common
control with the lessor or lessee;
(B) A party under common control
with the lessor or lessee that has made
an election described in paragraph (b)(1)
of this section for a trade or business to
be an electing real property trade or
business or electing farming business to
the extent that the real property is used
as part of its electing real property trade
or business or electing farming business;
or
(C) A party under common control
with the lessor or lessee that is an
excepted regulated utility trade or
business to the extent that the real
property is used as part of its excepted
regulated utility trade or business.
(iii) Inapplicability of exceptions to
consolidated groups. The exceptions in
paragraphs (j)(2)(i) and (ii) of this
section do not apply when the lessor
and lessee are members of the same
consolidated group.
(iv) Exception for certain REITs. The
special anti-abuse rule in paragraph
(j)(1) of this section does not apply to
REITs or to partnerships making an
election under paragraph (h)(7) of this
section that lease qualified lodging
facilities, as defined in section
856(d)(9)(D), and qualified health care
properties, as defined in section
856(e)(6)(D).
(3) Allocations. See § 1.163(j)–
10(c)(3)(iii)(D) for rules related to the
allocation of the basis of assets used in
lessor trades or businesses described in
paragraphs (j)(1) and (j)(2)(i) of this
section.
(4) Examples. The examples in this
paragraph (j)(4) illustrate the application
of paragraphs (j)(1), (2), and (3) of this
section. Unless otherwise indicated, the
parties are all domestic entities and are
not members of a single consolidated
group within the meaning of § 1.1502–
1(h).
(i) Example 1: Related party lease of
hotel—(A) Facts. X and Y are under
common control, as defined in
paragraph (j)(1) of this section. X owns
one piece of real property, a hotel, that
X leases to Y. Y operates the hotel and
provides hotel rooms and associated
amenities to third party guests of the
hotel. The form of the arrangement with
third party hotel guests is a license to
use rooms in the hotel and associated
amenities. Y is a real property trade or
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business that has made an election
under paragraph (b)(1) of this section.
(B) Analysis. Because X leases at least
80 percent of X’s real property to a party
under common control, X is subject to
the anti-abuse rule in paragraph (j)(1) of
this section. However, under the de
minimis exception under paragraph
(j)(2)(i) of this section, 100 percent of
the fair market rental value of the
building is leased to a party under
common control that has made an
election to be an electing real property
trade or business. Accordingly, X is
eligible to make the election described
in paragraph (b)(1) of this section for its
entire trade or business.
(ii) Example 2—(A) Facts. The facts
are the same as in Example 1 in
paragraph (j)(4)(i)(A) of this section,
except that Y has not made an election
under paragraph (b)(1) of this section,
and is not otherwise using the real
property in an excepted trade or
business.
(B) Analysis. Because X leases at least
80 percent of X’s real property,
determined by fair market rental value,
to Y, a party under common control, X
is subject to the anti-abuse rule in
paragraph (j)(1) of this section. X is not
eligible for the de minimis exception
under paragraph (j)(2)(i) of this section
because X does not lease at least 90
percent of its real property to a party
under common control, as defined in
paragraph (j)(1) of this section, such as
Y, and Y is not using the property in an
otherwise excepted trade or business.
However, X is eligible for the lookthrough exception under paragraph
(j)(2)(ii) of this section because X leases
100 percent of its real property to Y, a
party that is under common control, and
Y subleases 100 percent of the real
property to parties that are not under
common control with X or Y. The fact
that the license provided to hotel guests
is not denominated as a lease does not
prevent these licenses from being
treated as a lease for purposes of
paragraph (j) of this section.
Accordingly, under the look-through
exception under paragraph (j)(2)(ii) of
this section, X is eligible to make the
election described in paragraph (b)(1) of
this section with regard to its entire
trade or business.
(iii) Example 3: Sublease to related
party and unrelated third party—(A)
Facts. X owns one piece of real property
that X leases to Y, a party under
common control, as defined in
paragraph (j)(1) of this section. Y does
not operate an excepted trade or
business. Y subleases 80 percent of the
real property, determined by the fair
market rental value, to a party under
common control with Y that does not
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operate an excepted trade or business
and 20 percent of the real property,
determined by the fair market rental
value, to an unrelated third party.
(B) Analysis. Because X leases at least
80 percent of X’s real property,
determined by fair market rental value,
to a party under common control, X is
subject to the anti-abuse rule in
paragraph (j)(1) of this section. X is not
eligible for the de minimis exception in
paragraph (j)(2)(i) of this section because
X is not leasing at least 90 percent of the
real property, determined by fair market
rental value, to a party under common
control that operates an excepted trade
or business and/or unrelated parties.
Under the look-through exception under
paragraph (j)(2)(ii) of this section, X is
eligible to make the election described
in paragraph (b)(1) of this section with
respect to the 20 percent of the fair
market rental value of the real property
subleased to an unrelated party because
X is treated as directly leasing this
portion to an unrelated party. X is not
eligible to make the election described
in paragraph (b)(1) of this section with
respect to the 80 percent of the building
subleased to a party under common
control because X is still treated as
directly leasing this portion to a related
party. Under § 1.163(j)–10(c)(3)(iii)(D), X
must allocate 80 percent of the basis in
the real property as a non-excepted
trade or business and 20 percent of the
basis in the real property as an excepted
trade or business.
(iv) Example 4: Multiple subleases—
(A) Facts. X owns a building that X
leases to Y, a party under common
control as defined in paragraph (j)(1) of
this section. Y does not operate an
excepted trade or business. Y subleases
80 percent of the building, determined
by fair market rental value, to Z, a party
under common control with both X and
Y. Y subleases the remaining 20 percent
of the building, determined by fair
market rental value, to unrelated parties.
Z subleases 50 percent of its leasehold
interest, determined by fair market
rental value, to parties unrelated to X,
Y and Z, and uses the remaining
leasehold interest in its retail business.
Z does not operate an excepted trade or
business.
(B) Analysis. Because X leases at least
80 percent of X’s real property,
determined by fair market rental value,
to a party under common control, X is
subject to the anti-abuse rule in
paragraph (j)(1) of this section. X is not
eligible for the de minimis exception in
paragraph (j)(2)(i) because X is not
leasing at least 90 percent of the
building, determined by fair market
rental value, to a party under common
control that operates an excepted trade
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56817
or business and/or unrelated parties.
Under the look-through exception under
paragraph (j)(2)(ii) of this section, X is
eligible to make the election described
in paragraph (b)(1) of this section with
respect to the 60 percent of the building
that is subleased to unrelated parties,
determined by adding 40 percent (50
percent of the 80 percent leasehold
interest) from Z’s sublease to an
unrelated party and 20 percent from Y’s
sublease to unrelated parties (40 + 20).
X is not eligible to make the election
described in paragraph (b)(1) of this
section with respect to the 40 percent of
the building subleased to Z, because Z
is a related party that does not operate
an excepted trade or business.
(v) Example 5: Lessee’s Trade or
Business—(A) Facts. X owns a building
that X leases to W, a party under
common control as defined in paragraph
(j)(1) of this section. W operates the
building as a widget manufacturing
plant and does not sublease any portion
of the building.
(B) Analysis. X is not eligible to make
the election described in paragraph
(b)(1) of this section because X leases
the entire building to a party under
common control. X is not eligible for the
de minimis exception in paragraph
(j)(2)(i) of this section because X is not
leasing at least 90 percent of the real
property to a party under common
control that operates an excepted trade
or business and/or unrelated parties.
W’s trade or business cannot be an
electing real property trade or business.
X is not eligible for the look-through
exception under paragraph (j)(2)(ii) of
this section because W is not subleasing
any part of the building.
(k) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
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§ 1.163(j)–10 Allocation of interest
expense, interest income, and other items
of expense and gross income to an
excepted trade or business.
(a) Overview—(1) In general—(i)
Purposes. Except as provided in
§ 1.163(j)–6(m) or § 1.163(j)–9(h), this
section provides the exclusive rules for
allocating tax items that are properly
allocable to a trade or business between
excepted trades or businesses and nonexcepted trades or businesses for
purposes of section 163(j). The amount
of a taxpayer’s interest expense that is
properly allocable to excepted trades or
businesses is not subject to the section
163(j) limitation. The amount of a
taxpayer’s other items of income, gain,
deduction, or loss, including interest
income, that is properly allocable to
excepted trades or businesses is
excluded from the calculation of the
taxpayer’s section 163(j) limitation. See
section 163(j)(6) and (j)(8)(A)(i); see also
§ 1.163(j)–1(b)(1)(i)(H), (b)(1)(ii)(F), and
(b)(3). The general method of allocation
set forth in paragraph (c) of this section
is based on the approach that money is
fungible and that interest expense is
attributable to all activities and
property, regardless of any specific
purpose for incurring an obligation on
which interest is paid. In no event may
the amount of interest expense allocated
under this section exceed the amount of
interest paid or accrued, or treated as
paid or accrued, by the taxpayer within
the taxable year.
(ii) Application of section. The
amount of a taxpayer’s tax items
properly allocable to a trade or business,
other than interest expense and interest
income, that is properly allocable to
excepted trades or businesses for
purposes of section 163(j) is determined
as set forth in paragraph (b) of this
section. The amount of a taxpayer’s
interest expense and interest income
that is properly allocable to excepted
trades or businesses for purposes of
section 163(j) generally is determined as
set forth in paragraph (c) of this section,
except as otherwise provided in
paragraph (d) of this section. For
purposes of this section, a taxpayer’s
activities are not treated as a separate
trade or business to the extent those
activities involve the provision of real
property, goods, or services to a trade or
business of the taxpayer (or, if the
taxpayer is a member of a consolidated
group, the consolidated group). For
example, if a taxpayer engaged in a
manufacturing trade or business has inhouse legal personnel that provide legal
services solely with respect to the
taxpayer’s manufacturing business, the
taxpayer is not treated as also engaged
in the trade or business of providing
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legal services. Similarly, if the taxpayer
described in the previous sentence
constructs or acquires real property
solely for use by the taxpayer’s
manufacturing business, the taxpayer is
not treated as also engaged in a real
property trade or business.
(2) Coordination with other rules—(i)
In general. The rules of this section
apply after a taxpayer has determined
whether any interest expense or interest
income paid, received, or accrued is
properly allocable to a trade or business.
Similarly, the rules of this section apply
to other tax items after a taxpayer has
determined whether those items are
properly allocable to a trade or business.
For instance, a taxpayer must apply
§ 1.163–8T, if applicable, to determine
which items of interest expense are
investment interest under section 163(d)
before applying the rules in paragraph
(c) of this section to allocate interest
expense between excepted and nonexcepted trades or businesses. After
determining whether its tax items are
properly allocable to a trade or business,
a taxpayer that is engaged in both
excepted and non-excepted trades or
businesses must apply the rules of this
section to determine the amount of
interest expense that is business interest
expense subject to the section 163(j)
limitation and to determine which items
are included or excluded in computing
its section 163(j) limitation.
(ii) Treatment of investment interest,
investment income, investment
expenses, and certain other tax items of
a partnership with a C corporation or
tax-exempt corporation as a partner.
For rules governing the treatment of
investment interest, investment income,
investment expenses, and certain other
separately stated tax items of a
partnership with a C corporation or taxexempt corporation as a partner, see
§§ 1.163(j)–4(b)(3) and 1.163(j)–6(k).
(3) Application of allocation rules to
foreign corporations and foreign
partnerships. The rules of this section
apply to foreign corporations and
foreign partnerships.
(4) Application of allocation rules to
members of a consolidated group—(i) In
general. As provided in § 1.163(j)–4(d),
the computations required by section
163(j) and the regulations in this part
under section 163(j) of the Code
generally are made for a consolidated
group on a consolidated basis. In this
regard, for purposes of applying the
allocation rules of this section, all
members of a consolidated group are
treated as one corporation. Therefore,
the rules of this section apply to the
activities conducted by the group as if
those activities were conducted by a
single corporation. For example, the
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group (rather than a particular member)
is treated as engaged in excepted or nonexcepted trades or businesses. In the
case of intercompany obligations,
within the meaning of § 1.1502–
13(g)(2)(ii), for purposes of allocating
asset basis between excepted and nonexcepted trades or businesses, the
obligation of the member borrower is
not considered an asset of the creditor
member. Similarly, intercompany
transactions, within the meaning of
§ 1.1502–13(b)(1)(i), are disregarded for
purposes of this section, as are the
resulting offsetting items, and property
is allocated to a trade or business based
on the activities of the group as if the
members of the group were divisions of
a single corporation. Further, stock of a
group member that is owned by another
member of the same group is not treated
as an asset for purposes of this section,
and the transfer of any amount of
member stock to a non-member is
treated by the group as a transfer of the
member’s assets proportionate to the
amount of member stock transferred.
Additionally, stock of a corporation that
is not a group member is treated as
owned by the group.
(ii) Application of excepted business
percentage to members of a
consolidated group. After a consolidated
group has determined the percentage of
the group’s interest expense allocable to
excepted trades or businesses for the
taxable year (and thus not subject to the
section 163(j) limitation), this exempt
percentage is applied to the interest
paid or accrued by each member during
the taxable year to any lender that is not
a group member. Therefore, except to
the extent paragraph (d) of this section
(providing rules for certain qualified
nonrecourse indebtedness) applies, an
identical percentage of the interest paid
or accrued by each member of the group
to any lender that is not a group member
is treated as allocable to excepted trades
or businesses, regardless of whether any
particular member actually engaged in
an excepted trade or business.
(iii) Basis in assets transferred in an
intercompany transaction. For purposes
of allocating interest expense and
interest income under paragraph (c) of
this section, the basis of property does
not include any gain or loss realized
with respect to the property by another
member in an intercompany transaction,
as defined in § 1.1502–13(b), whether or
not the gain or loss is deferred.
(5) Tax-exempt organizations. For taxexempt organizations, section 512 and
the regulations in this part under
section 512 of the Code determine the
rules for allocating all income and
expenses among multiple trades or
businesses.
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(6) Application of allocation rules to
disallowed disqualified interest. A
taxpayer may apply the allocation rules
of this section to disallowed
disqualified interest by either:
(i) Applying the allocation rules of
this section to all of the taxpayer’s
disallowed disqualified interest in the
taxable year(s) in which the disallowed
disqualified interest was paid or
accrued (the historical approach); or
(ii) Treating all of the taxpayer’s
disallowed disqualified interest as if it
were paid or accrued in the taxpayer’s
first taxable year beginning after
December 31, 2017 (the effective date
approach).
(7) Examples. The following examples
illustrate the principles of this
paragraph (a).
(i) Example 1: Items properly
allocable to a trade or business—(A)
Facts. Individual T operates Business X,
a non-excepted trade or business, as a
sole proprietor. In Year 1, T pays or
accrues $40x of interest expense and
receives $100x of gross income with
respect to Business X that is not eligible
for a section 199A deduction. T borrows
money to buy a car for personal use, and
T pays or accrues $20x of interest
expense with respect to the car loan. T
also invests in corporate bonds, and, in
Year 1, T receives $50x of interest
income on those bonds.
(B) Analysis. Under paragraphs (a)(1)
and (2) of this section, T must determine
which items of income and expense,
including items of interest income and
interest expense, are properly allocable
to a trade or business. T’s $100x of gross
income and T’s $40x of interest expense
with respect to Business X are properly
allocable to a trade or business.
However, the interest expense on T’s car
loan is personal interest within the
meaning of section 163(h)(2) rather than
interest properly allocable to a trade or
business. Similarly, T’s interest income
from corporate bonds is not properly
allocable to a trade or business because
it is interest from investment activity.
See section 163(d)(4)(B).
(ii) Example 2: Intercompany
transaction—(A) Facts. S is a member of
a consolidated group of which P is the
common parent. P conducts an electing
real property trade or business (Business
X), and S conducts a non-excepted trade
or business (Business Y). P leases
Building V (which P owns) to S for use
in Business Y.
(B) Analysis. Under paragraph (a)(4)(i)
of this section, a consolidated group is
treated as a single corporation for
purposes of applying the allocation
rules of this section, and the
consolidated group (rather than a
particular member of the group) is
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treated as engaged in excepted and nonexcepted trades or businesses. Thus,
intercompany transactions are
disregarded for purposes of this section.
As a result, the lease of Building V by
P to S is disregarded. Moreover, because
Building V is used in Business Y, basis
in this asset is allocated to Business Y
rather than Business X for purposes of
these allocation rules, regardless of
which member (P or S) owns the
building.
(iii) Example 3: Intercompany sale of
natural gas—(A) Facts. S is a member of
a consolidated group of which P is the
common parent. S drills for natural gas
and is not an excepted regulated utility
trade or business. S sells most of its
natural gas production to P, which
produces electricity at its natural gasfired power plants, and S sells the rest
of its natural gas production to third
parties at market rates. P is an excepted
regulated utility trade or business to the
extent that it is engaged in a trade or
business described in § 1.163(j)–
1(b)(15)(i).
(B) Analysis. Intercompany
transactions are disregarded for
purposes of this section. As a result, the
intercompany sales of natural gas by S
to P are disregarded. Moreover, the
assets of S and P are allocated between
the excepted and non-excepted trades or
businesses of the P group based on the
assets used in each trade or business.
Assets of S may be allocated to the P
group’s excepted trade or business to
the extent those assets are used in the
trade or business of the furnishing or
sale of electrical energy. Likewise, assets
of P may be allocated to the P group’s
non-excepted trade or business to the
extent those assets are used in the trade
or business of natural gas production.
(iv) Example 4: Disallowed
disqualified interest—(A) Facts. S is a
member of a consolidated group of
which P is the common parent. P and
S are the only members of an affiliated
group under old section 163(j)(6)(C). S
operates a farm equipment leasing
business (Business X) that is not an
excepted trade or business. P is engaged
in an electing farming business
(Business Y). Entering its first taxable
year beginning after December 31, 2017,
the P group has disallowed disqualified
interest of $120x, all of which the P
group paid or accrued in earlier taxable
years in which it only operated Business
X. The P group also incurs $100x of
interest expense during its 2018 taxable
year, of which $25x (25 percent of
$100x) is business interest expense
properly allocable to Business X and
$75x (75 percent of $100x) is properly
allocable to Business Y under paragraph
(c) of this section.
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(B) Analysis. Under paragraph (a)(6)
of this section, the P group may allocate
disallowed disqualified interest to
Business X and Business Y by either
applying the allocation rules of this
section in the taxable years in which the
disallowed disqualified interest was
paid or accrued (the historical
approach) or by treating such interest as
though it were paid or accrued in the P
group’s first taxable year beginning after
December 31, 2017 (the effective date
approach). Accordingly, if the P group
chooses to rely on the historical
approach, it allocates all $120x of
disallowed disqualified interest to
Business X (a non-excepted trade or
business), and all $120x of disallowed
disqualified interest is subject to the
section 163(j) limitation. If, instead, the
P group chooses to rely on the effective
date approach, it allocates its $120x of
disallowed disqualified interest in the
same proportion as its $100x of business
interest expense that was paid or
accrued in its 2018 taxable year. Of the
$120x of disallowed disqualified
interest, $30x (25 percent of $120x) is
allocated to Business X and $90x (75
percent of $120x) is allocated to
Business Y. The $90x of disallowed
disqualified interest that is properly
allocable to Business Y (an excepted
trade or business) is not subject to the
section 163(j) limitation.
(b) Allocation of tax items other than
interest expense and interest income—
(1) In general. Except as otherwise
provided in § 1.163(j)–6(m) or
§ 1.163(j)–9(h), for purposes of
calculating ATI, tax items other than
interest expense and interest income are
allocated to a particular trade or
business in the manner described in this
paragraph (b). It is not necessary to
allocate items under this paragraph (b)
for purposes of calculating ATI if all of
the taxpayer’s items subject to allocation
under this paragraph (b) are allocable to
excepted trades or businesses, or if all
of those items are allocable to nonexcepted trades or businesses.
(2) Gross income other than dividends
and interest income. A taxpayer’s gross
income other than dividends and
interest income is allocated to the trade
or business that generated the gross
income.
(3) Dividends—(i) Look-through rule.
If a taxpayer receives a dividend, within
the meaning of section 316, that is not
investment income, within the meaning
of section 163(d), and if the taxpayer
satisfies the minimum ownership
threshold in paragraph (c)(7) of this
section, then, solely for purposes of
allocating amounts received as a
dividend during the taxable year to
excepted or non-excepted trades or
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businesses under this paragraph (b), the
dividend income is treated as allocable
to excepted or non-excepted trades or
businesses based upon the relative
amounts of the payor corporation’s
adjusted basis in the assets used in its
trades or businesses, determined
pursuant to paragraph (c) of this section.
If at least 90 percent of the payor
corporation’s adjusted basis in its assets
during the taxable year, determined
pursuant to paragraph (c) of this section,
is allocable to either excepted trades or
businesses or to non-excepted trades or
businesses, all of the taxpayer’s
dividend income from the payor
corporation for the taxable year is
treated as allocable to either excepted or
non-excepted trades or businesses,
respectively.
(ii) Inapplicability of the look-through
rule. If a taxpayer receives a dividend
that is not investment income, within
the meaning of section 163(d), and if the
taxpayer does not satisfy the minimum
ownership threshold in paragraph (c)(7)
of this section, then the taxpayer must
treat the dividend as allocable to a nonexcepted trade or business.
(4) Gain or loss from the disposition
of non-consolidated C corporation
stock, partnership interests, or S
corporation stock—(i) Non-consolidated
C corporations. (A) If a taxpayer
recognizes gain or loss upon the
disposition of stock in a nonconsolidated C corporation that is not
property held for investment, within the
meaning of section 163(d)(5), and if the
taxpayer looks through to the assets of
the C corporation under paragraph
(c)(5)(ii) of this section for the taxable
year, then the taxpayer must allocate
gain or loss from the disposition of stock
to excepted or non-excepted trades or
businesses based upon the relative
amounts of the C corporation’s adjusted
basis in the assets used in its trades or
businesses, determined pursuant to
paragraph (c) of this section. If at least
90 percent of the C corporation’s
adjusted basis in its assets during the
taxable year, determined pursuant to
paragraph (c) of this section, is allocable
to either excepted trades or businesses
or to non-excepted trades or businesses,
all of the taxpayer’s gain or loss from the
disposition is treated as allocable to
either excepted or non-excepted trades
or businesses, respectively.
(B) If a taxpayer recognizes gain or
loss upon the disposition of stock in a
non-consolidated C corporation that is
not property held for investment, within
the meaning of section 163(d)(5), and if
the taxpayer does not look through to
the assets of the C corporation under
paragraph (c)(5)(ii) of this section for the
taxable year, then the taxpayer must
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treat the gain or loss from the
disposition of stock as allocable to a
non-excepted trade or business.
(C) For rules governing the transfer of
stock of a member of a consolidated
group, see paragraph (a)(4)(i) of this
section.
(ii) Partnerships and S corporations.
(A) If a taxpayer recognizes gain or loss
upon the disposition of interests in a
partnership or stock in an S corporation
that owns—
(1) Non-excepted assets and excepted
assets;
(2) Investment assets; or
(3) Both;
(B) The taxpayer determines a
proportionate share of the amount
properly allocable to a non-excepted
trade or business in accordance with the
allocation rules set forth in paragraph
(c)(5)(ii)(A) or (c)(5)(ii)(B)(3) of this
section, as appropriate, and includes
such proportionate share of gain or loss
in the taxpayer’s ATI. However, if at
least 90 percent of the partnership’s or
S corporation’s adjusted basis in its
assets during the taxable year,
determined pursuant to paragraph (c) of
this section, is allocable to either
excepted trades or businesses or to nonexcepted trades or businesses, all of the
taxpayer’s gain or loss from the
disposition is treated as allocable to
either excepted or non-excepted trades
or businesses, respectively. This rule
also applies to tiered passthrough
entities by looking through each
passthrough entity tier (for example, an
S corporation that is the partner of the
highest-tier partnership would look
through each lower-tier partnership),
subject to paragraph (c)(5)(ii)(D) of this
section. With respect to a partner that is
a C corporation or tax-exempt
corporation, a partnership’s investment
assets are taken into account and treated
as non-excepted trade or business
assets. For purposes of this paragraph, a
passthrough entity means a partnership,
S corporation, or any other entity
(domestic or foreign) that is not a
corporation if all items of income and
deduction of the entity are included in
the income of its owners or
beneficiaries.
(5) Expenses, losses, and other
deductions—(i) Expenses, losses, and
other deductions that are definitely
related to a trade or business. Expenses
(other than interest expense), losses, and
other deductions (collectively,
deductions for purposes of this
paragraph (b)(5)) that are definitely
related to a trade or business are
allocable to the trade or business to
which they relate. A deduction is
considered definitely related to a trade
or business if the item giving rise to the
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deduction is incurred as a result of, or
incident to, an activity of the trade or
business or in connection with property
used in the trade or business (see
§ 1.861–8(b)(2)). If a deduction is
definitely related to one or more
excepted trades or businesses and one
or more non-excepted trades or
businesses, the deduction is
apportioned between the excepted and
non-excepted trades or businesses based
upon the relative amounts of the
taxpayer’s adjusted basis in the assets
used in those trades or businesses, as
determined under paragraph (c) of this
section.
(ii) Other deductions. Deductions that
are not described in paragraph (b)(5)(i)
of this section are ratably apportioned
based on the gross income of each trade
or business.
(6) Treatment of investment items and
certain other items of a partnership with
a C corporation partner. Any
investment income, investment
expense, or other item that a partnership
receives, pays, or accrues and that is
treated as properly allocable to a trade
or business of a C corporation partner
under § 1.163(j)–4(b)(3)(i) is treated as
properly allocable to a non-excepted
trade or business of the C corporation
partner, except that any item with
respect to property or activities for
which an election has been made by the
partnership under § 1.163(j)–9(b) is
treated as properly allocable to an
excepted trade or business. See, for
example, an election for activities
described in § 1.163(j)–9(b)(2)(ii) or an
election under § 1.163(j)–9(h).
(7) Examples: Allocation of income
and expense. The following examples
illustrate the principles of this
paragraph (b):
(i) Example 1: Allocation of income
and expense between excepted and nonexcepted trades or businesses—(A)
Facts. T conducts an electing real
property trade or business (Business Y),
which is an excepted trade or business.
T also operates a lumber yard (Business
Z), which is a non-excepted trade or
business. In Year 1, T receives $100x of
gross rental income from real property
leasing activities. T also pays or accrues
$60x of expenses in connection with its
real property leasing activities and $20x
of legal services performed on behalf of
both Business Y and Business Z. T
receives $60x of gross income from
lumber yard customers and pays or
accrues $50x of expenses related to the
lumber yard business. For purposes of
expense allocations under paragraphs
(b) and (c) of this section, T has $240x
of adjusted basis in its Business Y assets
and $80x of adjusted basis in its
Business Z assets.
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(B) Analysis. Under paragraph (b)(2)
of this section, for Year 1, $100x of
rental income is allocated to Business Y,
and $60x of income from lumber yard
customers is allocated to Business Z.
Under paragraph (b)(5)(i) of this section,
$60x of expenses paid or accrued in
connection with real property leasing
activities are allocated to Business Y,
and $50x of expenses related to the
lumber yard are allocated to Business Z.
The $20x of remaining expenses for
legal services performed on behalf of
both Business Y and Business Z are
allocated according to the relative
amounts of T’s basis in the assets used
in each business. The total amount of
T’s basis in the assets used in
Businesses Y and Z is $320x, of which
75 percent ($240x/$320x) is used in
Business Y and 25 percent ($80x/$320x)
is used in Business Z. Accordingly,
$15x of the expenses for legal services
are allocated to Business Y and $5x are
allocated to Business Z.
(ii) Example 2: Allocation of
partnership items from investment
activity—(A) Facts. U, a domestic C
corporation, directly conducts an
electing real property trade or business.
U also has an interest in PRS, a
partnership that holds real property for
investment. PRS’s investment in real
property is not a trade or business under
section 162 or a real property trade or
business under section 469. During the
taxable year, PRS sells some of its real
property to third parties and allocates
$80x of income to U from these sales.
In addition, PRS incurs deductible
expenses related to its investment in
real property and allocates $9x of these
deductible expenses to U.
(B) Analysis. Under paragraph (b)(6)
of this section, any investment income
or investment expense that a
partnership receives, pays, or accrues
and that is treated as properly allocable
to a trade or business of a C corporation
partner is treated as properly allocable
to a non-excepted trade or business of
the C corporation partner. Because PRS
generates its income and expense from
investment activity that is not a trade or
business under section 162 or a real
property trade or business under section
469, U’s allocation of $80x of income
and $9x of deductible expense from PRS
is treated as properly allocable to a nonexcepted trade or business.
(c) Allocating interest expense and
interest income that is properly
allocable to a trade or business—(1)
General rule—(i) In general. Except as
otherwise provided in this section,
§ 1.163(j)–6(m), or § 1.163(j)–9(h), the
amount of a taxpayer’s interest expense
and interest income that is properly
allocable to a trade or business is
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allocated to the taxpayer’s excepted or
non-excepted trades or businesses for
purposes of section 163(j) based upon
the relative amounts of the taxpayer’s
adjusted basis in the assets, as
determined under paragraph (c)(5) of
this section, used in its excepted or nonexcepted trades or businesses. The
taxpayer must determine the adjusted
basis in its assets as of the close of each
determination date, as defined in
paragraph (c)(6) of this section, in the
taxable year and average those amounts
to determine the relative amounts of
asset basis for its excepted and nonexcepted trades or businesses for that
year. It is not necessary to allocate
interest expense or interest income
under this paragraph (c) for purposes of
determining a taxpayer’s business
interest expense and business interest
income if all of the taxpayer’s interest
income and expense is allocable to
excepted trades or businesses (in which
case the taxpayer is not subject to the
section 163(j) limitation) or if all of the
taxpayer’s interest income and expense
is allocable to non-excepted trades or
businesses.
(ii) De minimis exception. If at least
90 percent of the taxpayer’s basis in its
assets for the taxable year is allocable to
either excepted or non-excepted trades
or businesses pursuant to this paragraph
(c), then all of the taxpayer’s interest
expense and interest income for that
year that is properly allocable to a trade
or business is treated as allocable to
either excepted or non-excepted trades
or businesses, respectively.
(2) Example. The following example
illustrates the principles of paragraph
(c)(1) of this section:
(i) Facts. T is a calendar-year C
corporation engaged in an electing real
property trade or business, the business
of selling wine, and the business of
selling hand-carved wooden furniture.
In Year 1, T has $100x of interest
expense that is deductible except for the
potential application of section 163(j).
Based upon determinations made on the
determination dates in Year 1, T’s
average adjusted basis in the assets used
in the electing real property trade or
business (an excepted trade or business)
in Year 1 is $800x, and T’s total average
adjusted basis in the assets used in the
other two businesses (which are nonexcepted trades or businesses) in Year 1
is $200x.
(ii) Analysis. $80x (($800x/($800x +
$200x)) × $100x) of T’s interest expense
for Year 1 is allocable to T’s electing real
property trade or business and is not
business interest expense subject to the
section 163(j) limitation. The remaining
$20x of T’s interest expense is business
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56821
interest expense for Year 1 that is
subject to the section 163(j) limitation.
(3) Asset used in more than one trade
or business—(i) General rule. If an asset
is used in more than one trade or
business during a determination period,
as defined in paragraph (c)(6) of this
section, the taxpayer’s adjusted basis in
the asset is allocated to each trade or
business using the permissible
methodology under this paragraph (c)(3)
that most reasonably reflects the use of
the asset in each trade or business
during that determination period. An
allocation methodology most reasonably
reflects the use of the asset in each trade
or business if it most properly reflects
the proportionate benefit derived from
the use of the asset in each trade or
business. A taxpayer is not required to
use the same allocation methodology for
each type of asset used in a trade a
business. Instead, a taxpayer may use
different allocation methodologies for
different types of assets used in a trade
or business. If none of the permissible
methodologies set forth in paragraph
(c)(3)(ii) of this section reasonably
reflects the use of the asset in each trade
or business, the taxpayer’s basis in the
asset is not taken into account for
purposes of this paragraph (c).
(ii) Permissible methodologies for
allocating asset basis between or among
two or more trades or businesses.
Subject to the special rules in
paragraphs (c)(3)(iii) and (c)(5) of this
section, a taxpayer’s basis in an asset
used in two or more trades or businesses
during a determination period may be
allocated to those trades or businesses
based upon—
(A) The relative amounts of gross
income that an asset generates, has
generated, or may reasonably be
expected to generate, within the
meaning of § 1.861–9T(g)(3), with
respect to the trades or businesses;
(B) If the asset is land or an inherently
permanent structure, the relative
amounts of physical space used by the
trades or businesses; or
(C) If the trades or businesses generate
the same unit of output, the relative
amounts of output of those trades or
businesses (for example, if an asset is
used in two trades or businesses, one of
which is an excepted regulated utility
trade or business, and the other of
which is a non-excepted regulated
utility trade or business, the taxpayer
may allocate basis in the asset based
upon the relative amounts of kilowatthours generated by each trade or
business).
(iii) Special rules—(A) Consistent
allocation methodologies—(1) In
general. Except as otherwise provided
in paragraph (c)(3)(iii)(A)(2) of this
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section, a taxpayer must maintain the
same allocation methodology for a
period of at least five taxable years.
(2) Consent to change allocation
methodology. If a taxpayer has used the
same allocation methodology for at least
five taxable years, the taxpayers may
change its method of allocation under
paragraphs (c)(3)(i) and (ii) of this
section without the consent of the
Commissioner. If a taxpayer has used
the same allocation methodology for
less than five taxable years, and if the
taxpayer determines that a different
allocation methodology properly reflects
the proportionate benefit derived from
the use of assets in its trades or
businesses, the taxpayer may change its
method of allocation under paragraphs
(c)(3)(i) and (ii) of this section only with
the consent of the Commissioner. To
obtain consent, a taxpayer must submit
a request for a letter ruling under the
applicable administrative procedures,
and consent will be granted only in
extraordinary circumstances.
(B) De minimis exception. If at least
90 percent of the taxpayer’s basis in an
asset would be allocated to either
excepted trades or businesses or nonexcepted trades or businesses during a
determination period pursuant to this
paragraph (c)(3), the taxpayer’s entire
basis in the asset for the determination
period must be allocated to either
excepted or non-excepted trades or
businesses, respectively. This rule
applies before the application of
paragraph (c)(1)(ii) of this section.
(C) Allocations of excepted regulated
utility trades or businesses—(1) In
general. Except as provided in the de
minimis rule in paragraph
(c)(3)(iii)(C)(3) of this section, a taxpayer
is engaged in an excepted regulated
utility trade or business only to the
extent that the taxpayer is engaged in an
excepted regulated utility trade or
business described in § 1.163(j)–
1(b)(15)(i)(A), (B), or (C), and any
remaining utility trade or business is a
non-excepted trade or business. Thus,
for example, electricity sold by a utility
trade or business at rates not established
or approved by an entity described in
§ 1.163(j)–1(b)(15)(i)(A)(2) and not
subject to an election under § 1.163(j)–
1(b)(15)(iii) must be treated as electricity
sold by a non-excepted regulated utility
trade or business. The taxpayer must
allocate under this paragraph (c) the
basis of assets used in the utility trade
or business between its excepted and
non-excepted trades or businesses.
(2) Permissible method for allocating
asset basis for utility trades or
businesses. In the case of a utility trade
or business described in paragraph
(c)(3)(iii)(C)(1) of this section, and
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except as provided in the de minimis
rule in paragraph (c)(3)(iii)(C)(3) of this
section, the method described in
paragraph (c)(3)(ii)(C) of this section is
the only permissible method under this
paragraph (c)(3) for allocating the
taxpayer’s basis in assets used in both
the excepted and non-excepted trades or
businesses of selling or furnishing the
items described in § 1.163(j)–
1(b)(15)(i)(A)(1).
(3) De minimis rule for excepted
utility trades or businesses. If a taxpayer
is engaged in a utility trade or business
described in paragraph (c)(3)(iii)(C)(1) of
this section, and if at least 90 percent of
the items described in § 1.163(j)–
1(b)(15)(i)(A)(1) are furnished or sold by
trades or businesses described in
§ 1.163(j)–1(b)(15)(i)(A), (B) or (C), the
taxpayer’s entire trade or business is an
excepted regulated utility trade or
business, and paragraph (c)(3)(iii)(C)(2)
of this section does not apply. This rule
applies before the application of
paragraph (c)(3)(iii)(B) of this section.
(4) Example. The following example
illustrates the principles of this
paragraph (c)(3)(iii)(C):
(i) Facts. X, a C corporation, is
engaged in the trade or business of
generating electrical energy. During
each determination period in the taxable
year, 80 percent of the megawatt-hours
generated in the electricity generation
trade or business is sold at rates
negotiated with the purchaser, and with
respect to which X filed a schedule of
rates with a public utility commission.
The public utility commission has the
authority to take action on the filed
schedule of rates, but if no action is
taken, the rules governing the public
utility commission explicitly state that
the public utility commission is deemed
to have approved the rates. The public
utility has taken no action with respect
to the negotiated rate. The remaining 20
percent of the megawatt-hours is sold on
the wholesale market at rates not
established or subject to approval by a
regulator described in § 1.163(j)–
1(b)(15)(i)(A)(2). X has not made an
election under § 1.163(j)–1(b)(15)(iii).
None of the assets used in X’s utility
generation trade or business are used in
any other trade or business.
(ii) Analysis. For purposes of section
163(j), under paragraph (c)(3)(iii)(C)(1)
of this section, 80 percent of X’s
electricity generation business is an
excepted regulated utility trade or
business, because the rate for the sale of
the electricity was subject to approval
by a regulator described in § 1.163(j)–
1(b)(15)(i)(A)(2). The remaining 20
percent of X’s business is a nonexcepted utility trade or business.
Under paragraph (c)(3)(iii)(C)(2) of this
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section, X must allocate 80 percent of
the basis of the assets used in its utility
business to excepted trades or business
and the remaining 20 percent of the
basis in the assets to non-excepted
trades or businesses.
(D) Special allocation rule for real
property trades or businesses subject to
special anti-abuse rule—(1) In general.
In the case of a trade or business that
leases real property subject to an
arrangement described in § 1.163(j)–
9(j)(1), including trades or businesses to
which the look-through exception in
§ 1.163(j)–9(j)(2)(ii) applies, the taxpayer
must allocate under this paragraph (c)(3)
the basis of property used in both the
excepted and non-excepted portions of
its trade or business, as determined
under § 1.163(j)–9(j)(3).
(2) Allocation methodology for real
property. For purposes of this paragraph
(c)(3)(iii)(D), a taxpayer must allocate
the basis of real property leased under
an arrangement described in § 1.163(j)–
9(j)(1) or (j)(2)(i) between the excepted
and non-excepted portions of the real
property trade or business based on the
relative fair market rental value of the
real property that is attributable to the
excepted and non-excepted portions of
the trade or business, respectively.
(3) Example. The following example
illustrates the principles of this
paragraph (c)(3)(iii)(D):
(i) Facts. X and Y are domestic C
corporations under common control
within the meaning of section 267(b),
but neither X nor Y are members of a
consolidated group. The small business
exemption in § 1.163(j)–2(d) does not
apply to X or Y. X owns an office
building and leases the entire building
to Y. Y subleases 80 percent of the office
building, measured by fair market rental
value, to a related party. Y subleases the
remaining 20 percent of the building to
unrelated third parties. X also owns
depreciable scaffolding equipment,
which it uses to clean all of the
building’s windows as part of its leasing
arrangement with Y.
(ii) Analysis. Under § 1.163(j)–
9(j)(2)(ii), X is eligible to make an
election for 20 percent of its business of
leasing the office building to be an
electing real property trade or business.
Assuming X makes such an election, X
must allocate the basis of assets used in
both the excepted and non-excepted
portions of its leasing trade or business
under this paragraph (c). Under
paragraph (c)(3)(iii)(D)(2) of this section,
X must allocate the basis of the office
building based on the relative fair
market value attributable to the
excepted and non-excepted portions of
its leasing business. Therefore, X must
allocate 20 percent of the basis of the
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building to the excepted portion of its
leasing business, and it must allocate
the remaining 80 percent of the building
to the non-excepted portion of its
leasing business. Under paragraph
(c)(3)(iii)(D)(2) of this section, X may
use one of the allocation methods
described in paragraph (c)(3)(ii) of this
section to allocate the basis of its
scaffolding equipment between the
excepted and non-excepted portions of
its leasing trade or business.
(4) Disallowed business interest
expense carryforwards; floor plan
financing interest expense. Disallowed
business interest expense carryforwards
(which were treated as allocable to a
non-excepted trade or business in a
prior taxable year) are not re-allocated
between non-excepted and excepted
trades or businesses in a succeeding
taxable year. Instead, the carryforwards
continue to be treated as allocable to a
non-excepted trade or business. Floor
plan financing interest expense also is
not subject to allocation between
excepted and non-excepted trades or
businesses (see § 1.163(j)–1(b)(19)) and
is always treated as allocable to nonexcepted trades or businesses.
(5) Additional rules relating to basis—
(i) Calculation of adjusted basis—(A)
Non-depreciable property other than
land. Except as otherwise provided in
paragraph (c)(5)(i)(E) of this section, for
purposes of this section, the adjusted
basis of an asset other than land with
respect to which no deduction is
allowable under section 167, former
section 168, or section 197, as
applicable, is the adjusted basis of the
asset for determining gain or loss from
the sale or other disposition of that asset
as provided in § 1.1011–1. Self-created
intangible assets are not taken into
account for purposes of this paragraph
(c).
(B) Depreciable property other than
inherently permanent structures. For
purposes of this section, the adjusted
basis of any tangible asset with respect
to which a deduction is allowable under
section 167, other than inherently
permanent structures, is determined by
using the alternative depreciation
system under section 168(g) before any
application of the additional first-year
depreciation deduction (for example,
under section 168(k) or (m)), and the
adjusted basis of any tangible asset with
respect to which a deduction is
allowable under former section 168,
other than inherently permanent
structures, is determined by using the
taxpayer’s method of computing
depreciation for the asset under former
section 168. The depreciation deduction
with respect to the property described
in this paragraph (c)(5)(i)(B) is allocated
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ratably to each day during the period in
the taxable year to which the
depreciation relates. A change to the
alternative depreciation system should
be determined in a manner similar to
that in § 1.168(i)–4(d)(4) or (d)(5)(ii)(B),
as applicable.
(C) Special rule for land and
inherently permanent structures. Except
as otherwise provided in paragraph
(c)(5)(i)(E) of this section, for purposes
of this section, the adjusted basis of any
asset that is land, including
nondepreciable improvements to land,
or an inherently permanent structure is
its unadjusted basis.
(D) Depreciable or amortizable
intangible property and depreciable
income forecast method property. For
purposes of this section, the adjusted
basis of any intangible asset with
respect to which a deduction is
allowable under section 167 or 197, as
applicable, is determined in accordance
with section 167 or 197, as applicable,
and the adjusted basis of any asset
described in section 167(g)(6) for which
a deduction is allowable under section
167 is determined in accordance with
section 167(g). The adjusted basis of any
intangible asset under this paragraph
(c)(5)(i)(D) is determined before any
application of the additional first-year
depreciation deduction. The
depreciation or amortization deduction
with respect to the property described
in this paragraph (c)(5)(i)(D) is allocated
ratably to each day during the period in
the taxable year to which the
depreciation or amortization relates.
(E) Assets not yet used in a trade or
business. Assets that have been acquired
or that are under development but that
are not yet used in a trade or business
are not taken into account for purposes
of this paragraph (c). For example,
construction works in progress (such as
buildings, airplanes, or ships) are not
taken into account for purposes of this
paragraph (c). Similarly, land acquired
by a taxpayer for construction of a
building by the taxpayer to be used in
a trade or business is not taken into
account for purposes of under this
paragraph (c) until the building is
placed in service. This rule does not
apply to interests in a partnership or
stock in a corporation.
(F) Trusts established to fund specific
liabilities. Trusts required to fund
specific liabilities (for example, pension
trusts, and nuclear decommissioning
funds (including, but not limited to,
those funds for which an election is
made under section 468A)) are not taken
into account for purposes of this
paragraph (c).
(G) Inherently permanent structure.
For purposes of this section, the term
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inherently permanent structure has the
meaning provided in § 1.856–10(d)(2).
(ii) Partnership interests; stock in nonconsolidated C corporations—(A)
Partnership interests—(1) Calculation of
asset basis. For purposes of this section,
a partner’s interest in a partnership is
treated as an asset of the partner. For
these purposes, the partner’s adjusted
basis in a partnership interest is
reduced, but not below zero, by the
partner’s share of partnership liabilities,
as determined under section 752, and is
further reduced as provided in
paragraph (c)(5)(ii)(A)(2)(iii) of this
section. If a partner elects or is required
to apply the rules in this paragraph
(c)(5)(ii)(A) to look through to a
partnership’s basis in the partnership’s
assets, the partner’s basis in the
partnership interest is adjusted to the
extent of the partner’s share of any
adjustments to the basis of the
partnership’s assets required pursuant
to the rules in paragraph (c)(5)(i) of this
section.
(2) Allocation of asset basis—(i) In
general. For purposes of determining
the extent to which a partner’s adjusted
basis in its partnership interest is
allocable to an excepted or nonexcepted trade or business, the partner
may look through to such partner’s
share of the partnership’s basis in the
partnership’s assets, taking into account
any adjustments under sections 734(b)
and 743(b), and adjusted to the extent
required under paragraph (d)(4) of this
section, except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section.
For purposes of the preceding sentence,
such partner’s share of partnership
assets is determined using a reasonable
method taking into account special
allocations under section 704(b).
Notwithstanding paragraph (c)(7) of this
section, if a partner’s direct and indirect
interest in a partnership is greater than
or equal to 80 percent of the
partnership’s capital or profits, the
partner must apply the rules in this
paragraph (c)(5)(ii)(A)(2) to look through
to the partnership’s basis in the
partnership’s assets. If a partner elects
or is required to apply the rules in this
paragraph (c)(5)(ii)(A)(2) to look through
to a partnership’s basis in the
partnership’s assets, the partner
allocates the basis of its partnership
interest between excepted and nonexcepted trades or businesses based on
the ratio in which the partner’s share of
the partnership’s adjusted tax basis in
its trade or business assets is allocated
between excepted and non-excepted
trade or business assets.
(ii) De minimis rule. If, after applying
paragraph (c)(5)(ii)(A)(2)(iii) of this
section, at least 90 percent of a partner’s
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share of a partnership’s basis in its
assets (including adjustments under
sections 734(b) and 743(b)) is allocable
to either excepted trades or businesses
or non-excepted trades or businesses,
without regard to assets not properly
allocable to a trade or business, the
partner’s entire basis in its partnership
interest is treated as allocable to either
excepted or non-excepted trades or
businesses, respectively. For purposes
of the preceding sentence, such
partner’s share of partnership assets is
determined using a reasonable method
taking into account special allocations
under section 704(b).
(iii) Partnership assets not properly
allocable to a trade or business. For
purposes of applying paragraphs
(c)(5)(ii)(A)(2)(i) and (ii) of this section
to a partner that is a C corporation or
tax-exempt corporation, such partner’s
share of a partnership’s assets that are
not properly allocable to a trade or
business is treated as properly allocable
to a non-excepted trade or business of
such partner. However, if the
partnership made an election under
§ 1.163(j)–9(b) or § 1.163(j)–9(h) with
respect to an asset or activity, the assets
(or assets related to such activities) are
treated as properly allocable to an
excepted trade or business of such
partner. See, for example, an election
under § 1.163(j)–9(h) for an asset or an
election under § 1.163(j)–9(b) with
respect to activities described in
§ 1.163(j)–9(b)(2)(ii). For a partner other
than a C corporation or tax-exempt
corporation, a partnership’s assets that
are not properly allocable to a trade or
business are treated as neither excepted
nor non-excepted trade or business
assets; instead, such partner’s adjusted
basis in its partnership interest is
decreased by that partner’s share of the
excess of the partnership’s basis in those
assets over the partnership’s debt that is
traced to such assets in accordance with
§ 1.163–8T, and it is increased by that
partner’s share of the excess of the
partnership’s debt that is traced to such
assets in accordance with § 1.163–8T
over the partnership’s basis in those
assets. For purposes of the preceding
sentence, the partnership’s asset basis in
property not allocable to a trade or
business is adjusted pursuant to the
rules in paragraph (c)(5)(i) of this
section. For purposes of this paragraph
(c)(5)(ii)(A)(2)(iii), such partner’s share
of a partnership’s assets is determined
under a reasonable method taking into
account special allocations under
section 704(b).
(iv) Inapplicability of partnership
look-through rule. If a partner, other
than a C corporation or a tax-exempt
corporation, chooses not to look through
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to the partnership’s basis in the
partnership’s assets under paragraph
(c)(5)(ii)(A)(2)(i) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying such
partnership look-through rule, the
partner generally will treat its basis in
the partnership interest as either an
asset held for investment or a nonexcepted trade or business asset as
determined under section 163(d). If a
partner that is a C corporation or a taxexempt corporation chooses not to look
through to the partnership’s basis in the
partnership’s assets under paragraph
(c)(5)(ii)(A)(2)(i) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying such
partnership look-through rule, the
taxpayer must treat its entire basis in the
partnership interest as allocable to a
non-excepted trade or business.
(B) Stock in domestic nonconsolidated corporations—(1) In
general. For purposes of this section, if
a taxpayer owns stock in a domestic C
corporation that is not a member of the
taxpayer’s consolidated group, or if the
taxpayer owns stock in an S
corporation, the stock is treated as an
asset of the taxpayer.
(2) Domestic non-consolidated C
corporations—(i) Allocation of asset
basis. If a shareholder satisfies the
minimum ownership threshold in
paragraph (c)(7) of this section for stock
in a domestic non-consolidated C
corporation, and if dividends paid on
such stock would not be included in the
shareholder’s investment income under
section 163(d)(4)(B), then, for purposes
of determining the extent to which the
shareholder’s basis in the stock is
allocable to an excepted or nonexcepted trade or business, the
shareholder must look through to the
corporation’s basis in the corporation’s
assets, adjusted to the extent required
under paragraph (d)(4) of this section,
except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section. If
a shareholder does not satisfy the
minimum ownership threshold in
paragraph (c)(7) of this section for stock
in a domestic non-consolidated C
corporation, but the shareholder’s direct
and indirect interest in such corporation
is greater than or equal to 80 percent by
value, and if dividends paid on such
stock would not be included in the
shareholder’s investment income under
section 163(d)(4)(B), then, for purposes
of determining the extent to which the
shareholder’s basis in the stock is
allocable to an excepted or nonexcepted trade or business, the
shareholder may look through to the
corporation’s basis in the corporation’s
assets, adjusted to the extent required
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under paragraph (d)(4) of this section,
except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section.
For purposes of the preceding sentence,
indirect stock ownership is determined
by applying the constructive ownership
rules of section 318(a).
(ii) De minimis rule. If at least 90
percent of the domestic nonconsolidated C corporation’s basis in the
corporation’s assets is allocable to either
excepted trades or businesses or nonexcepted trades or businesses, the
shareholder’s entire interest in the
corporation’s stock is treated as
allocable to either excepted or nonexcepted trades or businesses,
respectively.
(iii) Inapplicability of corporate lookthrough rule. If a shareholder other than
a C corporation or a tax-exempt
corporation is ineligible to look through
or chooses not to look through to a
corporation’s basis in its assets under
paragraph (c)(5)(ii)(B)(2)(i) of this
section, the shareholder generally will
treat its entire basis in the corporation’s
stock as an asset held for investment. If
a shareholder that is a C corporation or
a tax-exempt corporation is ineligible to
look through or chooses not to look
through to a corporation’s basis in its
assets under paragraph (c)(5)(ii)(B)(2)(i)
of this section, the shareholder must
treat its entire basis in the corporation’s
stock as allocable to a non-excepted
trade or business.
(iv) Use of inside basis for purposes of
C corporation look-through rule. This
paragraph (c)(5)(ii)(B)(2)(iv) applies if a
shareholder meets the requirements to
look through the stock of a domestic
non-consolidated C corporation under
paragraph (c)(5)(ii)(B)(2)(i) of this
section, determined without applying
the constructive ownership rules of
section 318(a). If this paragraph
(c)(5)(ii)(B)(2)(iv) applies, then solely for
purposes of allocating asset basis under
paragraph (c)(5)(ii)(B)(2)(i) of this
section, and except as otherwise
provided in paragraph (c)(5)(ii)(D) of
this section, the shareholder may look
through to such shareholder’s pro rata
share of the C corporation’s basis in its
assets, taking into account the
modifications in paragraph (c)(5)(i) of
this section with respect to the C
corporation’s assets, and adjusted to the
extent required under paragraph (d)(4)
of this section (asset basis look-through
approach). If a shareholder applies the
asset basis look-through approach, it
must do so for all domestic nonconsolidated C corporations for which
the shareholder is eligible to use this
approach, and it must report its use of
this approach on the information
statement described in paragraph
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(c)(6)(iii) of this section. The
shareholder also must continue to use
the asset basis look-through approach in
all future taxable years in which the
shareholder is eligible to use this
approach.
(3) S corporations—(i) Calculation of
asset basis. For purposes of this section,
a shareholder’s share of stock in an S
corporation is treated as an asset of the
shareholder. Additionally, for these
purposes, the shareholder’s adjusted
basis in a share of S corporation stock
is adjusted to take into account the
modifications in paragraph (c)(5)(i) of
this section with respect to the assets of
the S corporation (for example, a
shareholder’s adjusted basis in its S
corporation stock is increased by the
shareholder’s share of depreciation with
respect to an inherently permanent
structure owned by the S corporation).
(ii) Allocation of asset basis. For
purposes of determining the extent to
which a shareholder’s basis in its stock
of an S corporation is allocable to an
excepted or non-excepted trade or
business, the shareholder may look
through to such shareholder’s share of
the S corporation’s basis in the S
corporation’s assets, allocated on a pro
rata basis, adjusted to the extent
required under paragraph (d)(4) of this
section, except as otherwise provided in
paragraph (c)(5)(ii)(D) of this section.
Notwithstanding paragraph (c)(7) of this
section, if a shareholder’s direct and
indirect interest in an S corporation is
greater than or equal to 80 percent of the
S corporation’s stock by vote and value,
the shareholder must apply the rules in
this paragraph (c)(5)(ii)(B)(3) to look
through to the S corporation’s basis in
the S corporation’s assets. For these
purposes, indirect stock ownership is
determined by applying the constructive
ownership rules of section 318(a).
(iii) De minimis rule. If at least 90
percent of a shareholder’s share of an S
corporation’s basis in its assets is
allocable to either excepted trades or
businesses or non-excepted trades or
businesses, the shareholder’s entire
basis in its S corporation stock is treated
as allocable to either excepted or nonexcepted trades or businesses,
respectively.
(iv) Inapplicability of S corporation
look-through rule. If a shareholder
chooses not to look through to the S
corporation’s basis in the S
corporation’s assets under paragraph
(c)(5)(ii)(B)(3)(ii) of this section or is
precluded by paragraph (c)(5)(ii)(D) of
this section from applying such S
corporation look-through rule, the
shareholder will treat its basis in the S
corporation stock as either an asset held
for investment or a non-excepted trade
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or business asset as determined under
section 163(d).
(C) Stock in relevant foreign
corporations—(1) In general. The rules
applicable to domestic non-consolidated
C corporations in paragraph (c)(5)(ii)(B)
of this section also apply to relevant
foreign corporations (as defined in
§ 1.163(j)–1(b)(33)).
(2) Special rule for CFC utilities.
Solely for purposes of applying the rules
in paragraph (c)(5)(ii)(B) of this section,
a utility trade or business conducted by
an applicable CFC is treated as an
excepted regulated utility trade or
business, but only to the extent that the
applicable CFC sells or furnishes the
items described in § 1.163(j)–
1(b)(15)(i)(A)(1) pursuant to rates
established or approved by an entity
described in § 1.163(j)–1(b)(15)(i)(A)(2),
a foreign government, a public service
or public utility commission or other
similar body of any foreign government,
or the governing or ratemaking body of
a foreign electric cooperative. For
purposes of this paragraph
(c)(5)(ii)(C)(2), the term foreign
government means any foreign
government, any political subdivision of
a foreign government, or any wholly
owned agency or instrumentality of any
one of the foregoing within the meaning
of § 1.1471–6(b).
(D) Inapplicability of look-through
rule to partnerships or non-consolidated
C corporations to which the small
business exemption applies. A taxpayer
may not apply the look-through rules in
paragraphs (b)(3) and (c)(5)(ii)(A), (B),
and (C) of this section to a partnership,
S corporation, or non-consolidated C
corporation that is eligible for the small
business exemption under section
163(j)(3) and § 1.163(j)–2(d)(1), unless
the partnership, S corporation, or nonconsolidated C corporation elects under
§ 1.163(j)–9 for a trade or business to be
an electing real property trade or
business or an electing farming
business.
(E) Tiered entities. If a taxpayer
applies the look-through rules of this
paragraph (c)(5)(ii), the taxpayer must
do so for all lower-tier entities with
respect to which the taxpayer satisfies,
directly or indirectly, the minimum
ownership threshold in paragraph (c)(7)
of this section, subject to the limitation
in paragraph (c)(5)(ii)(D) of this section,
beginning with the lowest-tier entity.
(iii) Cash and cash equivalents and
customer receivables. Except as
otherwise provided in the last sentence
of this paragraph (c)(5)(iii), a taxpayer’s
basis in its cash and cash equivalents
and customer receivables is not taken
into account for purposes of this
paragraph (c). This rule also applies to
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56825
a lower-tier entity if a taxpayer looks
through to the assets of that entity under
paragraph (c)(5)(ii) of this section. For
purposes of this paragraph (c)(5)(iii), the
term cash and cash equivalents
includes cash, foreign currency,
commercial paper, any interest in an
investment company registered under
the Investment Company Act of 1940
(1940 Act) and regulated as a money
market fund under 17 CFR 270.2a–7
(Rule 2a–7 under the 1940 Act), any
obligation of a government, and any
derivative that is substantially secured
by an obligation of a government, or any
similar asset. For purposes of this
paragraph (c)(5)(iii), a derivative is a
derivative described in section
59A(h)(4)(A), without regard to section
59A(h)(4)(C). For purposes of this
paragraph (c)(5)(iii), the term
government means the United States or
any agency or instrumentality of the
United States; a State, a territory, a
possession of the United States, the
District of Columbia, or any political
subdivision thereof within the meaning
of section 103 and § 1.103–1; or any
foreign government, any political
subdivision of a foreign government, or
any wholly owned agency or
instrumentality of any one of the
foregoing within the meaning of
§ 1.1471–6(b). This paragraph (c)(5)(iii)
does not apply to an entity that qualifies
as a financial services entity as
described in § 1.904–4(e)(3).
(iv) Deemed asset sale. Solely for
purposes of determining the amount of
basis allocable to excepted and nonexcepted trades or businesses under this
section, an election under section 336,
338, or 754, as applicable, is deemed to
have been made for any acquisition of
corporate stock or partnership interests
with respect to which the taxpayer
demonstrates, in the information
statement required by paragraph
(c)(6)(iii)(B) of this section, that the
acquisition qualified for such an
election and that, immediately before
the acquisition, the acquired entity had
a regulatory liability for deferred taxes
recorded on its books with respect to
property predominantly used in an
excepted regulated utility trade or
business. Any additional basis taken
into account under this rule is reduced
ratably over a 15-year period beginning
with the month of the acquisition and
is not subject to the anti-abuse rule in
paragraph (c)(8) of this section.
(v) Other adjustments. The
Commissioner may make appropriate
adjustments to prevent a taxpayer from
intentionally and artificially increasing
its basis in assets attributable to an
excepted trade or business.
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(6) Determination dates;
determination periods; reporting
requirements—(i) Determination dates
and determination periods—(A)
Quarterly determination periods. For
purposes of this section, and except as
otherwise provided in paragraph
(c)(6)(i)(B) of this section, the term
determination date means the last day
of each quarter of the taxpayer’s taxable
year (and the last day of the taxpayer’s
taxable year, if the taxpayer has a short
taxable year), and the term
determination period means the period
beginning the day after one
determination date and ending on the
next determination date.
(B) Annual determination periods. If a
taxpayer satisfies the requirements of
the last sentence of this paragraph
(c)(6)(i)(B), the taxpayer may allocate
asset basis for a taxable year based on
the average of adjusted asset basis at the
beginning of the year and the end of the
year (annual determination method).
For these purposes, the term
determination date means the last day
of the taxpayer’s taxable year, and the
term determination period has the same
meaning as provided in paragraph
(c)(6)(i)(A) of this section. A taxpayer
may use the annual determination
method for a taxable year only if the
taxpayer demonstrates that its total
adjusted basis (as determined under
paragraph (c)(5) of this section) at the
end of the year in its assets used in its
excepted trades or businesses, as a
percentage of the taxpayer’s total
adjusted basis at the end of such year in
all of its assets used in a trade or
business, does not differ by more than
20 percent from such percentage at the
beginning of the year.
(ii) Application of look-through rules.
If a taxpayer that applies the lookthrough rules of paragraph (c)(5)(ii) of
this section has a different taxable year
than the partnership or nonconsolidated C corporation to which the
taxpayer is applying those rules, then,
for purposes of this paragraph (c)(6), the
taxpayer must use the most recent asset
basis figures from the partnership or
non-consolidated C corporation. For
example, assume that PS1 is a
partnership with a May 31 taxable year,
and that C (a calendar-year C
corporation that is ineligible to use the
annual determination method for the
taxable year) is a partner in PS1. PS1’s
determination dates are February 28,
May 31, August 31, and November 30.
In turn, C’s determination dates are
March 31, June 30, September 30, and
December 31. If C looks through to PS1’s
basis in its assets under paragraph
(c)(5)(ii) of this section, then, for
purposes of determining the amount of
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C’s asset basis that is attributable to its
excepted and non-excepted businesses
on March 31, C must use PS1’s asset
basis calculations for February 28.
(iii) Reporting requirements—(A)
Books and records. A taxpayer must
maintain books of account and other
records and data as necessary to
substantiate the taxpayer’s use of an
asset in an excepted trade or business
and to substantiate any adjustments to
asset basis for purposes of applying this
paragraph (c). One indication that a
particular asset is used in a particular
trade or business is if the taxpayer
maintains separate books and records
for all of its excepted and non-excepted
trades or businesses and can show the
asset in the books and records of a
particular excepted or non-excepted
trade or business. For rules governing
record retention, see § 1.6001–1.
(B) Information statement. Except as
otherwise provided in publications,
forms, instructions, or other guidance,
each taxpayer that is making an
allocation under this paragraph (c),
including any taxpayer that satisfies the
de minimis rule in paragraph (c)(1)(ii) of
this section, must prepare a statement
titled ‘‘Section 163(j) Asset Basis
Calculations’’ containing the
information described in paragraphs
(c)(6)(iii)(B)(1) through (7) of this
section and must attach the statement to
its timely filed Federal income tax
return for the taxable year:
(1) The taxpayer’s adjusted basis in
the assets used in its excepted and nonexcepted businesses, determined as set
forth in this section, including detailed
information for the different groups of
assets identified in paragraphs (c)(5)(i)
and (ii) and (d) of this section;
(2) The determination dates on which
asset basis was measured during the
taxable year;
(3) The names and taxpayer
identification numbers (TINs) of all
entities for which basis information is
being provided, including partnerships
and corporations if the taxpayer that
owns an interest in a partnership or
corporation looks through to the
partnership’s or corporation’s basis in
the partnership’s or corporation’s assets
under paragraph (c)(5)(ii) of this section.
If the taxpayer is a member of a
consolidated group, the name and TIN
of the agent for the group, as defined in
§ 1.1502–77, must be provided, but the
taxpayer need not provide the names
and TINs of all other consolidated group
members;
(4) Asset basis information for
corporations or partnerships if the
taxpayer looks through to the
corporation’s or partnership’s basis in
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the corporation’s or partnership’s assets
under paragraph (c)(5)(ii) of this section;
(5) A summary of the method or
methods used to determine asset basis
in property used in both excepted and
non-excepted businesses, as well as
information regarding any deemed sale
under paragraph (c)(5)(iv) of this
section;
(6) Whether the taxpayer used the
historical approach or the effective date
approach for all of its disallowed
disqualified interest; and
(7) If the taxpayer changed its
methodology for allocating asset basis
between or among two or more trades or
businesses under paragraph (c)(3)(ii) of
this section, a statement that the
taxpayer has changed the allocation
methodology and a description of the
new methodology or, if the taxpayer is
required to request consent for the
allocation methodology change under
paragraph (c)(3)(iii)(A)(2) of this section,
a statement that the request has been or
will be filed and a description of the
methodology change.
(iv) Failure to file statement. If a
taxpayer fails to file the statement
described in paragraph (c)(6)(iii) of this
section or files a statement that does not
comply with the requirements of
paragraph (c)(6)(iii) of this section, the
Commissioner may treat the taxpayer as
if all of its interest expense is properly
allocable to a non-excepted trade or
business, unless the taxpayer shows that
there was reasonable cause for failing to
comply with, and the taxpayer acted in
good faith with respect to, the
requirements of paragraph (c)(6)(iii) of
this section, taking into account all
pertinent facts and circumstances.
(7) Ownership threshold for lookthrough rules—(i) Corporations—(A)
Asset basis. For purposes of this section,
a shareholder must look through to the
assets of a domestic non-consolidated C
corporation or a relevant foreign
corporation under paragraph (c)(5)(ii) of
this section if the shareholder’s direct
and indirect interest in the corporation
satisfies the ownership requirements of
section 1504(a)(2). For purposes of this
paragraph (c)(7)(i)(A), indirect stock
ownership is determined by applying
the constructive ownership rules of
section 318(a). A shareholder may look
through to the assets of an S corporation
under paragraph (c)(5)(ii) of this section
for purposes of allocating the
shareholder’s basis in its stock in the S
corporation between excepted and nonexcepted trades or businesses regardless
of the shareholder’s direct and indirect
interest in the S corporation.
(B) Dividends. A shareholder must
look through to the activities of a
domestic non-consolidated C
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corporation or a relevant foreign
corporation under paragraph (b)(3) of
this section if the shareholder’s direct
interest in the corporation satisfies the
ownership requirements of section
1504(a)(2). A shareholder may look
through to the activities of a domestic
non-consolidated C corporation or an
applicable CFC under paragraph (b)(3)
of this section if the shareholder’s direct
interest in the corporation is greater
than or equal to 80 percent by value. A
shareholder may look through to the
activities of an S corporation under
paragraph (b)(3) of this section
regardless of the shareholder’s direct
interest in the S corporation.
(ii) Partnerships. A partner may look
through to the assets of a partnership
under paragraph (c)(5)(ii) of this section
for purposes of allocating the partner’s
basis in its partnership interest between
excepted and non-excepted trades or
businesses regardless of the partner’s
direct and indirect interest in the
partnership.
(iii) Inapplicability of look-through
rule. For circumstances in which a
taxpayer that satisfies the ownership
threshold in this paragraph (c)(7) may
not apply the look-through rules in
paragraphs (b)(3) and (c)(5)(ii) of this
section, see paragraph (c)(5)(ii)(D) of
this section.
(8) Anti-abuse rule. If a principal
purpose for the acquisition, disposition,
or change in use of an asset was to
artificially shift the amount of basis
allocable to excepted or non-excepted
trades or businesses on a determination
date, the additional basis or change in
use will not be taken into account for
purposes of this section. For example, if
an asset is used in a non-excepted trade
or business for most of the taxable year,
and if the taxpayer begins using the
asset in an excepted trade or business
towards the end of the year with a
principal purpose of shifting the amount
of basis in the asset that is allocable to
the excepted trade or business, the
change in use is disregarded for
purposes of this section. A purpose may
be a principal purpose even though it is
outweighed by other purposes (taken
together or separately). In determining
whether a taxpayer has a principal
purpose described in this paragraph
(c)(8), factors to be considered include,
for example, the following: The business
purpose for the acquisition, disposition,
or change in use; the length of time the
asset was used in a trade or business;
whether the asset was acquired from a
related person; and whether the
taxpayer’s aggregate basis in its assets
increased or decreased temporarily on
or around a determination date. A
principal purpose is presumed to be
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present in any case in which the
acquisition, disposition, or change in
use lacks a substantial business purpose
and increases the taxpayer’s basis in
assets used in its excepted trades or
businesses by more than 10 percent
during the taxable year.
(d) Direct allocations—(1) In general.
It is not necessary to allocate interest
expense under this paragraph (d) if all
of the taxpayer’s interest expense is
allocable to excepted trades or
businesses or if all of the taxpayer’s
interest expense is allocable to nonexcepted trades or businesses.
(2) Qualified nonrecourse
indebtedness. For purposes of this
section, a taxpayer with qualified
nonrecourse indebtedness must directly
allocate interest expense from the
indebtedness to the taxpayer’s assets in
the manner and to the extent provided
in § 1.861–10T(b). For purposes of this
paragraph (d)(2), the term qualified
nonrecourse indebtedness has the
meaning provided in § 1.861–10T(b),
except that the term cash flow from the
property (within the meaning of
§ 1.861–10T(b)(3)(i)) includes revenue
derived from the sale or lease of
inventory or similar property with
respect to an excepted regulated utility
trade or business or a non-excepted
regulated utility trade or business.
(3) Assets used in more than one trade
or business. If an asset is used in more
than one trade or business, the taxpayer
must apply the rules in paragraph (c)(3)
of this section to determine the extent
to which interest that is directly
allocated under this paragraph (d) is
allocable to excepted or non-excepted
trades or businesses.
(4) Adjustments to basis of assets to
account for direct allocations. In
determining the amount of a taxpayer’s
basis in the assets used in its excepted
and non-excepted trades or businesses
for purposes of paragraph (c) of this
section, adjustments must be made to
reflect direct allocations under this
paragraph (d). These adjustments
consist of reductions in the taxpayer’s
basis in its assets for purposes of
paragraph (c) of this section to reflect
assets to which interest expense is
directly allocated under this paragraph
(d). The amount of the taxpayer’s basis
in these assets must be reduced, but not
below zero, by the amount of qualified
nonrecourse indebtedness secured by
these assets. These adjustments must be
made before the taxpayer averages the
adjusted basis in its assets as
determined on each determination date
during the taxable year.
(5) Example: Direct allocation of
interest expense—(i) Facts. T conducts
an electing real property trade or
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business (Business X) and operates a
retail store that is a non-excepted trade
or business (Business Y). In Year 1, T
issues Note A to a third party in
exchange for $1,000x for the purpose of
acquiring Building B. Note A is
qualified nonrecourse indebtedness
(within the meaning of § 1.861–10T(b))
secured by Building B. T then uses
those funds to acquire Building B for
$1,200x, and T uses Building B in
Business X. During Year 1, T pays $500x
of interest, of which $100x is interest
payments on Note A. For Year 1, T’s
basis in its assets used in Business X (as
determined under paragraph (c) of this
section) is $3,600x (excluding cash and
cash equivalents), and T’s basis in its
assets used in Business Y (as
determined under paragraph (c) of this
section) is $800x (excluding cash and
cash equivalents). Each of Business X
and Business Y also has $100x of cash
and cash equivalents.
(ii) Analysis. Because Note A is
qualified nonrecourse indebtedness that
is secured by Building B, in allocating
interest expense between Businesses X
and Y, T first must directly allocate the
$100x of interest expense it paid with
respect to Note A to Business X in
accordance with paragraph (d)(2) of this
section. Thereafter, T must allocate the
remaining $400x of interest expense
between Businesses X and Y under
paragraph (c) of this section. After
excluding $1,000x of T’s basis in
Building B to reflect the amount of Note
A (see paragraph (d)(4) of this section),
and without regard to T’s $200x of cash
and cash equivalents (see paragraph
(c)(5)(iii) of this section), T’s basis in its
assets used in Businesses X and Y is
$2,600x and $800x (76.5 percent and
23.5 percent), respectively. Thus, $306x
of the remaining $400x of interest
expense would be allocated to Business
X, and $94x would be allocated to
Business Y.
(e) Examples. The examples in this
paragraph (e) illustrate the principles of
this section. For purposes of these
examples, no taxpayer is eligible for the
small business exemption under section
163(j)(3) and § 1.163(j)–2(d), no taxpayer
has floor plan financing interest
expense, and no taxpayer has qualified
nonrecourse indebtedness within the
meaning of § 1.861–10T(b).
(1) Example 1: Interest allocation
within a consolidated group—(i) Facts.
S is a member of a consolidated group
of which P is the common parent. P
conducts an electing real property trade
or business (Business X), and S
conducts a non-excepted trade or
business (Business Y). In Year 1, P pays
or accrues (without regard to section
163(j)) $35x of interest expense and
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receives $10x of interest income, and S
pays or accrues (without regard to
section 163(j)) $115x of interest expense
and receives $5x of interest income (for
a total of $150x of interest expense and
$15x of interest income). For purposes
of this example, assume that, pursuant
to paragraph (c) of this section, $30x of
the P group’s interest expense and $3x
of the P group’s interest income is
allocable to Business X, and the
remaining $120x of interest expense and
$12x of interest income is allocable to
Business Y.
(ii) Analysis. Under paragraph (a)(4)
of this section, 20 percent of the P
group’s Year 1 interest expense ($30x/
$150x) and interest income ($3x/$15x)
is allocable to an excepted trade or
business. Thus, $7x ($35x × 20 percent)
of P’s interest expense and $2x ($10x ×
20 percent) of P’s interest income is
allocable to an excepted trade or
business. The remaining $28x of P’s
interest expense is business interest
expense subject to the section 163(j)
limitation, and the remaining $8x of P’s
interest income is business interest
income that increases the group’s
section 163(j) limitation. In turn, $23x
($115x × 20 percent) of S’s interest
expense and $1x ($5x × 20 percent) of
S’s interest income is allocable to an
excepted trade or business. The
remaining $92x of S’s interest expense
is business interest expense subject to
the section 163(j) limitation, and the
remaining $4x of S’s interest income is
business interest income that increases
the group’s section 163(j) limitation.
(2) Example 2: Interest allocation
within a consolidated group with assets
used in more than one trade or
business—(i) Facts. S is a member of a
consolidated group of which P is the
common parent. P conducts an electing
real property trade or business (Business
X), and S conducts a non-excepted trade
or business (Business Y). In Year 1, P
pays or accrues (without regard to
section 163(j)) $50x of interest expense,
and S pays or accrues $100x of interest
expense (without regard to section
163(j)). P leases 40 percent of space in
Building V (which P owns) to S for use
in Business Y, and P leases the
remaining 60 percent of space in
Building V to third parties. For purposes
of allocating interest expense under
paragraph (c) of this section, the P
group’s basis in its assets (excluding
Building V) used in Businesses X and Y
is $180x and $620x, respectively. The P
group’s basis in Building V for purposes
of allocating interest expense under
paragraph (c) of this section is $200x.
(ii) Analysis. Under paragraph
(c)(3)(ii) of this section, the P group’s
basis in Building V ($200x) is allocated
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to excepted and non-excepted trades or
businesses in accordance with the use of
space by Business Y (40 percent) and
Business X (the remainder, or 60
percent). Accordingly, $120x of the
basis in Building V is allocated to
excepted trades or businesses (60
percent × $200x), and $80x is allocated
to non-excepted trades or businesses (40
percent × $200x). After allocating the
basis in Building V, the P group’s total
basis in the assets used in excepted and
non-excepted trades or businesses is
$300x and $700x, respectively. Under
paragraphs (a)(4) and (c) of this section,
30 percent ($300x/$1,000x) of the P
group’s Year 1 interest expense is
properly allocable to an excepted trade
or business. Thus, $15x ($50x × 30
percent) of P’s interest expense is
properly allocable to an excepted trade
or business, and the remaining $35x of
P’s interest expense is business interest
expense subject to the section 163(j)
limitation. In turn, $30x ($100x × 30
percent) of S’s interest expense is
properly allocable to an excepted trade
or business, and the remaining $70x of
S’s interest expense is business interest
expense subject to the section 163(j)
limitation.
(3) Example 3: Application of lookthrough rules—(i) Facts. (A) Each of
Corp A, Corp B, Corp C, and Corp D is
a domestic calendar-year corporation
that is not a member of a consolidated
group. Corp A owns 100 percent of the
stock of Corp C; the basis of Corp A’s
stock in Corp C is $500x. Corp C owns
10 percent of the interests in PS1 (a
domestic partnership), and Corp B owns
the remaining 90 percent. Corp C’s basis
in its PS1 interests is $25x; Corp B’s
basis in its PS1 interests is $225x. PS1
owns 100 percent of the stock of Corp
D; the basis of PS1’s stock in Corp D is
$1,000x. Corp A and Corp B are owned
by unrelated, non-overlapping
shareholders.
(B) In 2021, Corp C was engaged
solely in a non-excepted trade or
business. That same year, PS1’s only
activity was holding Corp D stock. In
turn, Corp D was engaged in both an
electing farming business and a nonexcepted trade or business. Under the
allocation rules in paragraph (c) of this
section, 50 percent of Corp D’s asset
basis in 2021 was allocable to the
electing farming business, and the
remaining 50 percent was allocable to
the non-excepted trade or business.
(C) Corp A and Corp B each paid or
accrued (without regard to section
163(j)) $150x of interest expense
allocable to a trade or business. Corp A’s
trade or business was an excepted trade
or business, and Corp B’s trade or
business was a non-excepted trade or
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business. Corp A’s basis in the assets
used in its trade or business was $100x,
and Corp B’s basis in the assets used in
its trade or business was $112.5x.
(ii) Analysis. (A) As provided in
paragraph (c)(5)(ii)(E) of this section, if
a taxpayer applies the look-through
rules of paragraph (c)(5)(ii) of this
section, the taxpayer must begin with
the lowest-tier entity to which it is
eligible to apply the look-through rules.
Corp A directly owns 100 percent of the
stock of Corp C; thus, Corp A satisfies
the 80 percent minimum ownership
threshold with respect to Corp C. Corp
A also owns 10 percent of the interests
in PS1. There is no minimum
ownership threshold for partnerships;
thus, Corp A may apply the lookthrough rules to PS1. However, Corp A
does not directly or indirectly own at
least 80 percent of the stock of Corp D;
thus, Corp A cannot look through its
indirect interest in Corp D. In turn, Corp
B directly owns 90 percent of the
interests in PS1, and Corp B indirectly
owns at least 80 percent of the stock of
Corp D. Thus, Corp B must apply the
look-through rules to PS1 and Corp D.
(B) From Corp A’s perspective, PS1 is
not engaged in a trade or business for
purposes of section 163(j); instead, PS1
is merely holding its Corp D stock as an
investment. Under paragraph
(c)(5)(ii)(A)(2) of this section, if a
partnership is not engaged in a trade or
business, then its C corporation partner
must treat its entire basis in the
partnership interest as allocable to a
non-excepted trade or business. Thus,
for purposes of Corp A’s application of
the look-through rules, Corp C’s entire
basis in its PS1 interest ($25x) is
allocable to a non-excepted trade or
business. Corp C’s basis in its other
assets also is allocable to a non-excepted
trade or business (the only trade or
business in which Corp C is engaged).
Thus, under paragraph (c) of this
section, Corp A’s $500x basis in its Corp
C stock is allocable entirely to a nonexcepted trade or business. Corp A’s
$100x basis in its other business assets
is allocable to an excepted trade or
business. Thus, 5⁄6 (or $125x) of Corp
A’s $150x of interest expense is
properly allocable to a non-excepted
trade or business and is business
interest expense subject to the section
163(j) limitation, and the remaining
$25x of Corp A’s $150x of interest
expense is allocable to an excepted
trade or business and is not subject to
the section 163(j) limitation.
(C) From Corp B’s perspective, PS1
must look through its stock in Corp D
to determine the extent to which PS1’s
basis in the stock is allocable to an
excepted or non-excepted trade or
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business. Half of Corp D’s basis in its
assets is allocable to an excepted trade
or business, and the other half is
allocable to a non-excepted trade or
business. Thus, from Corp B’s
perspective, $500x of PS1’s basis in its
Corp D stock (PS1’s only asset) is
allocable to an excepted trade or
business, and the other half is allocable
to a non-excepted trade or business.
Corp B’s basis in its PS1 interests is
$225x. Applying the look-through rules
to Corp B’s PS1 interests, $112.5x of
Corp B’s basis in its PS1 interests is
allocable to an excepted trade or
business, and $112.5x of Corp B’s basis
in its PS1 interests is allocable to a nonexcepted trade or business. Since Corp
B’s basis in the assets used in its nonexcepted trade or business also was
$112.5x, two-thirds of Corp B’s interest
expense ($100x) is properly allocable to
a non-excepted trade or business and is
business interest expense subject to the
section 163(j) limitation, and one-third
of Corp B’s interest expense ($50x) is
allocable to an excepted trade or
business and is not subject to the
section 163(j) limitation.
(4) Example 4: Excepted and nonexcepted trades or businesses in a
consolidated group—(i) Facts. P is the
common parent of a consolidated group
of which A and B are the only other
members. A conducts an electing real
property trade or business (Business X),
and B conducts a non-excepted trade or
business (Business Y). In Year 1, A pays
or accrues (without regard to section
163(j)) $50x of interest expense and
earns $70x of gross income in the
conduct of Business X, and B pays or
accrues (without regard to section
163(j)) $100x of interest expense and
earns $150x of gross income in the
conduct of Business Y. B owns Building
V, which it uses in Business Y. For
purposes of allocating the P group’s
Year 1 business interest expense
between excepted and non-excepted
trades or businesses under paragraph (c)
of this section, the P group’s basis in its
assets (other than Building V) used in
Businesses X and Y is $180x and $620x,
respectively, and the P group’s basis in
Building V is $200x. At the end of Year
1, B sells Building V to a third party and
realizes a gain of $60x in addition to the
$150x of gross income B earned that
year from the conduct of Business Y.
(ii) Analysis. (A) Under paragraphs
(a)(4) and (c) of this section, the P
group’s basis in its assets used in its
trades or businesses is allocated
between the P group’s excepted trade or
business (Business X) and its nonexcepted trade or business (Business Y)
as though these trades or businesses
were conducted by a single corporation.
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Under paragraph (c) of this section, the
P group’s basis in its assets used in
Businesses X and Y is $180x and $820x,
respectively. Accordingly, 18 percent
($180x/$1,000x) of the P group’s total
interest expense ($150x) is properly
allocable to an excepted trade or
business ($27x), and the remaining 82
percent of the P group’s total interest
expense is business interest expense
properly allocable to a non-excepted
trade or business ($123x).
(B) To determine the P group’s section
163(j) limitation, paragraph (a) of this
section requires that certain items of
income and deduction be allocated to
the excepted and non-excepted trades or
businesses of the P group as though
these trades or businesses were
conducted by a single corporation. In
Year 1, the P group’s excepted trade or
business (Business X) has gross income
of $70x, and the P group’s non-excepted
trade or business (Business Y) has gross
income of $150x. Because Building V
was used exclusively in Business Y, the
$60x of gain from the sale of Building
V in Year 1 is attributed to Business Y
under paragraph (b)(2) of this section.
The P group’s section 163(j) limitation
is $63x (30 percent × $210x), which
allows the P group to deduct $63x of its
$123x of business interest expense
allocated to the P group’s non-excepted
trades or businesses. The group’s $27x
of interest expense that is allocable to
excepted trades or businesses may be
deducted without limitation under
section 163(j).
(iii) Intercompany transaction. The
facts are the same as in Example 4 in
paragraph (e)(4)(i) of this section, except
that A owns Building V and leases it to
B in Year 1 for $20x for use in Business
Y, and A sells Building V to a third
party for a $60 gain at the end of Year
1. Under paragraphs (a)(4) and (c) of this
section, all members of the P group are
treated as a single corporation. As a
result, the P group’s basis in its assets
used in its trades or businesses is
allocated between the P group’s
excepted trade or business (Business X)
and its non-excepted trade or business
(Business Y) as though these trades or
businesses were conducted by a single
corporation. A lease between two
divisions of a single corporation would
produce no rental income or expense.
Thus, the $20x of rent paid by B to A
does not affect the P group’s ATI.
Moreover, under paragraph (c) of this
section, Building V is an asset used in
the P group’s non-excepted trade or
business (Business Y). Accordingly,
although A owns Building V, the basis
in Building V is added to the P group’s
basis in assets used in Business Y for
purposes of allocating interest expense
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under paragraph (c) of this section. In
the same vein, when A sells Building V
to a third party at a gain of $60x, the
gain is included in the P group’s ATI
because Building V was used in a nonexcepted trade or business of the P
group (Business Y) prior to its sale.
(5) Example 5: Captive activities—(i)
Facts. S and T are members of a
consolidated group of which P is the
common parent. P conducts an electing
real property trade or business (Business
X), S conducts a non-excepted trade or
business (Business Y), and T provides
transportation services to Businesses X
and Y but does not have any customers
outside of the P group. For Year 1, T
provides transportation services using a
single bus with a basis of $120x.
(ii) Analysis. Under paragraph (a)(4)
of this section, activities conducted by
a consolidated group are treated as
though those activities were conducted
by a single corporation. Because the
activities of T are limited to providing
intercompany transportation services, T
does not conduct a trade or business for
purposes of section 163(j). Under
paragraph (c)(3) of this section, business
interest expense is allocated to excepted
and non-excepted trades or businesses
based on the relative basis of the assets
used in those businesses. The basis in
T’s only asset, a bus, is therefore
allocated between Business X and
Business Y according to the use of T’s
bus by these businesses. Business X
uses one-third of T’s services, and
Business Y uses two-thirds of T’s
services. Thus, $40x of the basis of T’s
bus is allocated to Business X, and $80x
of the basis of T’s bus is allocated to
Business Y.
(6) Example 6: Constructive
ownership—(i) Facts. P, S, T, and U are
domestic C corporations that are not
members of a consolidated group. P
directly owns 80 percent of the stock of
each of S and T as measured by total
voting power and value; an unrelated
third party, X, owns the remaining 20
percent. In turn, S and T directly own
15 percent and 80 percent, respectively,
of the stock of U as measured by total
voting power and value; P directly owns
the remaining 5 percent. P conducts
both excepted and non-excepted trades
or businesses. S and T conduct only
non-excepted trades or businesses, and
U conducts both excepted and nonexcepted trades or businesses.
(ii) Analysis. Under paragraph
(c)(7)(i)(A) of this section, a shareholder
must look through to the assets of a
domestic non-consolidated C
corporation for purposes of allocating
the shareholder’s basis in its stock in the
corporation between excepted and nonexcepted trades or businesses if the
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shareholder’s direct and indirect
interest in the corporation satisfies the
ownership requirements of section
1504(a)(2). For purposes of paragraph
(c)(7)(i)(A) of this section, a
shareholder’s stock ownership is
determined by applying the constructive
ownership rules of section 318(a). P
directly owns 80 percent of each of S
and T as measured by total voting power
and value; thus, P must look through to
the assets of S and T when allocating
the basis in its stock of S and T. P
directly owns 5 percent of the stock of
U as measured by total voting power
and value, and P constructively owns
the other 95 percent; thus, P also must
look through to U’s assets when
allocating the basis in its U stock. S
directly owns 15 percent of the stock of
U, and S constructively owns only 5
percent through P; thus, S cannot look
through to U’s assets when allocating
the basis in its U stock. T directly owns
80 percent of the stock of U, and T
constructively owns an additional 5
percent; thus, T must look through to
U’s assets when allocating the basis in
its U stock.
(iii) Dividend. The facts are the same
as in paragraph (e)(6)(i) of this section,
except that U distributes a $160x
dividend pro rata to its shareholders.
Thus, P receives $8x (5 percent of
$160x) of the U dividend, S receives
$24x (15 percent of $160x), and T
receives $128x (80 percent of $160x).
Under paragraph (c)(7)(i)(B) of this
section, if a shareholder’s direct interest
in a corporation satisfies the ownership
requirements of section 1504(a)(2), the
shareholder must look through to the
activities of a domestic nonconsolidated C corporation in
determining whether dividend income
is from an excepted or non-excepted
trade or business. The constructive
ownership rules do not apply in
allocating dividends under paragraph
(c)(7)(i)(B) of this section. P directly
owns 5 percent of the stock of U as
measured by vote and value, and S
directly owns 15 percent of the stock of
U as measured by vote and value; thus,
neither P nor S is required to apply the
look-through rules in allocating its
dividend income from U, and all such
income is allocable to non-excepted
trades or businesses. T directly owns 80
percent of the stock of U as measured
by vote and value; thus, T must allocate
its U dividend in accordance with the
activities of U’s excepted and nonexcepted trades or businesses.
(7) Example 7: Dispositions with a
principal purpose of shifting basis—(i)
Facts. U and V are members of a
consolidated group of which P is the
common parent. U conducts an electing
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farming business (Business F), and V
conducts a farm equipment leasing
business (Business L) that is a nonexcepted trade or business. After the
end of a farming season, the P group,
with a principal purpose of shifting
basis from Business L to Business F, has
V sell to U all off-lease farming
equipment that previously was leased
out as part of Business L. Immediately
before the start of the next season, U
sells the farming equipment back to V
for use in Business L.
(ii) Analysis. Under paragraph (c)(8)
of this section, in the case of a
disposition of assets undertaken with a
principal purpose of artificially shifting
the amount of basis allocable to
excepted or non-excepted trades or
businesses on a determination date, the
additional basis or change in use will
not be taken into account. Because V’s
sale of farming equipment to U for
storage in Business F’s facilities is
undertaken with a principal purpose of
shifting basis from Business L to
Business F, the additional basis
Business F receives from these
transactions will not be taken into
account for purposes of this section.
Instead, the basis of the farming
equipment will be allocated as though
the farming equipment continued to be
used in Business L.
(f) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year. Accordingly, for purposes of
§ 1.163(j)–10(c)(5), taxpayers make any
change to the alternative depreciation
system as of November 13, 2020, or if
relying on the provisions of § 1.163(j)–
10 in regulation project REG–106089–18
(83 FR 67490), as of December 28, 2018.
§ 1.163(j)–11
Transition rules.
(a) Overview. This section provides
transition rules regarding the section
163(j) limitation. Paragraph (b) of this
section provides rules regarding the
application of the section 163(j)
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limitation to a corporation that joins a
consolidated group during a taxable
year of the group beginning before
January 1, 2018 and is subject to the
section 163(j) limitation at the time of
its change in status. Paragraph (c) of this
section provides rules regarding the
treatment of carryforwards of
disallowed disqualified interest.
(b) Application of section 163(j)
limitation if a corporation joins a
consolidated group during a taxable
year of the group beginning before
January 1, 2018—(1) In general. If a
corporation (S) joins a consolidated
group during a taxable year of the group
beginning before January 1, 2018, and if
S is subject to the section 163(j)
limitation at the time of its change in
status, then section 163(j) will apply to
S’s short taxable year that ends on the
day of S’s change in status, but section
163(j) will not apply to S’s short taxable
year that begins the next day (when S
is a member of the acquiring
consolidated group). Any business
interest expense paid or accrued
(without regard to section 163(j)) by S in
its short taxable year ending on the day
of S’s change in status for which a
deduction is disallowed under section
163(j) will be carried forward to the
acquiring group’s first taxable year
beginning after December 31, 2017.
Those disallowed business interest
expense carryforwards may be subject to
limitation under other provisions of
these regulations (see, for example,
§ 1.163(j)–5(c), (d), (e), and (f)).
(2) Example. Acquiring Group is a
consolidated group with a fiscal year
end of November 30; Target is a standalone calendar-year C corporation. On
May 31, 2018, Acquiring Group acquires
Target in a transaction that is not an
ownership change for purposes of
section 382. Acquiring Group is not
subject to the section 163(j) limitation
during its taxable year beginning
December 1, 2017. As a result of the
acquisition, Target has a short taxable
year beginning January 1, 2018 and
ending May 31, 2018. Target is subject
to the section 163(j) limitation during
this short taxable year. However, Target
(as a member of Acquiring Group) is not
subject to the section 163(j) limitation
during Acquiring Group’s taxable year
ending November 30, 2018. Any
disallowed business interest expense
carryforwards from Target’s taxable year
ending May 31, 2018, will not be
available for use in Acquiring Group’s
taxable year ending November 30, 2018.
However, that disallowed business
interest expense is carried forward to
Acquiring Group’s taxable year
beginning December 1, 2018, and can be
deducted by the group, subject to the
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separate return limitation year (SRLY)
limitation. See § 1.163(j)–5(d).
(c) Treatment of disallowed
disqualified interest—(1) In general.
Disallowed disqualified interest is
carried forward to the taxpayer’s first
taxable year beginning after December
31, 2017. Disallowed disqualified
interest is subject to disallowance as a
disallowed business interest expense
carryforward under section 163(j) and
§ 1.163(j)–2 to the extent the interest is
properly allocable to a non-excepted
trade or business under § 1.163(j)–10.
Disallowed disqualified interest that is
properly allocable to an excepted trade
or business is not subject to the section
163(j) limitation. See § 1.163(j)–10(a)(6)
for rules governing the allocation of
disallowed disqualified interest between
excepted and non-excepted trades or
businesses.
(2) Earnings and profits. A taxpayer
may not reduce its earnings and profits
in a taxable year beginning after
December 31, 2017, to reflect any
disallowed disqualified interest
carryforwards to the extent the payment
or accrual of the disallowed disqualified
interest reduced the earnings and profits
of the taxpayer in a prior taxable year.
(3) Disallowed disqualified interest of
members of an affiliated group—(i)
Scope. This paragraph (c)(3)(i) applies
to corporations that were treated as a
single taxpayer under old section
163(j)(6)(C) and that had disallowed
disqualified interest.
(ii) Allocation of disallowed
disqualified interest to members of the
affiliated group—(A) In general. Each
member of the affiliated group is
allocated its allocable share of the
affiliated group’s disallowed
disqualified interest as provided in
paragraph (c)(3)(ii)(B) of this section.
(B) Definitions. The following
definitions apply for purposes of
paragraph (c)(3)(ii) of this section.
(1) Allocable share of the affiliated
group’s disallowed disqualified interest.
The term allocable share of the
affiliated group’s disallowed
disqualified interest means, with respect
to any member of an affiliated group for
the member’s last taxable year beginning
before January 1, 2018, the product of
the total amount of the disallowed
disqualified interest of all members of
the affiliated group under old section
163(j)(6)(C) and the member’s
disallowed disqualified interest ratio.
(2) Disallowed disqualified interest
ratio. The term disallowed disqualified
interest ratio means, with respect to any
member of an affiliated group for the
member’s last taxable year beginning
before January 1, 2018, the ratio of the
exempt related person interest expense
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of the member for the last taxable year
beginning before January 1, 2018, to the
sum of the amounts of exempt related
person interest expense for all members
of the affiliated group.
(3) Exempt related person interest
expense. The term exempt related
person interest expense means interest
expense that is, or is treated as, paid or
accrued by a domestic C corporation, or
by a foreign corporation with income,
gain, or loss that is effectively
connected, or treated as effectively
connected, with the conduct of a trade
or business in the United States, to—
(i) Any person related to the taxpayer,
within the meaning of sections 267(b) or
707(b)(1), applying the constructive
ownership and attribution rules of
section 267(c), if no U.S. tax is imposed
with respect to the interest under
subtitle A of the Code, determined
without regard to net operating losses or
net operating loss carryovers, and taking
into account any applicable treaty
obligation of the United States. For this
purpose, interest that is subject to a
reduced rate of tax under any treaty
obligation of the United States
applicable to the recipient is treated as,
in part, subject to the statutory tax rate
under sections 871 or 881 and, in part,
not subject to tax, based on the
proportion that the rate of tax under the
treaty bears to the statutory tax rate.
Thus, for purposes of section 163(j), if
the statutory tax rate is 30 percent, and
pursuant to a treaty U.S. tax is instead
limited to a rate of 10 percent, twothirds of the interest is considered
interest not subject to U.S. tax under
subtitle A of the Code;
(ii) A person that is not related to the
taxpayer, within the meaning of section
267(b) or 707(b)(1), applying the
constructive ownership and attribution
rules of section 267(c), with respect to
indebtedness on which there is a
disqualified guarantee, within the
meaning of paragraph (6)(D) of old
section 163(j), of such indebtedness, and
no gross basis U.S. tax is imposed with
respect to the interest. For purposes of
this paragraph (c)(3)(ii)(B)(3)(ii), a gross
basis U.S. tax means any tax imposed by
this subtitle A of the Code that is
determined by reference to the gross
amount of any item of income without
any reduction for any deduction
allowed by subtitle A of the Code.
Interest that is subject to a gross basis
U.S. tax that is eligible for a reduced
rate of tax under any treaty obligation of
the United States applicable to the
recipient is treated as, in part, subject to
the statutory tax rate under section 871
or 881 and, in part, not subject to a gross
basis U.S. tax, based on the proportion
that the rate of tax under the treaty bears
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56831
to the statutory tax rate. Thus, for
purposes of section 163(j), if the
statutory tax rate is 30 percent, and
pursuant to a treaty U.S. tax is instead
limited to a rate of 10 percent, twothirds of the interest is considered
interest not subject to a gross basis U.S.
tax under subtitle A of the Code; or
(iii) A REIT, directly or indirectly, to
the extent that the domestic C
corporation, or a foreign corporation
with income, gain, or loss that is
effectively connected, or treated as
effectively connected, with the conduct
of a trade or business in the United
States, is a taxable REIT subsidiary, as
defined in section 856(l), with respect to
the REIT.
(iii) Treatment of carryforwards. The
amount of disallowed disqualified
interest allocated to a taxpayer pursuant
to paragraph (c)(3)(ii) of this section is
treated in the same manner as described
in paragraph (c)(1) of this section.
(4) Application of section 382—(i)
Ownership change occurring before
November 13, 2020—(A) Pre-change
loss. For purposes of section 382(d)(3),
unless the rules of § 1.382–2(a)(7) apply,
disallowed disqualified interest is not a
pre-change loss under § 1.382–2(a)
subject to a section 382 limitation with
regard to an ownership change on a
change date occurring before November
13, 2020. But see section 382(h)(6)(B)
(regarding built-in deduction items).
(B) Loss corporation. For purposes of
section 382(k)(1), unless the rules of
§ 1.382–2(a)(7) apply, disallowed
disqualified interest is not a
carryforward of disallowed interest
described in section 381(c)(20) with
regard to an ownership change on a
change date occurring before November
13, 2020. But see section 382(h)(6)
(regarding built-in deductions).
(ii) Ownership change occurring on or
after November 13, 2020—(A) Prechange loss. For rules governing the
treatment of disallowed disqualified
interest as a pre-change loss for
purposes of section 382 with regard to
an ownership change on a change date
occurring on or after November 13,
2020, see §§ 1.382–2(a)(2) and 1.382–
6(c)(3).
(B) Loss corporation. For rules
governing when disallowed disqualified
interest causes a corporation to be a loss
corporation with regard to an ownership
change occurring on or after November
13, 2020, see § 1.382–2(a)(1)(i)(A).
(5) Treatment of excess limitation
from taxable years beginning before
January 1, 2018. No amount of excess
limitation under old section 163(j)(2)(B)
may be carried forward to taxable years
beginning after December 31, 2017.
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(6) Example: Members of an affiliated
group—(i) Facts. A, B, and C are
calendar-year domestic C corporations
that are members of an affiliated group
(within the meaning of section 1504(a))
that was treated as a single taxpayer
under old section 163(j)(6)(C) and the
proposed regulations in this part under
old section 163(j) (see formerly
proposed § 1.163(j)–5). For the taxable
year ending December 31, 2017, the
separately determined amounts of
exempt related person interest expense
of A, B, and C were $0, $600x, and
$150x, respectively (for a total of
$750x). The affiliated group has $200x
of disallowed disqualified interest in
that year.
(ii) Analysis. The affiliated group’s
disallowed disqualified interest expense
for the 2017 taxable year ($200x) is
allocated among A, B, and C based on
the ratio of each member’s exempt
related person interest expense to the
group’s exempt related person interest
expense. Because A has no exempt
related person interest expense, no
disallowed disqualified interest is
allocated to A. Disallowed disqualified
interest of $160x is allocated to B
(($600x/$750x) × $200x), and
disallowed disqualified interest of $40x
is allocated to C (($150x/$750x) ×
$200x). Thus, B and C have $160x and
$40x, respectively, of disallowed
disqualified interest that is carried
forward to the first taxable year
beginning after December 31, 2017. No
excess limitation that was allocated to
A, B, or C under old section 163(j) will
carry forward to a taxable year
beginning after December 31, 2017.
(iii) Carryforward of disallowed
disqualified interest to 2018 taxable
year. The facts are the same as in the
Example in paragraph (c)(7)(i) of this
section, except that, for the taxable year
ending December 31, 2018, A, B, and C
are members of a consolidated group
that has a section 163(j) limitation of
$140x, current-year business interest
expense (as defined in § 1.163(j)–1(b)(9))
of $80x, and no excepted trade or
business. Under paragraph (c)(1) of this
section, disallowed disqualified interest
is carried to the taxpayer’s first taxable
year beginning after December 31, 2017,
and is subject to disallowance under
section 163(j) and § 1.163(j)–2. Under
§ 1.163(j)–5(b)(3)(ii)(D)(1), a
consolidated group that has section
163(j) limitation remaining for the
current year after deducting all currentyear business interest expense deducts
each member’s disallowed disqualified
interest carryforwards from prior taxable
years, starting with the earliest taxable
year, on a pro rata basis (subject to
certain limitations). In accordance with
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paragraph (c)(1) of this section, the rule
in § 1.163(j)–5(b)(3)(ii)(D)(1) applies to
disallowed disqualified interest carried
forward to the taxpayer’s first taxable
year beginning after December 31, 2017.
Accordingly, after deducting $80x of
current-year business interest expense
in 2018, the group may deduct $60x of
its $200x disallowed disqualified
interest carryforwards. Under paragraph
(c)(3) of this section, B has $160x of
disallowed disqualified interest
carryforwards, and C has $40x of
disallowed disqualified interest
carryforwards. Thus, $48x (($160x/
$200x) × $60x) of B’s disallowed
disqualified interest carryforwards, and
$12x (($40x/$200x) × $60x) of C’s
disallowed disqualified interest
carryforwards, are deducted by the
consolidated group in the 2018 taxable
year.
(d) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
■ Par. 4. Section 1.263A–9 is amended
by revising the first and third sentences
of paragraph (g)(1)(i) to read as follows:
§ 1.263A–9
The avoided cost method.
*
*
*
*
*
(g) * * *
(1) * * *
(i) * * * Interest must be capitalized
under section 263A(f) before the
application of section 163(d) (regarding
the investment interest limitation),
section 163(j) (regarding the limitation
on business interest expense), section
266 (regarding the election to capitalize
carrying charges), section 469 (regarding
the limitation on passive losses), and
section 861 (regarding the allocation of
interest to United States sources). * * *
However, in applying section 263A(f)
with respect to the excess expenditure
amount, the taxpayer must capitalize all
interest that is neither investment
interest under section 163(d), business
interest expense under section 163(j),
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nor passive interest under section 469
before capitalizing any interest that is
either investment interest, business
interest expense, or passive interest.
* * *
*
*
*
*
*
■ Par. 5. Section 1.263A–15 is amended
by adding paragraph (a)(4) to read as
follows:
§ 1.263A–15 Effective dates, transitional
rules, and anti-abuse rules.
(a) * * *
(4) Section 1.263A–9(g)(1)(i) applies
to taxable years beginning on or after
November 13, 2020. However, taxpayers
and their related parties, within the
meaning of sections 267(b) and
707(b)(1), may choose to apply the rules
of that section to a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations (as defined
in § 1.163(j)–1(b)(37)), and, if applicable,
§§ 1.381(c)(20)–1, 1.382–1, 1.382–2,
1.382–5, 1.382–6, 1.382–7, 1.383–0,
1.383–1, 1.469–9, 1.469–11, 1.704–1,
1.882–5, 1.1362–3, 1.1368–1, 1.1377–1,
1.1502–13, 1.1502–21, 1.1502–36,
1.1502–79, 1.1502–91 through 1.1502–
99 (to the extent they effectuate the
rules of §§ 1.382–2, 1.382–5, 1.382–6,
and 1.383–1), and 1.1504–4, to that
taxable year.
*
*
*
*
*
■ Par. 6. Section 1.381(c)(20)–1 is added
to read as follows:
§ 1.381(c)(20)–1 Carryforward of
disallowed business interest.
(a) Carryover requirement. Section
381(c)(20) provides that the acquiring
corporation in a transaction described in
section 381(a) will succeed to and take
into account the carryover of disallowed
business interest described in section
163(j)(2) to taxable years ending after
the date of distribution or transfer.
(b) Carryover of disallowed business
interest described in section 163(j)(2).
For purposes of section 381(c)(20) and
this section, the term carryover of
disallowed business interest described
in section 163(j)(2) means the
disallowed business interest expense
carryforward (as defined in § 1.163(j)–
1(b)(11)), including any disallowed
disqualified interest (as defined in
§ 1.163(j)–1(b)(12)), and including the
distributor or transferor corporation’s
disallowed business interest expense
from the taxable year that ends on the
date of distribution or transfer. For the
application of section 382 to disallowed
business interest expense described in
section 163(j)(2), see the regulations in
this part under section 382 of the Code,
including but not limited to § 1.382–2.
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(c) Limitation on use of disallowed
business interest expense carryforwards
in the acquiring corporation’s first
taxable year ending after the date of
distribution or transfer—(1) In general.
In determining the extent to which the
acquiring corporation may use
disallowed business interest expense
carryforwards in its first taxable year
ending after the date of distribution or
transfer, the principles of §§ 1.381(c)(1)–
1 and 1.381(c)(1)–2 apply with
appropriate adjustments, including but
not limited to the adjustments described
in paragraphs (c)(2) and (3) of this
section.
(2) One date of distribution or transfer
within the acquiring corporation’s
taxable year. If the acquiring
corporation succeeds to the disallowed
business interest expense carryforwards
of one or more distributor or transferor
corporations on a single date of
distribution or transfer within one
taxable year of the acquiring
corporation, then, for the acquiring
corporation’s first taxable year ending
after the date of distribution or transfer,
that part of the acquiring corporation’s
business interest expense deduction (if
any) that is attributable to the
disallowed business interest expense
carryforwards of the distributor or
transferor corporation is limited under
this paragraph (c) to an amount equal to
the post-acquisition portion of the
acquiring corporation’s section 163(j)
limitation, as defined in paragraph (c)(4)
of this section.
(3) Two or more dates of distribution
or transfer in the taxable year. If the
acquiring corporation succeeds to the
disallowed business interest expense
carryforwards of two or more distributor
or transferor corporations on two or
more dates of distribution or transfer
within one taxable year of the acquiring
corporation, the limitation to be applied
under this paragraph (c) is determined
by applying the principles of
§ 1.381(c)(1)–2(b) to the post-acquisition
portion of the acquiring corporation’s
section 163(j) limitation, as defined in
paragraph (c)(4) of this section.
(4) Definition. For purposes of this
paragraph (c), the term post-acquisition
portion of the acquiring corporation’s
section 163(j) limitation means the
amount that bears the same ratio to the
acquiring corporation’s section 163(j)
limitation (within the meaning of
§ 1.163(j)–1(b)(31)) (or, if the acquiring
corporation is a member of a
consolidated group, the consolidated
group’s section 163(j) limitation) for the
first taxable year ending after the date of
distribution or transfer (taking into
account items to which the acquiring
corporation succeeds under section 381,
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other than disallowed business interest
expense carryforwards) as the number of
days in that year after the date of
distribution or transfer bears to the total
number of days in that year.
(5) Examples. For purposes of this
paragraph (c)(5), unless otherwise
stated, X, Y, and Z are taxable domestic
C corporations that were incorporated
on January 1, 2021 and that file their tax
returns on a calendar-year basis; none of
X, Y, or Z is a member of a consolidated
group; the small business exemption in
§ 1.163(j)–2(d) does not apply; interest
expense is deductible except to the
extent of the potential application of
section 163(j); and the facts set forth the
only corporate activity. The principles
of this paragraph (c) are illustrated by
the following examples.
(i) Example 1: Transfer before last day
of acquiring corporation’s taxable
year—(A) Facts. On October 31, 2022, X
transferred all of its assets to Y in a
statutory merger to which section 361
applies. For the 2021 taxable year, X
had $400x of disallowed business
interest expense, and Y had $0 of
disallowed business interest expense.
For the taxable year ending October 31,
2022, X had an additional $350x of
disallowed business interest expense (X
did not deduct any of its 2021
carryforwards in its 2022 taxable year).
For the taxable year ending December
31, 2022, Y had business interest
expense of $100x, business interest
income of $200x, and ATI of $1,000x.
Y’s section 163(j) limitation for the 2022
taxable year was $500x ($200x + (30
percent × $1,000x) = $500x).
(B) Analysis. Pursuant to § 1.163(j)–
5(b)(2), Y deducts its $100x of currentyear business interest expense (as
defined in § 1.163(j)–1(b)(9)) before any
disallowed business interest expense
carryforwards (including X’s
carryforwards) from a prior taxable year
are deducted. The aggregate disallowed
business interest expense of X carried
forward under section 381(c)(20) to Y’s
taxable year ending December 31, 2022,
is $750x. However, pursuant to
paragraph (c)(2) of this section, for Y’s
first taxable year ending after the date of
distribution or transfer, the maximum
amount of X’s disallowed business
interest expense carryforwards that Y
can deduct is equal to the postacquisition portion of Y’s section 163(j)
limitation. Pursuant to paragraph (c)(4)
of this section, the post-acquisition
portion of Y’s section 163(j) limitation
means Y’s section 163(j) limitation
times the ratio of the number of days in
the taxable year after the date of
distribution or transfer to the total
number of days in that year. Therefore,
only $84x of the aggregate amount
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56833
($500x × (61/365) = $84x) may be
deducted by Y in that year, and the
remaining $666x ($750x¥$84x = $666x)
is carried forward to the succeeding
taxable year.
(C) Transfer on last day of acquiring
corporation’s taxable year. The facts are
the same as in Example 1 in paragraph
(c)(5)(i)(A) of this section, except that
X’s transfer of its assets to Y occurred
on December 31, 2022. For the taxable
year ending December 31, 2022, X had
an additional $350x of disallowed
business interest expense (X did not
deduct any of its 2021 carryforwards in
its 2022 taxable year). For the taxable
year ending December 31, 2023, Y had
business interest expense of $100x,
business interest income of $200x, and
ATI of $1,000x. Y’s section 163(j)
limitation for the 2023 taxable year was
$500x ($200x + (30 percent × $1,000x)
= $500x). The aggregate disallowed
business interest expense of X carried
under section 381(c)(20) to Y’s taxable
year ending December 31, 2023, is
$750x. Paragraph (c)(2) of this section
does not limit the amount of X’s
disallowed business interest expense
carryforwards that may be deducted by
Y in the 2023 taxable year. Since the
amount of Y’s section 163(j) limit for the
2023 taxable year was $500x, Y may
deduct the full amount ($100x) of its
own business interest expense for the
2023 taxable year, along with $400x of
X’s disallowed business interest
expense carryforwards.
(ii) Example 2: Multiple transferors on
same date—(A) Facts. On October 31,
2022, X and Y transferred all of their
assets to Z in statutory mergers to which
section 361 applies. For the 2021
taxable year, X had $300x of disallowed
business interest expense, Y had $200x,
and Z had $0. For the taxable year
ending October 31, 2022, each of X and
Y had an additional $125x of disallowed
business interest expense (neither X nor
Y deducted any of its 2021
carryforwards in 2022). For the taxable
year ending December 31, 2022, Z had
business interest expense of $100x,
business interest income of $200x, and
ATI of $1,000x. Z’s section 163(j)
limitation for the 2022 taxable year was
$500x ($200x + (30 percent × $1,000x)
= $500x).
(B) Analysis. The aggregate
disallowed business interest expense of
X and Y carried under section 381(c)(20)
to Z’s taxable year ending December 31,
2022, is $750x. However, pursuant to
paragraph (c)(2) of this section, only
$84x of the aggregate amount ($500x ×
(61/365) = $84x) may be deducted by Z
in that year. Moreover, under paragraph
(b)(2) of this section, this amount only
may be deducted by Z in that year after
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Z has deducted its $100x of current-year
business interest expense (as defined in
§ 1.163(j)–1(b)(9)).
(d) Applicability date. This section
applies to taxable years beginning on or
after November 13, 2020. However,
taxpayers and their related parties,
within the meaning of sections 267(b)
and 707(b)(1), may choose to apply the
rules of this section to ta axable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
the section 163(j) regulations (as defined
in § 1.163(j)–1(b)(37)), and, if applicable,
§§ 1.263A–9, 1.263A–15, 1.382–1,
1.382–2, 1.382–5, 1.382–6, 1.382–7,
1.383–0, 1.383–1, 1.469–9, 1.469–11,
1.704–1, 1.882–5, 1.1362–3, 1.1368–1,
1.1377–1, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, and 1.383–1), and 1.1504–4,
to that taxable year.
■ Par. 7. Section 1.382–1 is amended
by:
■ 1. Adding an entry for § 1.382–
2(a)(1)(vi) and (a)(7) and (8);
■ 2. Revising the entry for § 1.382–
2(b)(3);
■ 3. Adding entries for § 1.382–6(a)(1)
and (2) and (b)(4);
■ 4. Revising the entry for § 1.382–6(h);
and
■ 5. Adding an entry for § 1.382–7(c),
(d), (d)(1) through (5), (e) through (g),
and (g)(1) through (4).
The additions and revisions read as
follows:
§ 1.382–1
*
*
Table of contents.
*
*
*
§ 1.382–2 General rules for ownership
change.
(a) * * *
(1) * * *
(vi) Any section 382 disallowed business
interest carryforward.
*
*
*
*
*
(7) Section 382 disallowed business
interest carryforward.
(8) Testing period.
(b) * * *
(3) Rules provided in paragraphs
(a)(1)(i)(A), (a)(1)(ii), (iv), and (v), (a)(2)(iv)
through (vi), (a)(3)(i), and (a)(4) through (8)
of this section.
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*
*
*
*
*
§ 1.382–6 Allocation of income and loss to
periods before and after the change date
for purposes of section 382.
(a) * * *
(1) In general.
(2) Allocation of business interest expense.
(i) Scope.
(ii) Deductibility of business interest
expense.
*
*
*
*
*
(b) * * *
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18:00 Sep 11, 2020
Jkt 250001
(4) Allocation of business interest expense.
(i) Scope.
(ii) Deductibility of business interest
expense.
(iii) Example.
*
*
*
*
*
(h) Applicability date.
(1) In general.
(2) Paragraphs (a) and (b)(1) and (4) of this
section.
*
*
*
*
*
*
*
*
§ 1.382–7
*
*
(c) [Reserved]
(d) Special rules.
(1)–(4) [Reserved]
(5) Section 382 disallowed business
interest carryforwards.
(e)–(f) [Reserved]
(g) Applicability dates.
(1)–(3) [Reserved]
(4) Paragraph (d)(5) of this section.
*
*
*
*
*
Par. 8. Section 1.382–2 is amended
by:
■ 1. Revising paragraph (a)(1)(i)(A);
■ 2. Removing ‘‘, or’’ and adding ‘‘; or’’
in its place at the end of paragraph
(a)(1)(i)(B);
■ 3. Revising paragraphs (a)(1)(ii)
introductory text and (a)(1)(ii)(A);
■ 4. Removing ‘‘, and’’ and adding ‘‘;
and’’ in its place at the end of paragraph
(a)(1)(ii)(B);
■ 5. Removing the last sentence in
paragraphs (a)(1)(iv) and (v);
■ 6. Removing the commas and adding
semicolons in their place at the end of
paragraphs (a)(2)(i) and (iii);
■ 7. Removing the period and adding a
semicolon in its place at the end of
paragraph (a)(2)(ii);
■ 8. Removing ‘‘, and’’ and adding a
semicolon in its place at the end of
paragraph (a)(2)(iv);
■ 9. Removing the period and adding ‘‘;
and’’ in its place at the end of paragraph
(a)(2)(v);
■ 10. Adding paragraph (a)(2)(vi);
■ 11. Removing the last sentence in
paragraphs (a)(3)(i), (a)(4)(i), and (a)(5)
and (6);
■ 12. Adding paragraphs (a)(7) and (8);
and
■ 13. Revising paragraph (b)(3).
The revisions and additions read as
follows:
■
§ 1.382–2
change.
General rules for ownership
(a) * * *
(1) * * *
(i) * * *
(A) Is entitled to use a net operating
loss carryforward, a capital loss
carryover, a carryover of excess foreign
taxes under section 904(c), a
carryforward of a general business credit
under section 39, a carryover of a
minimum tax credit under section 53, or
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Sfmt 4700
a section 382 disallowed business
interest carryforward described in
paragraph (a)(7) of this section;
*
*
*
*
*
(ii) Distributor or transferor loss
corporation in a transaction under
section 381. Notwithstanding that a loss
corporation ceases to exist under state
law, if its disallowed business interest
expense carryforwards, net operating
loss carryforwards, excess foreign taxes,
or other items described in section
381(c) are succeeded to and taken into
account by an acquiring corporation in
a transaction described in section
381(a), such loss corporation will be
treated as continuing in existence
until—
(A) Any pre-change losses (excluding
pre-change credits described in § 1.383–
1(c)(3)), determined as if the date of
such transaction were the change date,
are fully utilized or expire under section
163(j), 172, or 1212;
*
*
*
*
*
(2) * * *
(vi) Any section 382 disallowed
business interest carryforward.
*
*
*
*
*
(7) Section 382 disallowed business
interest carryforward. The term section
382 disallowed business interest
carryforward includes the following
items:
(i) The loss corporation’s disallowed
business interest expense carryforwards
(as defined in § 1.163(j)–1(b)(11)),
including disallowed disqualified
interest (as defined in § 1.163(j)–
1(b)(12)), as of the date of the ownership
change.
(ii) The loss corporation’s current-year
business interest expense (as defined in
§ 1.163(j)–1(b)(9)) in the change year (as
defined in § 1.382–6(g)(1)) that is
allocable to the pre-change period (as
defined in § 1.382–6(g)(2)) under
§ 1.382–6(a) or (b) and that becomes
disallowed business interest expense (as
defined in § 1.163(j)–1(b)(10)).
(8) Testing period. Notwithstanding
the temporal limitations provided in
§ 1.382–2T(d)(3)(i), the testing period for
a loss corporation can begin as early as
the first day of the first taxable year
from which there is a section 382
disallowed business interest
carryforward to the first taxable year
ending after the testing date.
(b) * * *
(3) Rules provided in paragraphs
(a)(1)(i)(A), (a)(1)(ii), (iv), and (v),
(a)(2)(iv) through (vi), (a)(3)(i), and (a)(4)
through (8) of this section. The rules
provided in paragraphs (a)(1)(i)(A),
(a)(1)(ii), (iv), and (v), (a)(2)(iv) through
(vi), (a)(3)(i), and (a)(4) through (8) of
this section apply to testing dates
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occurring on or after November 13,
2020. For loss corporations that have
testing dates occurring before November
13, 2020, see § 1.382–2 as contained in
26 CFR part 1, revised April 1, 2019.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may choose to
apply the rules of this section to testing
dates occurring during a taxable year
beginning after December 31, 2017, and
before November 13, 2020, so long as
the taxpayers and their related parties
consistently apply the rules of this
section, the section 163(j) regulations (as
defined in § 1.163(j)–1(b)(37)), §§ 1.382–
1, 1.382–5, 1.382–6, 1.382–7, 1.383–0,
and 1.383–1, and, if applicable,
§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, and
1.383–1), and 1.1504–4, to that taxable
year.
■ Par. 9. Section 1.382–5 is amended by
revising the first and second sentences
of paragraph (d)(1) and by adding three
sentences to the end of paragraph (f) to
read as follows:
§ 1.382–5
Section 382 limitation.
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*
*
*
*
*
(d) * * *
(1) * * * If a loss corporation has two
(or more) ownership changes, any losses
or section 382 disallowed business
interest carryforwards ((within the
meaning of § 1.382–2(a)(7)) attributable
to the period preceding the earlier
ownership change are treated as prechange losses with respect to both
ownership changes. Thus, the later
ownership change may result in a lesser
(but never in a greater) section 382
limitation with respect to such prechange losses. * * *
*
*
*
*
*
(f) * * * Paragraph (d)(1) of this
section applies with respect to an
ownership change occurring on or after
November 13, 2020. For loss
corporations that have undergone an
ownership change before or after
November 13, 2020, see § 1.382–5 as
contained in 26 CFR part 1, revised
April 1, 2019. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to testing dates occurring during a
taxable year beginning after December
31, 2017, so long as the taxpayers and
their related parties consistently apply
the rules of this section, the section
163(j) regulations (as defined in
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18:00 Sep 11, 2020
Jkt 250001
§ 1.163(j)–1(b)(37)), §§ 1.382–1, 1.382–2,
1.382–6, 1.382–7, 1.383–0, and 1.383–1,
and, if applicable, §§ 1.263A–9, 1.263A–
15, 1.381(c)(20)–1, 1.469–9, 1.469–11,
1.704–1, 1.882–5, 1.1362–3, 1.1368–1,
1.1377–1, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, and 1.383–1), and 1.1504–4,
to that taxable year.
■ Par. 10. Section 1.382–6 is amended
by:
■ 1. Redesignating the text of paragraph
(a) as paragraph (a)(1);
■ 2. Adding a subject heading to newly
redesignated paragraph (a)(1);
■ 3. Adding paragraph (a)(2);
■ 4. Removing the language ‘‘Subject to
paragraphs (b)(3)(ii) and (d)’’ in the first
sentence of paragraph (b)(1) and adding
‘‘Subject to paragraphs (b)(3)(ii), (b)(4),
and (d)’’ in its place;
■ 5. Adding paragraph (b)(4); and
■ 6. Revising paragraph (h).
The additions and revision read as
follows:
§ 1.382–6 Allocation of income and loss to
periods before and after the change date for
purposes of section 382.
(a) * * *
(1) In general. * * *
(2) Allocation of business interest
expense—(i) Scope. Except as provided
in paragraph (b)(4) of this section, this
paragraph (a)(2) applies if a loss
corporation has business interest
expense (as defined in § 1.163(j)–1(b)(3))
in the change year. The rules of this
paragraph (a)(2) apply to determine the
amount of current-year business interest
expense (as defined in § 1.163(j)–1(b)(9))
that is deducted in the change year.
These rules also apply to determine the
amount of any current-year business
interest expense that is characterized as
disallowed business interest expense (as
defined in § 1.163(j)–1(b)(10)) allocable
to the pre-change period and the postchange period, and to allocate
disallowed business interest expense
carryforwards (as defined in § 1.163(j)–
1(b)(11)) to the change year for
deduction in the pre-change period and
the post-change period.
(ii) Deductibility of business interest
expense. The rules of this paragraph
(a)(2)(ii) apply in the following order.
(A) First, the loss corporation
calculates its section 163(j) limitation
(as defined in § 1.163(j)–1(b)(36)) for the
change year.
(B) Second, the loss corporation
calculates its deductible current-year
BIE and deducts this amount in
determining its taxable income or net
operating loss for the change year. For
purposes of this paragraph (a)(2)(ii), the
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Fmt 4701
Sfmt 4700
56835
term deductible current-year BIE means
the loss corporation’s current-year
business interest expense (including its
floor plan financing interest expense, as
defined in § 1.163(j)–1(b)(19)), to the
extent of its section 163(j) limitation.
(C) Third, if the loss corporation has
disallowed business interest expense
paid or accrued (without regard to
section 163(j)) in the change year that is
carried forward to post-change years, it
allocates an equal portion of that
disallowed business interest expense to
each day in the change year. Any
amount of disallowed business interest
expense that is allocated to the prechange period pursuant to this
paragraph (a)(2)(ii)(C) is carried forward
subject to section 382(d)(3). Any amount
of disallowed business interest expense
that is allocated to the post-change
period pursuant to this paragraph
(a)(2)(ii)(C) is carried forward and is not
subject to section 382(d)(3).
(D) Fourth, if the loss corporation has
excess section 163(j) limitation, then the
loss corporation calculates its
deductible disallowed business interest
expense carryforward and allocates an
equal portion to each day in the change
year. For purposes of this paragraph
(a)(2)(ii), the term excess section 163(j)
limitation means the excess, if any, of
the loss corporation’s section 163(j)
limitation over its deductible currentyear BIE, and the term deductible
disallowed business interest expense
carryforward means the loss
corporation’s disallowed business
interest expense carryforward to the
extent of its excess section 163(j)
limitation.
(E) Fifth, the loss corporation deducts
its deductible disallowed business
interest expense carryforward that was
allocated to the pre-change period under
paragraph (a)(2)(ii)(D) of this section.
Subject to the application of sections
382(b)(3)(B) and 382(d)(3), the loss
corporation deducts its deductible
disallowed business interest expense
carryforward that was allocated to the
post-change period under paragraph
(a)(2)(ii)(D) of this section. Any amount
of disallowed business interest expense
carryforward that is not deducted
pursuant to this paragraph (a)(2)(ii)(E) is
carried forward subject to section
382(d)(3).
*
*
*
*
*
(b) * * *
(4) Allocation of business interest
expense—(i) Scope. This paragraph
(b)(4) applies if a loss corporation makes
a closing-of-the-books election pursuant
to paragraph (b) of this section and has
business interest expense in the change
year. The rules of this paragraph (b)(4)
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Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
apply to determine the amount of
deductible current-year business
interest expense that is allocable to the
pre-change period and the post-change
period for purposes of the allocations
referred to in paragraph (b)(1) of this
section. These rules also apply to
determine the amount of any currentyear business interest expense that is
characterized as disallowed business
interest expense allocable to the prechange period and the post-change
period, and to allocate disallowed
business interest expense carryforwards
to the change year between the prechange period and the post-change
period for deduction.
(ii) Deductibility of business interest
expense. The rules of this paragraph
(b)(4)(ii) apply in the order provided.
(A) The loss corporation calculates its
ATI limit, which is the product of its
ATI (as defined in § 1.163(j)–1(b)(1)) for
the change year and 30 percent. For
purposes of this paragraph (b)(4)(ii), the
terms pre-change ATI limit and postchange ATI limit mean the amount of
ATI limit allocated to the pre-change
period or the post-change period,
respectively, computed by allocating an
equal portion of the ATI limit to each
day in the change year.
(B) Pursuant to paragraph (b)(1) of this
section, the loss corporation allocates its
current-year business interest expense
(including its floor plan financing
interest expense) and its business
interest income (as defined in § 1.163(j)–
1(b)(4)) to the pre-change and postchange periods as if the loss
corporation’s books were closed on the
change date. For purposes of this
paragraph (b)(4)(ii), the terms prechange BIE and post-change BIE mean
the amount of the loss corporation’s
current-year business interest expense
that is allocated to the pre-change
period or the post-change period,
respectively, under this paragraph
(b)(4)(ii)(B).
(C) The loss corporation deducts its
pre-change BIE to the extent of its prechange section 163(j) limit, and the loss
corporation deducts its post-change BIE
to the extent of its post-change section
163(j) limit. For purposes of this
paragraph (b)(4)(ii), the term pre-change
section 163(j) limit means the sum of the
pre-change ATI and the amount of
business interest income and floor plan
financing interest expense allocated to
the pre-change period; the term postchange section 163(j) limit means the
sum of the post-change ATI limit and
the amount of business interest income
and floor plan financing interest
expense allocated to the post-change
period.
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(D) If any pre-change BIE or postchange BIE has not been deducted
under paragraph (b)(4)(ii)(C) of this
section, the loss corporation deducts
either any pre-change BIE that has not
been deducted to the extent of its
surplus post-change section 163(j) limit
or any post-change BIE that has not been
deducted to the extent of its surplus prechange section 163(j) limit. For
purposes of this paragraph (b)(4)(ii), the
term surplus pre-change section 163(j)
limit means the amount by which the
pre-change section 163(j) limit exceeds
the amount of pre-change BIE deducted
pursuant to paragraph (b)(4)(ii)(C) of
this section; the term surplus postchange section 163(j) limit means the
amount by which the post-change
section 163(j) limit exceeds the amount
of post-change BIE deducted pursuant to
paragraph (b)(4)(ii)(C) of this section.
(E) If the loss corporation has any
excess pre-change section 163(j) limit or
excess post-change section 163(j) limit,
the loss corporation allocates its
disallowed business interest expense
carryforward, if any, ratably between the
pre-change and post-change periods
based upon the relative amounts of
excess pre-change section 163(j) limit
and excess post-change section 163(j)
limit. For purposes of this paragraph
(b)(4)(ii), the term excess pre-change
section 163(j) limit means the amount
by which the surplus pre-change section
163(j) limit exceeds the amount of postchange BIE deducted pursuant to
paragraph (b)(4)(ii)(D) of this section;
the term excess post-change section
163(j) limit means the amount by which
the surplus post-change section 163(j)
limit exceeds the amount of pre-change
BIE deducted pursuant to paragraph
(b)(4)(ii)(D) of this section.
(F) The loss corporation deducts its
disallowed business interest expense
carryforward that was allocated to the
pre-change period under paragraph
(b)(4)(ii)(E) of this section to the extent
of its excess pre-change section 163(j)
limit. Subject to the application of
sections 382(b)(3)(B) and 382(d)(3), the
loss corporation deducts its disallowed
business interest expense carryforward
that was allocated to the post-change
period under paragraph (b)(4)(ii)(E) of
this section to the extent of its excess
post-change section 163(j) limit. Any
amount of disallowed business interest
expense carryforward that is not
deducted pursuant to this paragraph
(b)(4)(ii)(F) is subject to section
382(d)(3) irrespective of the period to
which it was allocated pursuant to
paragraph (b)(4)(ii)(E) of this section.
(iii) Example 1—(A) Facts. X is a
calendar-year domestic C corporation
that is not a member of a consolidated
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Sfmt 4700
group. As of January 1, 2021, X has no
disallowed business interest expense
carryforwards. On October 19, 2021, X
experiences an ownership change under
section 382(g). For calendar year 2021,
X’s ATI is $500. For the period
beginning on January 1, 2021 and
ending on October 19, 2021, X pays or
accrues $250 of current-year business
interest expense that is deductible but
for the potential application of section
163(j), including $50 of floor plan
financing interest expense, and X has
$60 of business interest income. For the
period beginning on October 20, 2021
and ending on December 31, 2021, X
pays or accrues $100 of current-year
business interest expense that is
deductible but for the potential
application of section 163(j), including
$40 of floor plan financing interest
expense, and X has $70 of business
interest income. X makes a closing-ofthe-books election pursuant to
paragraph (b) of this section.
(B) Analysis—(1) Calculation and
allocation of ATI limit. For purposes of
allocating its net operating loss or
taxable income for the change year
between the pre-change period and the
post-change period under § 1.382–6, X
applies paragraph (b)(4) of this section
to allocate items related to section
163(j). X’s ATI for calendar year 2021 is
$500x. Therefore, pursuant to paragraph
(b)(4)(ii)(A) of this section, X’s ATI limit
is $150 ($500 × 30 percent).
Additionally, pursuant to paragraph
(b)(4)(ii)(A) of this section, X’s prechange ATI limit is $120 ($150 × (292
days/365 days)), and X’s post-change
ATI limit is $30 ($150 × (73 days/365
days)).
(2) Determination of pre-change BIE
and post-change BIE. Pursuant to
paragraph (b)(4)(ii)(B) of this section,
X’s pre-change BIE and post-change BIE
are $250 and $100, respectively.
(3) Determination of pre-change
section 163(j) limit and post-change
section 163(j) limit. Pursuant to
paragraph (b)(4)(ii)(C) of this section,
X’s pre-change section 163(j) limit is
$230 ($120 (X’s pre-change ATI limit) +
$60 (X’s business interest income
allocated to the pre-change period) +
$50 (X’s floor plan financing interest
expense allocated to the pre-change
period)). Additionally, pursuant to
paragraph (b)(4)(ii)(C) of this section,
X’s post-change section 163(j) limit is
$140 ($30 (X’s post-change ATI limit) +
$70 (X’s business interest income
allocated to the post-change period) +
$40 (X’s floor plan financing interest
expense allocated to the post-change
period)).
(4) Initial deduction of BIE. Pursuant
to paragraph (b)(4)(ii)(C) of this section,
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X deducts $230 (its pre-change section
163(j) limit) of its $250 pre-change BIE
and all $100 (less than its $140 postchange section 163(j) limit) of its postchange BIE.
(5) Deduction of BIE due to surplus
post-change section 163(j) limit. After
applying paragraph (b)(4)(ii)(C) of this
section, X has $20 of pre-change BIE
that has not been deducted
($250¥$230) and a surplus post-change
section 163(j) limit of $40 ($140¥$100).
As a result, pursuant to paragraph
(b)(4)(ii)(D) of this section, X deducts its
remaining $20 of pre-change BIE. (If,
after applying paragraph (b)(4)(ii)(C) of
this section, X instead had $20 of postchange BIE that had not yet been
deducted and a $40 surplus pre-change
section 163(j) limit, then X would
deduct its remaining $20 of post-change
BIE pursuant to paragraph (b)(4)(ii)(D) of
this section.)
(iv) Example 2—Potential deduction
of disallowed business interest expense
carryforwards. The facts are the same as
in paragraph (b)(4)(iii)(A) of this section,
except that, as of January 1, 2021, X has
$90 of disallowed business interest
expense carryforwards and $150 (rather
than $250) of pre-change BIE. X’s prechange section 163(j) limit and postchange section 163(j) limit are the same
as in paragraph (b)(4)(iii)(B)(3) of this
section. Pursuant to paragraph
(b)(4)(ii)(C) of this section, X deducts all
$150 of its pre-change BIE and all $100
of its post-change BIE. X has no
remaining pre-change BIE or postchange BIE to deduct under paragraph
(b)(4)(ii)(D) of this section. Paragraph
(b)(4)(ii)(E) of this section applies
because X has $80 of excess pre-change
section 163(j) limit ($230¥$150) and
$40 of excess post-change section 163(j)
limit ($140¥$100). Under paragraph
(b)(4)(ii)(E) of this section, X allocates
$60 of its disallowed business interest
expense carryforwards to the pre-change
period ($90 × ($80/($80 + $40))) and $30
of its disallowed business interest
expense carryforwards to the postchange period ($90 × ($40/($80 + $40))).
As provided in paragraph (b)(4)(ii)(F) of
this section, X deducts all $60 of its
disallowed business interest expense
carryforwards that are allocated to the
pre-change period; subject to the
application of section 382, X deducts all
$30 of its disallowed business interest
expense carryforwards that are allocated
to the post-change period.
*
*
*
*
*
(h) Applicability date—(1) In general.
This section applies to ownership
changes occurring on or after June 22,
1994.
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(2) Ownership changes. Paragraphs (a)
and (b)(1) and (4) of this section apply
with respect to an ownership change
occurring during a taxable year
beginning on or after November 13,
2020. For ownership changes occurring
during a taxable year beginning before
November 13, 2020, see § 1.382–6 as
contained in 26 CFR part 1, revised
April 1, 2019. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to testing dates occurring during a
taxable year beginning after December
31, 2017, so long as the taxpayers and
their related parties consistently apply
the rules of this section, the section
163(j) regulations (as defined in
§ 1.163(j)–1(b)(37)), §§ 1.382–1, 1.382–2,
1.382–5, 1.383–0, and 1.383–1, and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.469–9, 1.469–11,
1.704–1, 1.882–5, 1.1362–3, 1.1368–1,
1.1377–1, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, 1.382–7, and 1.383–1), and
1.1504–4, to taxable years beginning
after December 31, 2017.
■ Par. 11. Section 1.382–7 is amended
by adding paragraphs (c), (d), (e), (f),
and (g) to read as follows:
§ 1.382–7
Built-in gains and losses.
*
*
*
*
*
(c) [Reserved]
(d) Special rules. This paragraph (d)
contains special rules regarding the
identification of recognized built-in
losses.
(1)–(4) [Reserved]
(5) Section 382 disallowed business
interest carryforwards. Section 382
disallowed business interest
carryforwards are not treated as
recognized built-in losses.
(e)–(f) [Reserved]
(g) Applicability dates.
(1)–(3) [Reserved]
(4) Paragraph (d)(5) of this section.
Paragraph (d)(5) of this section applies
with respect to an ownership change
occurring on or after November 13,
2020. For loss corporations that have
undergone an ownership change before
or after November 13, 2020, see § 1.382–
7 as contained in 26 CFR part 1, revised
April 1, 2019. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
choose to apply the rules of paragraph
(d)(5) of this section to testing dates
occurring during a taxable year
beginning after December 31, 2017.
■ Par. 12. Section 1.383–0 is amended
by revising paragraph (a) to read as
follows:
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§ 1.383–0
56837
Effective date.
(a) The regulations in this part under
section 383 of the Code (other than the
regulations described in paragraph (b) of
this section) reflect the amendments
made to sections 382 and 383 by the Tax
Reform Act of 1986 and the
amendments made to section 382 by
Public Law 115–97 (2017). See § 1.383–
1(j) for effective date rules.
*
*
*
*
*
■ Par. 13. Section 1.383–1 is amended
by:
■ 1. In paragraph (a):
■ a. Adding entries for paragraphs
(d)(1)(i) and (ii);
■ b. Revising the entries for paragraphs
(e)(3) and (j);
■ c. Adding entries for paragraphs (j)(1)
and (2); and
■ d. Removing the entry for paragraph
(k).
■ 2. Removing ‘‘(iv)’’ and adding ‘‘(v)’’
in its place in paragraph (c)(6)(i)(B).
■ 3. Revising paragraphs (c)(6)(ii) and
(d)(1).
■ 4. Removing the commas and adding
semicolons in their place at ends of
paragraphs (d)(2)(i), (ii), and (vi).
■ 5. Revising paragraph (d)(2)(iii).
■ 6. Redesignating paragraphs (d)(2)(iv)
through (vii) as paragraphs (d)(2)(v)
through (viii), respectively.
■ 7. Adding a new paragraph (d)(2)(iv).
■ 8. Revising newly redesignated
paragraph (d)(2)(v) and paragraph
(d)(3)(ii).
■ 9. Removing ‘‘(iv)’’ and adding ‘‘(v)’’
in its place in paragraph (e)(1).
■ 10. In paragraph (e)(2):
■ a. Removing ‘‘sections 11(b)(2) and
(15)’’ and adding ‘‘section 15’’ in its
place in the fourth sentence; and
■ b. Removing the last two sentences.
■ 11. Removing and reserving paragraph
(e)(3).
■ 12. In paragraph (f):
■ a. Removing Example 4;
■ b. Designating Examples 1 through 3
as paragraphs (f)(1) through (3),
respectively; and
■ c. Revising newly designated
paragraphs (f)(2) and (3).
■ 13. In the last sentence of paragraph
(g), removing ‘‘(e.g., 0.34 for taxable
years beginning in 1989)’’.
■ 14. In paragraph (j):
■ a. Revising the subject heading;
■ b. Designating the text of paragraph (j)
as paragraph (j)(1) and adding a heading
to newly designated paragraph (j)(1);
and
■ c. Adding paragraph (j)(2).
■ 15. Removing paragraph (k).
The revisions and additions read as
follows:
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§ 1.383–1 Special limitations on certain
capital losses and excess credits.
(a) * * *
*
*
*
*
(d) * * *
(1) * * *
(i) In general.
(ii) Ordering rule for losses or credits
from same taxable year.
*
*
*
*
*
(e) * * *
(3) [Reserved]
*
*
*
*
*
(j) Applicability date.
(1) In general.
(2) Interaction with section 163(j).
*
*
*
*
*
(c) * * *
(6) * * *
(ii) Example. L, a new loss
corporation, is a calendar-year taxpayer.
L has an ownership change on
December 31, 2021. For 2022, L has
taxable income (prior to the use of any
pre-change losses) of $100,000. In
addition, L has a section 382 limitation
of $25,000, a pre-change net operating
loss carryover of $12,000, a pre-change
general business credit carryforward
under section 39 of $50,000, and no
items described in § 1.383–1(d)(2)(i)
through (iv). L’s section 383 credit
limitation for 2022 is the excess of its
regular tax liability computed after
allowing a $12,000 net operating loss
deduction (taxable income of $88,000;
regular tax liability of $18,480), over its
regular tax liability computed after
allowing an additional deduction in the
amount of L’s section 382 limitation
remaining after the application of
paragraphs (d)(2)(i) through (v) of this
section, or $13,000 (taxable income of
$75,000; regular tax liability of $15,750).
L’s section 383 credit limitation is
therefore $2,730 ($18,480 minus
$15,750).
(d) * * *
(1) In general—(i) General rule. The
amount of taxable income of a new loss
corporation for any post-change year
that may be offset by pre-change losses
shall not exceed the amount of the
section 382 limitation for the post*
change year. The amount of the regular
tax liability of a new loss corporation for
any post-change year that may be offset
by pre-change credits shall not exceed
the amount of the section 383 credit
limitation for the post-change year.
(ii) Ordering rule for losses or credits
from same taxable year. A loss
corporation’s taxable income is offset
first by losses subject to a section 382
limitation, to the extent the section 382
limitation for that taxable year has not
yet been absorbed, before being offset by
losses of the same type from the same
taxable year that are not subject to a
section 382 limitation. For example,
assume that Corporation X has an
ownership change in Year 1 and carries
over disallowed business interest
expense as defined in § 1.163(j)–
1(b)(10), some of which constitutes a
section 382 disallowed business interest
carryforward, from Year 1 to Year 2. To
the extent of its section 163(j) limitation,
as defined in § 1.163(j)–1(b)(36), and its
remaining section 382 limitation,
Corporation X offsets its Year 2 income
with the section 382 disallowed
business interest carryforward before
using any of the disallowed business
interest expense that is not a section 382
disallowed business interest
carryforward. Similar principles apply
to the use of tax credits.
(2) * * *
(iii) Pre-change losses that are
described in § 1.382–2(a)(2)(iii), other
than losses that are pre-change capital
losses, that are recognized and are
subject to the section 382 limitation in
such post-change year;
(iv)(A) With respect to an ownership
change date occurring prior to
November 13, 2020, but during the
taxable year which includes November
13, 2020, the pre-change loss described
in section 382(d)(3);
(B) With respect to an ownership
change date occurring on or after
November 13, 2020, section 382
disallowed business interest
carryforwards (within the meaning of
§ 1.382–2(a)(7));
(v) Pre-change losses not described in
paragraphs (d)(2)(i) through (iv) of this
section;
*
*
*
*
*
(3) * * *
(ii) Example. L, a calendar-year
taxpayer, has an ownership change on
December 31, 2021. For 2022, L has
taxable income of $300,000 and a
regular tax liability of $63,000. L has no
pre-change losses, but it has a business
credit carryforward from 2020 of
$25,000. L has a section 382 limitation
for 2022 of $50,000. L’s section 383
credit limitation is $10,500, an amount
equal to the excess of L’s regular tax
liability ($63,000) over its regular tax
liability calculated by allowing an
additional deduction of $50,000
($52,500). Pursuant to the limitation
contained in section 38(c), however, L is
entitled to use only $9,500
(($63,000¥$25,000) × 25 percent) of its
business credit carryforward in 2022.
The unabsorbed portion of L’s section
382 limitation, $1,000 (computed
pursuant to paragraph (e) of this
section), is carried forward under
section 382(b)(2). The unused portion of
L’s business credit carryforward,
$14,500, is carried forward to the extent
provided in section 39.
*
*
*
*
*
(f) * * *
(2) Example 2—(i) Facts. L, a
calendar-year taxpayer, has an
ownership change on December 31,
2021. For 2022, L has $750,000 of
ordinary taxable income (before the
application of carryovers) and a section
382 limitation of $1,500,000. L’s only
carryovers are from pre-2021 taxable
years and consist of a $500,000 net
operating loss (NOL) carryover, and a
$200,000 foreign tax credit carryover (all
of which may be used under the section
904 limitation). The NOL carryover is a
pre-change loss, and the foreign tax
credit carryover is a pre-change credit.
L has no other pre-change losses or
credits that can be used in 2022.
(ii) Analysis. The following
computation illustrates the application
of this section for 2022:
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TABLE 1 TO PARAGRAPH (f)(2)(ii)
1. Taxable income before carryovers ......................................................................................................................................................
2. Pre-change NOL carryover .................................................................................................................................................................
3. Section 382 limitation ..........................................................................................................................................................................
4. Amount of pre-change NOL carryover that can be used (least of line 1, 2, or 3) .............................................................................
5. Taxable income (line 1 minus line 4) ..................................................................................................................................................
6. Section 382 limitation remaining (line 3 minus line 4) ........................................................................................................................
7. Pre-change credit carryover ................................................................................................................................................................
8. Regular tax liability (line 5 × section 11 rates) ....................................................................................................................................
9. Modified tax liability (line 5 minus line 6 (but not less than zero) × section 11 rates) .......................................................................
10. Section 383 credit limitation (line 8 minus line 9) .............................................................................................................................
11. Amount of pre-change credits that can be used in 2022 (lesser of line 7 or line 10) ......................................................................
12. Amount of pre-change credits to be carried over to 2023 under section 904(c) (line 7 minus line 11) ..........................................
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14SER2
$750,000
500,000
1,500,000
500,000
250,000
1,000,000
200,000
52,500
0
52,500
52,500
147,500
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Rules and Regulations
56839
TABLE 1 TO PARAGRAPH (f)(2)(ii)—Continued
13. Section 383 credit reduction amount: $52,500/0.21 .........................................................................................................................
14. Section 382 limitation to be carried to 2023 under section 382(b)(2) (line 6 minus line 13) ...........................................................
(3) Example 3—(i) Facts. L, a
calendar-year taxpayer, has an
ownership change on December 31,
2021. L has $80,000 of ordinary taxable
income (before the application of
carryovers) and a section 382 limitation
of $25,000 for 2022, a post-change year.
L’s only carryover is from a pre-2021
taxable year and is a general business
credit carryforward under section 39 in
the amount of $10,000 (no portion of
which is attributable to the investment
tax credit under section 46). The general
business credit carryforward is a pre-
250,000
750,000
change credit. L has no other credits
which can be used in 2022.
(ii) Analysis. The following
computation illustrates the application
of this section:
TABLE 2 TO PARAGRAPH (f)(3)(ii)
1. Taxable income before carryovers ......................................................................................................................................................
2. Section 382 limitation ..........................................................................................................................................................................
3. Pre-change credit carryover ................................................................................................................................................................
4. Regular tax liability (line 1 × section 11 rates) ....................................................................................................................................
5. Modified tax liability ((line 1 minus line 2) × section 11 rates) ...........................................................................................................
6. Section 383 credit limitation (line 4 minus line 5) ...............................................................................................................................
7. Amount of pre-change credits that can be used (lesser of line 3 or line 6) .......................................................................................
8. Amount of pre-change credits to be carried over to 2023 under sections 39 and 382(l)(2) (line 3 minus line 7) .............................
9. Regular tax payable (line 4 minus line 7) ...........................................................................................................................................
10. Section 383 credit reduction amount: $5,250/0.21 ...........................................................................................................................
11. Section 382 limitation to be carried to 2023 under section 382(b)(2) (line 2 minus line 10) ...........................................................
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*
*
*
*
*
(j) Applicability date—(1) In general.
* * *
(2) Interaction with section 163(j).
Paragraphs (c)(6)(i)(B) and (c)(6)(ii),
(d)(1), (d)(2)(iii) through (viii), (d)(3)(ii),
(e)(1) through (3), (f), and (g) of this
section apply with respect to ownership
changes occurring during a taxable year
beginning on or after November 13,
2020. For loss corporations that have
undergone an ownership change during
a taxable year beginning before
November 13, 2020, see § 1.383–1 as
contained in 26 CFR part 1, revised
April 1, 2019. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to an ownership change occurring
during a taxable year beginning after
December 31, 2017, so long as the
taxpayers and their related parties
consistently apply either the rules of
this section (except paragraph
(d)(2)(iv)(B) of this section), the section
163(j) regulations (as defined in
§ 1.163(j)–1(b)(37)), §§ 1.382–1, 1.382–2,
1.382–5, 1.382–6, 1.382–7, and 1.383–0,
and, if applicable, §§ 1.263A–9, 1.263A–
15, 1.381(c)(20)–1, 1.469–9, 1.469–11,
1.704–1, 1.882–5, 1.1362–3, 1.1368–1,
1.1377–1, 1.1502–13, 1.1502–21,
1.1502–36, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2,
§ 1.382–5, 1.382–6, and 1.383–1), and
1.1504–4; or the rules of this section
(except paragraph (d)(2)(iv)(A) of this
section), the section 163(j) regulations
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(as defined in § 1.163(j)–1(b)(37)) and
§§ 1.382–1, 1.382–2, 1.382–5, 1.382–6,
and 1.383–0, and, if applicable,
§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, 1.382–7,
and 1.383–1), and 1.1504–4, to those
ownership changes.
■ Par. 14. Section 1.446–3 is amended
by revising paragraphs (g)(4) and (j)(2) to
read as follows:
§ 1.446–3
Notional principal contracts.
*
*
*
*
*
(g) * * *
(4) Swaps with significant
nonperiodic payments—(i) General rule.
Except as provided in paragraph
(g)(4)(ii) of this section, a swap with
significant nonperiodic payments is
treated as two separate transactions
consisting of an on-market, level
payment swap and a loan. The loan
must be accounted for by the parties to
the contract independently of the swap.
The time value component associated
with the loan, determined in accordance
with paragraph (f)(2)(iii)(A) of this
section, is recognized as interest
expense to the payor and interest
income to the recipient.
(ii) Exception for cleared swaps and
non-cleared swaps subject to margin or
collateral requirements. Paragraph
(g)(4)(i) of this section does not apply to
a swap if the contract is described in
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$80,000
25,000
10,000
16,800
11,550
5,250
5,250
4,750
11,550
25,000
0
paragraph (g)(4)(ii)(A) or (B) of this
section.
(A) The swap is cleared by a
derivatives clearing organization, as
such term is defined in section 1a of the
Commodity Exchange Act (7 U.S.C. 1a),
or by a clearing agency, as such term is
defined in section 3 of the Securities
Exchange Act of 1934 (15 U.S.C. 78c),
that is registered as a derivatives
clearing organization under the
Commodity Exchange Act or as a
clearing agency under the Securities
Exchange Act of 1934, respectively, and
the derivatives clearing organization or
clearing agency requires the parties to
the swap to post and collect margin or
collateral.
(B) The swap is a non-cleared swap
that requires the parties to meet the
margin or collateral requirements of a
federal regulator or that provides for
margin or collateral requirements that
are substantially similar to a cleared
swap or a non-cleared swap subject to
the margin or collateral requirements of
a federal regulator. For purposes of this
paragraph (g)(4)(ii)(B), the term federal
regulator means the Securities and
Exchange Commission (SEC), the
Commodity Futures Trading
Commission (CFTC), or a prudential
regulator, as defined in section 1a(39) of
the Commodity Exchange Act (7 U.S.C.
1a), as amended by section 721 of the
Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010,
Public Law 111–203, 124 Stat. 1376,
Title VII.
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(iii) Coordination with section 163(j).
For the treatment of swaps with
significant nonperiodic payments under
section 163(j), see § 1.163(j)–1(b)(22)(ii).
*
*
*
*
*
(j) * * *
(2) The rules provided in paragraph
(g)(4) of this section apply to notional
principal contracts entered into on or
after September 14, 2021. Taxpayers
may choose to apply the rules provided
in paragraph (g)(4) of this section to
notional principal contracts entered into
before September 14, 2021.
■ Par. 15. Section 1.469–9 is amended
by revising paragraph (b)(2) to read as
follows:
§ 1.469–9 Rules for certain rental real
estate activities.
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*
*
*
*
*
(b) * * *
(2) Real property trade or business.
The following terms have the following
meanings in determining whether a
trade or business is a real property trade
or business for purposes of section
469(c)(7)(C) and this section.
(i) Real property—(A) In general. The
term real property includes land,
buildings, and other inherently
permanent structures that are
permanently affixed to land. Any
interest in real property, including fee
ownership, co-ownership, a leasehold,
an option, or a similar interest is real
property under this section. Tenant
improvements to land, buildings, or
other structures that are inherently
permanent or otherwise classified as
real property under this section are real
property for purposes of section
469(c)(7)(C). However, property
manufactured or produced for sale that
is not real property in the hands of the
manufacturer or producer, but that may
be incorporated into real property
through installation or any similar
process or technique by any person after
the manufacture or production of such
property (for example, bricks, nails,
paint, and windowpanes), is not treated
as real property in the hands of any
person (including any person involved
in the manufacture, production, sale,
incorporation or installation of such
property) prior to the completed
incorporation or installation of such
property into the real property for
purposes of section 469(c)(7)(C) and this
section.
(B) Land. The term land includes
water and air space superjacent to land
and natural products and deposits that
are unsevered from the land. Natural
products and deposits, such as plants,
crops, trees, water, ores, and minerals,
cease to be real property when they are
harvested, severed, extracted, or
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removed from the land. Accordingly,
any trade or business that involves the
cultivation and harvesting of plants,
crops, or certain types of trees in a
farming operation as defined in section
464(e), or severing, extracting, or
removing natural products or deposits
from land is not a real property trade or
business for purposes of section
469(c)(7)(C) and this section. The
storage or maintenance of severed or
extracted natural products or deposits,
such as plants, crops, trees, water, ores,
and minerals, in or upon real property
does not cause the stored property to be
recharacterized as real property, and
any trade or business relating to or
involving such storage or maintenance
of severed or extracted natural products
or deposits is not a real property trade
or business, even though such storage or
maintenance otherwise may occur upon
or within real property.
(C) Inherently permanent structure.
The term inherently permanent
structure means any permanently
affixed building or other permanently
affixed structure. If the affixation is
reasonably expected to last indefinitely,
based on all the facts and
circumstances, the affixation is
considered permanent. However, an
asset that serves an active function, such
as an item of machinery or equipment
(for example, HVAC system, elevator or
escalator), is not a building or other
inherently permanent structure, and
therefore is not real property for
purposes of section 469(c)(7)(C) and this
section, even if such item of machinery
or equipment is permanently affixed to
or becomes incorporated within a
building or other inherently permanent
structure. Accordingly, a trade or
business that involves the manufacture,
installation, operation, maintenance, or
repair of any asset that serves an active
function will not be a real property
trade or business, or a unit or
component of another real property
trade or business, for purposes of
section 469(c)(7)(C) and this section.
(D) Building—(1) In general. A
building encloses a space within its
walls and is generally covered by a roof
or other external upper covering that
protects the walls and inner space from
the elements.
(2) Types of buildings. Buildings
include the following assets if
permanently affixed to land: Houses;
townhouses; apartments;
condominiums; hotels; motels;
stadiums; arenas; shopping malls;
factory and office buildings;
warehouses; barns; enclosed garages;
enclosed transportation stations and
terminals; and stores.
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(E) Other inherently permanent
structures—(1) In general. Other
inherently permanent structures include
the following assets if permanently
affixed to land: Parking facilities;
bridges; tunnels; roadbeds; railroad
tracks; pipelines; storage structures such
as silos and oil and gas storage tanks;
and stationary wharves and docks.
(2) Facts and circumstances
determination. The determination of
whether an asset is an inherently
permanent structure is based on all the
facts and circumstances. In particular,
the following factors must be taken into
account:
(i) The manner in which the asset is
affixed to land and whether such
manner of affixation allows the asset to
be easily removed from the land;
(ii) Whether the asset is designed to be
removed or to remain in place
indefinitely on the land;
(iii) The damage that removal of the
asset would cause to the asset itself or
to the land to which it is affixed;
(iv) Any circumstances that suggest
the expected period of affixation is not
indefinite (for example, a lease that
requires or permits removal of the asset
from the land upon the expiration of the
lease); and
(v) The time and expense required to
move the asset from the land.
(ii) Other definitions—(A) through (G)
[Reserved]
(H) Real property operation. The term
real property operation means handling,
by a direct or indirect owner of the real
property, the day-to-day operations of a
trade or business, under paragraph (b)(1)
of this section, relating to the
maintenance and occupancy of the real
property that affect the availability and
functionality of that real property used,
or held out for use, by customers where
payments received from customers are
principally for the customers’ use of the
real property. The principal purpose of
such business operations must be the
provision of the use of the real property,
or physical space accorded by or within
the real property, to one or more
customers, and not the provision of
other significant or extraordinary
personal services, under § 1.469–
1T(e)(3)(iv) and (v), to customers in
conjunction with the customers’
incidental use of the real property or
physical space. If the real property or
physical space is provided to a customer
to be used to carry on the customer’s
trade or business, the principal purpose
of the business operations must be to
provide the customer with exclusive use
of the real property or physical space in
furtherance of the customer’s trade or
business, and not to provide other
significant or extraordinary personal
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services to the customer in addition to
or in conjunction with the use of the
real property or physical space,
regardless of whether the customer pays
for the services separately. However, for
purposes of and with respect to the
preceding sentence, other incidental
personal services may be provided to
the customer in conjunction with the
use of real property or physical space,
as long as such services are
insubstantial in relation to the
customer’s use of the real property or
physical space.
(I) Real property management. The
term real property management means
handling, by a professional manager, the
day-to-day operations of a trade or
business, under paragraph (b)(1) of this
section, relating to the maintenance and
occupancy of real property that affect
the availability and functionality of that
property used, or held out for use, by
customers where payments received
from customers are principally for the
customers’ use of the real property. The
principal purpose of such business
operations must be the provision of the
use of the real property, or physical
space accorded by or within the real
property, to one or more customers, and
not the provision of other significant or
extraordinary personal services, under
§ 1.469–1T(e)(3)(iv) and (v), to
customers in conjunction with the
customers’ incidental use of the real
property or physical space. If the real
property or physical space is provided
to a customer to be used to carry on the
customer’s trade or business, the
principal purpose of the business
operations must be to provide the
customer with exclusive use of the real
property or physical space in
furtherance of the customer’s trade or
business, and not to provide other
significant or extraordinary personal
services to the customer in addition to
or in conjunction with the use of the
real property or physical space,
regardless of whether the customer pays
for the services separately. However, for
purposes of and with respect to the
preceding sentence, other incidental
personal services may be provided to
the customer in conjunction with the
use of real property or physical space,
as long as such services are
insubstantial in relation to the
customer’s use of the real property or
physical space. A professional manager
is a person responsible, on a full-time
basis, for the overall management and
oversight of the real property or
properties and who is not a direct or
indirect owner of the real property or
properties.
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(iii) Examples. The following
examples illustrate the operation of this
paragraph (b)(2):
(A) Example 1. A owns farmland and
uses the land in A’s farming business to
grow and harvest crops of various kinds.
As part of this farming business, A
utilizes a greenhouse that is an
inherently permanent structure to grow
certain crops during the winter months.
Under the rules of this section, any
trade or business that involves the
cultivation and harvesting of plants,
crops, or trees is not a real property
trade or business for purposes of section
469(c)(7)(C) and this section, even
though the cultivation and harvesting of
crops occurs upon or within real
property. Accordingly, under these
facts, A is not engaged in a real property
trade or business for purposes of section
469(c)(7)(C) and this section.
(B) Example 2. B is a retired farmer
and owns farmland that B rents
exclusively to C to operate a farm. The
arrangement between B and C is a trade
or business (under paragraph (b)(1) of
this section) where payments by C are
principally for C’s use of B’s real
property. B also provides certain farm
equipment for C’s use. However, C is
solely responsible for the maintenance
and repair of the farm equipment along
with any costs associated with operating
the equipment. B also occasionally
provides oral advice to C regarding
various aspects of the farm operation,
based on B’s prior experience as a
farmer. Other than the provision of this
occasional advice, B does not provide
any significant or extraordinary
personal services to C in connection
with the rental of the farmland to C.
Under these facts, B is engaged in a real
property trade or business (which does
not include the use or deemed rental of
any farm equipment) for purposes of
section 469(c)(7)(C) and this section,
and B’s oral advice is an incidental
personal service that B provides in
conjunction with C’s use of the real
property. Nevertheless, under these
facts, C is not engaged in a real property
trade or business for purposes of section
469(c)(7)(C) and this section because C
is engaged in the business of farming.
(C) Example 3. D owns a building in
which D operates a restaurant and bar.
Even though D provides customers with
use of the physical space inside the
building, D is not engaged in a trade or
business where payments by customers
are principally for the use of real
property or physical space. Instead, the
payments by D’s customers are
principally for the receipt of significant
or extraordinary personal services
(under § 1.469–1T(e)(3)(iv) and (v)),
mainly food and beverage preparation
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56841
and presentation services, and the use of
the physical space by customers is
incidental to the receipt of these
personal services. Under the rules of
this section, any trade or business that
involves the provision of significant or
extraordinary personal services to
customers in conjunction with the
customers’ incidental use of real
property or physical space is not a real
property trade or business, even though
the business operations occur upon or
within real property. Accordingly,
under these facts, D is not engaged in a
real property trade or business for
purposes of section 469(c)(7)(C) and this
section.
(D) Example 4. E owns a majority
interest in an S corporation, X, that is
engaged in the trade or business of
manufacturing industrial cooling
systems for installation in commercial
buildings and for other uses. E also
owns a majority interest in an S
corporation, Y, that purchases the
industrial cooling systems from X and
that installs, maintains, and repairs
those systems in both existing
commercial buildings and commercial
buildings under construction. Under the
rules of this section, any trade or
business that involves the manufacture,
installation, operation, maintenance, or
repair of any machinery or equipment
that serves an active function will not be
a real property trade or business (or a
unit or component of another real
property trade or business) for purposes
of section 469(c)(7)(C) and this section,
even though the machinery or
equipment will be permanently affixed
to real property once it is installed. In
this case, the industrial cooling systems
are machinery or equipment that serves
an active function. Accordingly, under
these facts, E, X and Y will not be
treated as engaged in one or more real
property trades or businesses for
purposes of section 469(c)(7)(C) and this
section.
(E) Example 5. (1) F owns an interest
in P, a limited partnership. P owns and
operates a luxury hotel. In addition to
providing rooms and suites for use by
customers, the hotel offers many
additional amenities such as in-room
food and beverage service, maid and
linen service, parking valet service,
concierge service, front desk and
bellhop service, dry cleaning and
laundry service, and in-room barber and
hairdresser service. P contracted with M
to provide maid and janitorial services
to P’s hotel. M is an S corporation
principally engaged in the trade or
business of providing maid and
janitorial services to various types of
businesses, including hotels. G is a
professional manager employed by M
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who handles the day-to-day business
operations relating to M’s provision of
maid and janitorial services to M’s
various customers, including P.
(2) Even though the personal services
that P provides to the customers of its
hotel are significant personal services
under § 1.469–1T(e)(3)(iv), the principal
purpose of P’s hotel business operations
is the provision of use of the hotel’s
rooms and suites to customers, and not
the provision of the significant personal
services to P’s customers in conjunction
with the customers’ incidental use of
those rooms or suites. The provision of
these significant personal services by P
to P’s customers is incidental to the
customers’ use of the hotel’s real
property. Accordingly, under these
facts, F is treated as owning an interest
in a real property trade or business
conducted by or through P and P is
treated as engaged in a real property
trade or business for purposes of section
469(c)(7)(C) and this section.
(3) With respect to the maid and
janitorial services provided by M, M’s
operations affect the availability and
functionality of real property used, or
held out for use, by customers in a trade
or business where payments by
customers are principally for the use of
real property (in this case, P’s hotel).
However, M does not operate or manage
real property. Instead, M is engaged in
a trade or business of providing maid
and janitorial services to customers,
such as P, that are engaged in real
property trades or businesses. Thus, M’s
business operations are merely ancillary
to real property trades or businesses.
Therefore, M is not engaged in real
property operations or management as
defined in this section. Accordingly,
under these facts, M is not engaged in
a real property trade or business under
section 469(c)(7)(C) and this section.
(4) With respect to the day-to-day
business operations that G handles as a
professional manager of M, the business
operations that G manages is not the
provision of use of P’s hotel rooms and
suites to customers. G does not operate
or manage real property. Instead, G
manages the provision of maid and
janitorial services to customers,
including P’s hotel. Therefore, G is not
engaged in real property management as
defined in this section. Accordingly,
under these facts, G is not engaged in a
real property trade or business under
section 469(c)(7)(C) and this section.
*
*
*
*
*
Par. 16. Section 1.469–11 is amended
by:
■ 1. Revising the section heading;
■
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2. Removing the period at the end of
paragraph (a)(1) and adding a semicolon
in its place;
■ 3. Revising paragraph (a)(3);
■ 4. Redesignating paragraphs (a)(4) and
(5) as paragraphs (a)(5) and (6),
respectively; and
■ 5. Adding a new paragraph (a)(4).
The revision and addition read as
follows:
■
§ 1.469–11 Applicability date and
transition rules.
(a) * * *
(3) The rules contained in § 1.469–9,
other than paragraph (b)(2), apply for
taxable years beginning on or after
January 1, 1995, and to elections made
under § 1.469–9(g) with returns filed on
or after January 1, 1995;
(4) The rules contained in § 1.469–
9(b)(2) apply to taxable years beginning
on or after November 13, 2020.
However, taxpayers and their related
parties, under sections 267(b) and
707(b)(1), may choose to apply the rules
of § 1.469–9(b)(2) for a taxable year
beginning after December 31, 2017, so
long as they consistently apply the rules
of § 1.469–9(b)(2), the section 163(j)
regulations (as defined in § 1.163(j)–
1(b)(37)), and, if applicable, §§ 1.263A–
9, 1.263A–15, 1.381(c)(20)–1, 1.382–1,
1.382–2, 1.382–5, 1.382–6, 1.382–7,
1.383–0, 1.383–1, 1.469–9, 1.704–1,
1.882–5, 1.1362–3, 1.1368–1, 1.1377–1,
1.1502–13, 1.1502–21, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, 1.382–7,
and 1.383–1), and 1.1504–4 to that
taxable year;
*
*
*
*
*
■ Par. 17. Section 1.704–1 is amended
by adding paragraph (b)(4)(xi) to read as
follows:
§ 1.704–1
Partner’s distributive share.
*
*
*
*
*
(b) * * *
(4) * * *
(xi) Section 163(j) excess items.
Allocations of section 163(j) excess
items as defined in § 1.163(j)–6(b)(6) do
not have substantial economic effect
under paragraph (b)(2) of this section
and, accordingly, such expenditures
must be allocated in accordance with
the partners’ interests in the
partnership. See paragraph (b)(3)(iv) of
this section. Allocations of section
163(j) excess items will be deemed to be
in accordance with the partners’
interests in the partnership if such
allocations are made in accordance with
§ 1.163(j)–6(f).
*
*
*
*
*
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Par. 18. Section 1.860C–2 is amended
by revising paragraph (b)(2) to read as
follows:
■
§ 1.860C–2 Determination of REMIC
taxable income or net loss.
*
*
*
*
*
(b) * * *
(2) Deduction allowable under section
163—(i) A REMIC is allowed a
deduction, determined without regard
to section 163(d), for any interest
expense accrued during the taxable
year.
(ii) For taxable years beginning after
December 31, 2017, a REMIC is allowed
a deduction, determined without regard
to section 163(j), for any interest
expense accrued during the taxable
year.
*
*
*
*
*
■ Par. 19. Section 1.1362–3 is amended
by:
■ 1. Redesignating the text in paragraph
(c)(3) as paragraph (c)(3)(i), adding a
subject heading to newly redesignated
paragraph (c)(3)(i), and adding
paragraph (c)(3)(ii); and
■ 2. Designating Examples 1 through 4
of paragraph (d) as paragraphs (d)(1)
through (d)(4), respectively.
The additions read as follows:
§ 1.1362–3
year.
Treatment of S termination
*
*
*
*
*
(c) * * *
(3) * * *
(i) In general. * * *
(ii) Application of section 163(j). For
purposes of section 163(j), a separate
limitation (as defined in § 1.163(j)–
1(b)(36)) applies to each S short year
and each C short year. Any items
necessary to determine the amount of
business interest expense (as defined in
§ 1.163(j)–1(b)(3)) that are deducted in
each S short year or C short year must
be allocated between the S short year
and C short year in accordance with an
allocation methodology provided in
section 1362(e).
*
*
*
*
*
■ Par. 20. Section 1.1368–1 is amended
by adding a sentence to the end of
paragraph (g)(2)(ii) to read as follows:
§ 1.1368–1 Distributions by S
corporations.
*
*
*
*
*
(g) * * *
(2) * * *
(ii) * * * In the case of a taxable year
for which an election is made under
paragraph (g)(2)(i), for purposes of
section 163(j), a separate section 163(j)
limitation (as defined in § 1.163(j)–
1(b)(36)) applies to each separate taxable
year. Any items necessary to determine
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the amount of business interest expense
(as defined in § 1.163(j)–1(b)(3)) that are
deducted in each separate taxable year
must be allocated between the two
separate taxable years in accordance
with an allocation methodology
provided in this paragraph (g).
*
*
*
*
*
■ Par. 21. Section 1.1377–1 is amended
by:
■ 1. Redesignating paragraphs (b)(3)(ii)
through (iv) as paragraphs (b)(3)(iii)
through (v), respectively; and
■ 2. Adding a new paragraph (b)(3)(ii).
The addition reads as follows:
§ 1.1377–1
Pro rata share.
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*
*
*
*
*
(b) * * *
(3) * * *
(ii) Section 163(j). If a terminating
election is made to treat the S
corporation’s taxable year as consisting
of separate taxable years, for purposes of
section 163(j), a separate limitation (as
defined in § 1.163(j)–1(b)(36)) will apply
to each separate taxable year. Any items
necessary to determine the amount of
business interest expense (as defined in
§ 1.163(j)–1(b)(3)) that are deducted in
each separate taxable year must be
allocated between the separate taxable
years in accordance with an allocation
methodology provided in this section.
*
*
*
*
*
■ Par. 22. Section 1.1502–13 is
amended:
■ 1. In paragraph (a)(6)(ii), under the
heading ‘‘Anti-avoidance rules.
(§ 1.1502–13(h)(2))’’, by:
■ i. Designating Examples 1 through 5
as entries (i) through (v); and
■ ii. Adding an entry (vi);
■ 2. In paragraph (h)(2) by:
■ a. Designating Examples 1 through 5
as paragraphs (h)(2)(i) through (v),
respectively.
■ b. In newly designated paragraphs
(h)(2)(i) through (v):
■ i. Redesignating paragraphs (h)(2)(i)(a)
and (b) as paragraphs (h)(2)(i)(A) and
(B);
■ ii. Redesignating paragraphs
(h)(2)(ii)(a) and (b) as paragraphs
(h)(2)(ii)(A) and (B);
■ iii. Redesignating paragraphs
(h)(2)(iii)(a) and (b) as paragraphs
(h)(2)(iii)(A) and (B);
■ iv. Redesignating paragraphs
(h)(2)(iv)(a) and (b) as paragraphs
(h)(2)(iv)(A) and (B);
■ v. Redesignating paragraphs
(h)(2)(v)(a) and (b) as paragraphs
(h)(2)(iv)(A) and (B); and
■ c. Adding paragraph (h)(2)(vi).
The additions read as follows:
§ 1.1502–13
Intercompany transactions.
(a) * * *
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(6) * * *
(ii) * * *
Anti-avoidance rules. (§ 1.1502–
13(h)(2))
*
*
*
*
*
(vi) Example 6. Section 163(j) interest
limitation.
*
*
*
*
*
(h) * * *
(2) * * *
(vi) Example 6: Section 163(j) interest
limitation—(A) Facts. S1 and S2 are
members of a consolidated group of
which P is the common parent. S1 is
engaged in an excepted trade or
business, and S2 is engaged in a nonexcepted trade or business. If S1 were to
lend funds directly to S2 in an
intercompany transaction, under
§ 1.163(j)–10(a)(4)(i), the intercompany
obligation of S2 would not be
considered an asset of S1 for purposes
of § 1.163(j)–10 (concerning allocations
of interest and other taxable items
between excepted and non-excepted
trades or businesses for purposes of
section 163(j)). With a principal purpose
of avoiding treatment of a lending
transaction between S1 and S2 as an
intercompany transaction (and
increasing the P group’s basis in its
assets allocable to excepted trades or
businesses), S1 lends funds to X (an
unrelated third party). X then on-lends
funds to S2 on substantially similar
terms.
(B) Analysis. A principal purpose of
the steps undertaken was to avoid
treatment of a lending transaction
between S1 and S2 as an intercompany
transaction. Therefore, under paragraph
(h)(1) of this section, appropriate
adjustments are made, and the X
obligation in the hands of S1 is not
treated as an asset of S1 for purposes of
§ 1.163(j)–10, to the extent of the loan
from X to S2.
*
*
*
*
*
■ Par. 23. Section 1.1502–21 is
amended by adding new paragraph
(c)(3) to read as follows:
§ 1.1502–21
Net operating losses.
*
*
*
*
*
(c) * * *
(3) Cross-reference. For rules
governing the application of a SRLY
limitation to business interest expense
for which a deduction is disallowed
under section 163(j), see § 1.163(j)–5(d)
and (f).
*
*
*
*
*
■ Par. 24. Section 1.1502–36 is
amended by:
■ 1. Revising the second sentence of
paragraph (f)(2);
■ 2. Revising the paragraph (h) heading;
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3. Designating the text of paragraph
(h) as paragraph (h)(1) and adding a
heading to newly designated paragraph
(h)(1); and
■ 4. Adding paragraph (h)(2).
The revisions and addition read as
follows:
■
§ 1.1502–36
Unified loss rule.
*
*
*
*
*
(f) * * *
(2) * * * Such provisions include, for
example, sections 163(j), 267(f), and
469, and § 1.1502–13. * * *
*
*
*
*
*
(h) Applicability date—(1) In general.
* * *
(2) Definition in paragraph (f)(2) of
this section. Paragraph (f)(2) of this
section applies to taxable years
beginning on or after November 13,
2020. For taxable years beginning before
November 13, 2020, see § 1.1502–36 as
contained in 26 CFR part 1, revised
April 1, 2019. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after
December 31, 2017, and before
November 13, 2020, so long as the
taxpayers and their related parties
consistently apply the rules of this
section, the section 163(j) regulations (as
defined in § 1.163(j)–1(b)(37)), and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–79, 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–2, 1.382–
5, 1.382–6, 1.382–7, and 1.383–1), and
1.1504–4, to that taxable year.
■ Par. 25. Section 1.1502–79 is
amended by adding paragraph (f) to read
as follows:
§ 1.1502–79
Separate return years.
*
*
*
*
*
(f) Disallowed business interest
expense carryforwards. For the
treatment of disallowed business
interest expense carryforwards (as
defined in § 1.163(j)–1(b)(11)) of a
member arising in a separate return
limitation year, see § 1.163(j)–5(d) and
(f).
■ Par. 26. Section 1.1502–90 is
amended by revising the entry for
§ 1.1502–98 and adding an entry for
§ 1.1502–99(d) to read as follows:
§ 1.1502–90
Table of contents.
*
*
*
*
*
§ 1.1502–98 Coordination with
sections 383 and 163(j).
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§ 1.1502–99 Effective dates.
*
*
*
*
*
(d) Application to section 163(j).
■ Par. 27. Section 1.1502–91 is
amended by revising paragraph (e)(2) to
read as follows:
§ 1.1502–91 Application of section 382
with respect to a consolidated group.
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*
*
*
*
*
(e) * * *
(2) Example—(i) Facts. The L group
has a consolidated net operating loss
arising in Year 1 that is carried over to
Year 2. The L loss group has an
ownership change at the beginning of
Year 2.
(ii) Analysis. The net operating loss
carryover of the L loss group from Year
1 is a pre-change consolidated attribute
because the L group was entitled to use
the loss in Year 2 and therefore the loss
was described in paragraph (c)(1)(i) of
this section. Under paragraph (a)(2)(i) of
this section, the amount of consolidated
taxable income of the L group for Year
2 that may be offset by this loss
carryover may not exceed the
consolidated section 382 limitation of
the L group for that year. See § 1.1502–
93 for rules relating to the computation
of the consolidated section 382
limitation.
(iii) Business interest expense. The
facts are the same as in the Example in
paragraph (e)(2)(i) of this section, except
that, rather than a consolidated net
operating loss, a member of the L group
pays or accrues a business interest
expense in Year 1 for which a deduction
is disallowed in that year under section
163(j) and § 1.163(j)–2(b). The
disallowed business interest expense is
carried over to Year 2 under section
163(j)(2) and § 1.163(j)–2(c). Thus, the
disallowed business interest expense
carryforward is a pre-change loss. Under
section 163(j), the L loss group is
entitled to deduct the carryforward in
Year 2; however, the amount of
consolidated taxable income of the L
group for Year 2 that may be offset by
this carryforward may not exceed the
consolidated section 382 limitation of
the L group for that year. See § 1.1502–
98(b) (providing that §§ 1.1502–91
through 1.1502–96 apply section 382 to
business interest expense, with
appropriate adjustments).
*
*
*
*
*
■ Par. 28. Section 1.1502–95 is
amended in paragraph (b)(4) by:
■ 1. Designating Examples 1 and 2 as
paragraphs (b)(4)(i) and (ii),
respectively;
■ 2. In newly designated paragraph
(b)(4)(i), redesignating paragraphs
(b)(4)(i)(i) and (ii) as paragraphs
(b)(4)(i)(A) and (B), respectively;
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3. In newly designated paragraph
(b)(4)(ii), redesignating paragraphs
(b)(4)(ii)(i) and (ii) as paragraphs
(b)(4)(ii)(A) and (B), respectively; and
■ 4. Adding two sentences at the end of
newly redesignated paragraph
(b)(4)(ii)(B).
The additions read follows:
■
§ 1.1502–95 Rules on ceasing to be a
member of a consolidated group (or loss
subgroup).
*
*
*
*
*
(b) * * *
(4) * * *
(ii) * * *
(B) * * * The analysis would be
similar if the L loss group had an
ownership change under § 1.1502–92 in
Year 2 with respect to disallowed
business interest expense paid or
accrued by L2 in Year 1 and carried
forward under section 163(j)(2) to Year
2 and Year 3. See § 1.1502–98(b)
(providing that §§ 1.1502–91 through
1.1502–96 apply section 382 to business
interest expense, with appropriate
adjustments).
*
*
*
*
*
■ Par. 29. Section 1.1502–98 is
amended by:
■ 1. Revising the section heading;
■ 2. Designating the undesignated text
as paragraph (a) and adding a subject
heading for newly designated paragraph
(a); and
■ 3. Adding paragraph (b).
The revision and additions read as
follows:
§ 1.1502–98 Coordination with sections
383 and 163(j).
(a) Coordination with section 383.
* * *
(b) Application to section 163(j)—(1)
In general. The regulations in this part
under sections 163(j), 382, and 383 of
the Code contain rules governing the
application of section 382 to interest
expense governed by section 163(j) and
the regulations in this part under
section 163(j) of the Code. See, for
example, §§ 1.163(j)–11(c), 1.382–2,
1.382–6, 1.382–7, and 1.383–1. The
rules contained in §§ 1.1502–91 through
1.1502–96 apply these rules to members
of a consolidated group, or corporations
that join or leave a consolidated group,
with appropriate adjustments. For
example, for purposes of §§ 1.1502–91
through 1.1502–96, the term loss group
includes a consolidated group in which
any member is entitled to use a
disallowed business interest expense
carryforward, as defined in § 1.163(j)–
1(b)(11), that did not arise, and is not
treated as arising, in a SRLY with regard
to that group. Additionally, a reference
to net operating loss carryovers in
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§§ 1.1502–91 through 1.1502–96
generally includes a reference to
disallowed business interest expense
carryforwards. References to a loss or
losses in §§ 1.1502–91 through 1.1502–
96 include references to disallowed
business interest expense carryforwards
or section 382 disallowed business
interest carryforwards, within the
meaning of § 1.382–2(a)(7), as
appropriate.
(2) Appropriate adjustments. For
purposes of applying the rules in
§§ 1.1502–91 through 1.1502–96 to
current-year business interest expense
(as defined in § 1.163(j)–1(b)(9)),
disallowed business interest expense
carryforwards, and section 382
disallowed business interest
carryforwards, appropriate adjustments
are required.
■ Par. 30. Section 1.1502–99 is
amended by adding paragraph (d) to
read as follows:
§ 1.1502–99
*
Effective/applicability dates.
*
*
*
*
(d) Application to section 163(j)—(1)
Sections 1.382–2 and 1.382–5. To the
extent the rules of §§ 1.1502–91 through
1.1502–99 effectuate the rules of
§§ 1.382–2 and 1.382–5, the provisions
apply with respect to ownership
changes occurring on or after November
13, 2020. For loss corporations that have
ownership changes occurring before
November 13, 2020, see §§ 1.1502–91
through 1.1502–99 as contained in 26
CFR part 1, revised April 1, 2019.
However, taxpayers and their related
parties, within the meaning of sections
267(b) and 707(b)(1), may choose to
apply the rules of §§ 1.1502–91 through
1.1502–99 to the extent they apply the
rules of §§ 1.382–2 and 1.382–5, to
ownership changes occurring during a
taxable year beginning after December
31, 2017, as well as consistently
applying the rules of the §§ 1.1502–91
through 1.1502–99 (to the extent they
effectuate the rules of §§ 1.382–6 and
1.383–1), the section 163(j) regulations
(as defined in § 1.163(j)–1(b)(37)), and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–7, 1.469–9, 1.469–
11, 1.704–1, 1.882–5, 1.1362–3, 1.1368–
1, 1.1377–1, 1.1502–13, 1.1502–21,
1.1502–79, and 1.1504–4, to that taxable
year.
(2) Sections 1.382–6 and 1.383–1. To
the extent the rules of §§ 1.1502–91
through 1.1502–98 effectuate the rules
of §§ 1.382–6 and 1.383–1, the
provisions apply with respect to
ownership changes occurring during a
taxable year beginning on or after
November 13, 2020. For the application
of these rules to an ownership change
with respect to an ownership change
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khammond on DSKJM1Z7X2PROD with RULES2
occurring during a taxable year
beginning before November 13, 2020,
see §§ 1.1502–91 through 1.1502–99 as
contained in 26 CFR part 1, revised
April 1, 2019. However, taxpayers and
their related parties, within the meaning
of sections 267(b) and 707(b)(1), may
choose to apply the rules of §§ 1.1502–
91 through 1.1502–99 (to the extent that
those rules effectuate the rules of
§§ 1.382–6 and 1.383–1), to ownership
changes occurring during a taxable year
beginning after December 31, 2017, so
long as the taxpayers and their related
parties consistently apply the rules of
1.1502–91 through 1.1502–99 (to the
extent that those rules effectuate the
rules of §§ 1.382–2 and 1.382–5), the
section 163(j) regulations (as defined in
§ 1.163(j)–1(b)(37)), and, if applicable,
§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,
1.382–7, 1.469–9, 1.469–11, 1.704–1,
1.882–5, 1.1362–3, 1.1368–1, 1.1377–1,
1.1502–13, 1.1502–21, 1.1502–36,
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18:00 Sep 11, 2020
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1.1502–79, and 1.1504–4, to a taxable
year beginning after December 31, 2017.
■ Par. 31. Section 1.1504–4 is amended
by:
■ 1. Removing ‘‘163(j), 864(e),’’ from the
first sentence of paragraph (a)(2) and
adding ‘‘864(e)’’ in its place; and
■ 2. Adding two sentences at the end of
paragraph (i).
The additions read as follows:
§ 1.1504–4 Treatment of warrants, options,
convertible obligations, and other similar
interests.
*
*
*
*
*
(i) * * * Paragraph (a)(2) of this
section applies with respect to taxable
years beginning on or after November
13, 2020. However, taxpayers and their
related parties, within the meaning of
sections 267(b) and 707(b)(1), may
choose to apply the rules of this section
to a taxable year beginning after
December 31, 2017, so long as the
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Fmt 4701
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56845
taxpayers and their related parties
consistently apply the rules of this
section, the section 163(j) regulations (as
defined in § 1.163(j)–1(b)(37)), and, if
applicable, §§ 1.263A–9, 1.263A–15,
1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–
5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,
1.469–9, 1.469–11, 1.704–1, 1.882–5,
1.1362–3, 1.1368–1, 1.1377–1, 1.1502–
13, 1.1502–21, 1.1502–36, 1.1502–79,
1.1502–91 through 1.1502–99 (to the
extent they effectuate the rules of
§§ 1.382–2, 1.382–5, 1.382–6, 1.382–7,
and 1.383–1), to that taxable year.
Sunita Lough,
Deputy Commissioner for Services and
Enforcement.
Approved: July 14, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax
Policy).
[FR Doc. 2020–16531 Filed 9–3–20; 4:15 pm]
BILLING CODE 4830–01–P
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]]>Agencies
[Federal Register Volume 85, Number 178 (Monday, September 14, 2020)]
[Rules and Regulations]
[Pages 56686-56845]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16531]
[[Page 56685]]
Vol. 85
Monday,
No. 178
September 14, 2020
Part II
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Limitation on Deduction for Business Interest Expense; Limitation on
Deduction for Business Interest Expense; Allocation of Interest Expense
by Passthrough Entities; Dividends Paid by Regulated Investment
Companies; Application of Limitation on Deduction for Business Interest
Expense to United States Shareholders of Controlled Foreign
Corporations and to Foreign Persons With Effectively Connected Income;
Final Rule and Proposed Rule
Federal Register / Vol. 85 , No. 178 / Monday, September 14, 2020 /
Rules and Regulations
[[Page 56686]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9905]
RIN 1545-BO73; RIN 1545-BP07
Limitation on Deduction for Business Interest Expense
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations providing guidance
about the limitation on the deduction for business interest expense
after amendment of the Internal Revenue Code (Code) by the provisions
commonly known as the Tax Cuts and Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus Aid, Relief, and Economic
Security Act, which was enacted on March 27, 2020. The regulations
provide guidance to taxpayers on how to calculate the limitation, what
constitutes interest for purposes of the limitation, which taxpayers
and trades or businesses are subject to the limitation, and how the
limitation applies in consolidated group, partnership, international,
and other contexts.
DATES:
Effective date: The regulations are effective on November 13, 2020.
Sections 1.163(j)-1 through 1.163(j)-11 are generally applicable to
taxable years beginning on or after November 13, 2020.
Applicability dates: For dates of applicability, see Sec. Sec.
1.163(j)-1(c), 1.163(j)-2(k), 1.163(j)-3(d), 1.163(j)-4(g), 1.163(j)-
5(h), 1.163(j)-6(p), 1.163(j)-9(k), 1.163(j)-10(f), 1.163(j)-11(d),
1.263A-15(a), 1.381(c)(20)-1(d), 1.382-2(b)(3), 1.382-5(f), 1.382-6(h),
1.383-1(j), 1.446-3(j)(2), 1.469-11(a)(3) and (4), 1.1502-36(h)(2),
1.1502-99(d), and 1.1504-4(i).
Pursuant to section 7805(b)(7), taxpayers and their related
parties, within the meaning of sections 267(b) and 707(b)(1), may apply
the rules set forth in Sec. Sec. 1.163(j)-1 through 1.163(j)-11, in
their entirety, to a taxable year beginning after December 31, 2017,
and before November 13, 2020, so long as the taxpayers and their
related parties consistently apply these rules, and, if applicable,
Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2,
1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1,469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-90, 1.1502-91 through 1.1502-99 (to the extent
they effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and
1.383-1), and 1.1504-4, to that taxable year. However, see Sec.
1.163(j)-1(c) for the applicability date rules relating to notional
principal contracts and the interest anti-avoidance rule; see also part
II(E)(2) (relating to notional principal contracts) and part II(E)(4)
(relating to the interest anti-avoidance rule) of the Summary of
Comments and Revisions section of this preamble.
Alternatively, taxpayers and their related parties, within the
meaning of sections 267(b) and 707(b)(1), may rely on proposed
Sec. Sec. 1.163(j)-1 through 1.163(j)-11, which were issued in a
notice of proposed rulemaking (REG-106089-18) and published on December
28, 2018, in the Federal Register (83 FR 67490), in their entirety, for
a taxable year beginning after December 31, 2017, and before November
13, 2020, so long as the taxpayers and their related parties
consistently apply proposed Sec. Sec. 1.163(j)-1 through -11, and, if
applicable, proposed Sec. Sec. 1.263A-9, 1.381(c)(20)-1, 1.382-1,
1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-
11, 1.882-5, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91
through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to
that taxable year. Notwithstanding the preceding sentence, taxpayers
applying the provisions in the notice of proposed rulemaking may apply
Sec. 1.163(j)-1(b)(1)(iii) in these final regulations for taxable
years beginning after December 31, 2017.
With respect to Sec. 1.382-2 and, if applicable, Sec. Sec.
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. 1.382-2), and with respect to Sec. 1.382-5 and, if applicable,
Sec. Sec. 1.1502-91 through 1.1502-99 (to the extent they effectuate
the rules of Sec. 1.382-5), the regulations apply to testing dates and
ownership changes, respectively, occurring on or after November 13,
2020.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of Sec. 1.382-2
and, if applicable, Sec. Sec. 1.1502-91 through 1.1502-99 (to the
extent they effectuate the rules of Sec. 1.382-2), and Sec. 1.382-5
and, if applicable, Sec. Sec. 1.1502-91 through 1.1502-99 (to the
extent they effectuate the rules of Sec. 1.382-5), to a testing date
or an ownership change, respectively, that occurs in a taxable year
beginning after December 31, 2017, and before November 13, 2020, so
long as the taxpayers and their related parties consistently apply the
rules of Sec. Sec. 1.163(j)-1 through -11, 1.382-1, 1.382-2, 1.382-5,
1.382-6, 1.382-7, 1.383-0, and 1.383-1, and, if applicable, Sec. Sec.
1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36,
1.1502-79, 1.1502-90, 1.1502-91 through 1.1502-99 (to the extent they
effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and
1.383-1), and 1.1504-4, to that taxable year.
Alternatively, taxpayers and their related parties, within the
meaning of sections 267(b) and 707(b)(1), may rely on the rules of
proposed Sec. 1.382-2 and, if applicable, Sec. Sec. 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. 1.382-2),
and Sec. 1.382-5 and, if applicable, Sec. Sec. 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. 1.382-5),
which were issued in a notice of proposed rulemaking (REG-106089-18)
and published on December 28, 2018, in the Federal Register (83 FR
67490), with respect to a testing date or an ownership change,
respectively, that occurs in a taxable year beginning after December
31, 2017, and before November 13, 2020, so long as the taxpayers and
their related parties consistently apply the rules of proposed
Sec. Sec. 1.163(j)-1 through -11, 1.382-1, 1.382-2, 1.382-5, 1.382-6,
1.382-7, 1.383-0, and 1.383-1, and, if applicable, proposed Sec. Sec.
1.263A-9, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.882-5, 1.1502-13,
1.1502-21, 1.1502-36, 1.1502-79, 1.1502-90, 1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of Sec. Sec. 1.382-2, 1.382-
5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year. As noted
previously, taxpayers relying on the provisions in the notice of
proposed rulemaking may apply Sec. 1.163(j)-1(b)(1)(iii) in these
final regulations for taxable years ending after December 31, 2017.
FOR FURTHER INFORMATION CONTACT: Concerning Sec. 1.163(j)-1, Sec.
1.163(j)-2, Sec. 1.163(j)-3, Sec. 1.163(j)-9, Sec. 1.263A-9, or
Sec. 1.263A-15, Sophia Wang, (202) 317-4890 or Justin Grill, (202)
317-4850; concerning Sec. 1.163(j)-4, Sec. 1.163(j)-5, Sec.
1.163(j)-10, Sec. 1.163(j)-11, Sec. 1.381(c)(20)-1, Sec. 1.382-1,
Sec. 1.382-2, Sec. 1.382-5, Sec. 1.382-6, Sec. 1.382-7, Sec.
1.383-0, Sec. 1.383-1, Sec. 1.1502-13, Sec. 1.1502-21, Sec. 1.1502-
36, Sec. 1.1502-79, Sec. 1.1502-90, Sec. 1.1502-91, Sec. 1.1502-95,
Sec. 1.1502-98, Sec. 1.1502-99, or Sec. 1.1504-4, Russell Jones,
(202) 317-5357, John Lovelace, (202) 317-5363, Aglaia Ovtchinnikova,
(202) 317-6975, or Marie C. Milnes-Vasquez, (202) 317-3181; concerning
Sec. 1.163(j)-6, Sec. 1.469-9(b)(2), Sec. 1.469-11, Sec. 1.704-1,
Sec. 1.1362-3, Sec. 1.1368-1, or
[[Page 56687]]
Sec. 1.1377-1, William Kostak, (202) 317-6852, Anthony McQuillen,
(202) 317-5027, or Adrienne Mikolashek, (202) 317-5050; concerning
Sec. 1.163(j)-7, Sec. 1.163(j)-8, or Sec. 1.882-5, Azeka Abramoff,
(202) 317-3800, Angela Holland, (202) 317-5474, or Steve Jensen, (202)
317-6938; concerning Sec. 1.446-3, Sec. 1.860C-2, RICs, REITs,
REMICs, and the definition of the term ``interest'', Michael Chin,
(202) 317-5846 (not toll-free numbers).
ADDRESSES: Submit electronic submissions to the Federal eRulemaking
Portal at https://www.regulations.gov (indicate IRS and REG-106089-18)
by following the online instructions for submitting comments. Once
submitted to the Federal eRulemaking Portal, comments cannot be edited
or withdrawn. The Department of the Treasury (Treasury Department) and
the Internal Revenue Service (IRS) will publish for public availability
any comment received to its public docket, whether submitted
electronically or in hard copy. Send hard copy submissions to
CC:PA:LPD:PR (REG-106089-18), Room 5203, Internal Revenue Service, P.O.
Box 7604, Ben Franklin Station, Washington, DC 20044.
SUPPLEMENTARY INFORMATION:
Background
Table of Contents
I. Overview
II. Comments on and Changes to Proposed Sec. 1.163(j)-1:
Definitions
A. Definition and Calculation of Adjusted Taxable Income (ATI)--
Proposed Sec. 1.163(j)-1(b)(1)
1. Taxable Income and Tentative Taxable Income
2. Adjustments to ATI for Amounts Incurred as Depreciation,
Amortization, and Depletion
3. ATI and Floor Plan Financing Interest
4. Adjustments to Taxable Income in Computing ATI Under Section
163(j)(8)(A)
5. Certain Adjustments to Tentative Taxable Income in Computing
ATI Under Section 163(j)(8)(B)
6. Adjustments to Adjusted Taxable Income in Respect of United
States Shareholders of CFCs
B. Definition of Business Interest Expense--Proposed Sec.
1.163(j)-1(b)(2)
C. Definition of Excepted Regulated Utility Trade or Business--
Proposed Sec. 1.163(j)-1(b)(13)
D. Definition of Floor Plan Financing Interest Expense--Proposed
Sec. 1.163(j)-1(b)(17)
E. Definition of Interest--Proposed Sec. 1.163(j)-1(b)(20)
1. In General
2. Swaps With Significant Nonperiodic Payments
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary Income or Loss on Certain
Debt Instruments, Section 1258 Gain, and Factoring Income
ii. Substitute Interest Payments
iii. Commitment Fees
iv. Debt Issuance Costs
v. Guaranteed Payments
vi. Hedging Transactions
vii. Other Items
a. Dividends From Regulated Investment Company (RIC) Shares
b. MMF Income
c. Negative Interest
d. Leases
4. Anti-Avoidance Rule for Amounts Predominantly Associated With
the Time Value of Money
5. Authority Comments
F. Definition of Motor Vehicle--Proposed Sec. 1.163(j)-1(b)(25)
G. Definition of Taxable Income--Proposed Sec. 1.163(j)-
1(b)(37)
1. Calculation of Taxable Income
2. Interaction With Section 250
3. When Disallowed Business Interest Expense is ``Paid or
Accrued''
4. Interaction With Sections 461(l), 465, and 469--Proposed
Sec. 1.163(j)-1(b)(37)
H. Definition of Trade or Business--Proposed Sec. 1.163(j)-
1(b)(38)
1. In General
2. Multiple Trades or Businesses Within an Entity
3. Rental Real Estate Activities as a Trade or Business
4. Separate Entities
I. Applicability Dates
III. Comments on and Changes to Proposed Sec. 1.163(j)-2: Deduction
for Business Interest Expense Limited
A. Whether the Section 163(j) Limitation Is a Method of
Accounting
B. General Gross Receipts Test and Aggregation
C. Small Business Exemption and Single Employer Aggregation
Rules--Proposed Sec. Sec. 1.163(j)-2(d) and 1.52-1(d)(1)(i)
D. Small Business Exemption and Tax Shelters--Proposed Sec.
1.163(j)-2(d)(1)
E. Gross Receipts for Partners in Partnerships and Shareholders
of S Corporation Stock--Proposed Sec. 1.163(j)-2(d)(2)(iii)
IV. Comments on and Changes to Section Proposed Sec. 1.163(j)-3:
Relationship of Section 163(j) Limitation to Other Provisions
Affecting Interest
A. Capitalized Interest
B. Provisions That Characterize Interest Expense as Something
Other Than Business Interest Expense
C. Section 108
D. Sections 461(l), 465, and 469
V. Comments on and Changes to Proposed Sec. 1.163(j)-4: General
Rules Applicable to C Corporations (Including Real Estate Investment
Trusts (REITs), RICs, and Members of Consolidated Groups) and Tax-
Exempt Corporations
A. Aggregating Affiliated but Non-Consolidated Entities
B. Intercompany Transactions and Intercompany Obligations
C. Repurchase Premium on Obligations That Are Deemed Satisfied
and Reissued
D. Intercompany Transfers of Partnership Interests
1. Overview of Proposed Sec. 1.163(j)-4(d)(4)
2. Intercompany Transfers of Partnership Interests Treated as
Dispositions; Single-Entity Treatment; Application of Sec. 1.1502-
13
3. Possible Approach to Intercompany Partnership Interest
Transfers
4. Offsetting Excess Business Interest Expense and Adjusted
Taxable Income Within the Consolidated Group
5. Intercompany Nonrecognition Transactions
6. Basis Adjustments Under Sec. 1.1502-32
7. Partnership Terminations
E. Application of Sec. 1.1502-36 to Excess Business Interest
Expense
F. Calculating ATI for Cooperatives
G. Calculating ATI for a Consolidated Group
H. Application of Section 163(j) to Life-Nonlife Groups
I. Application of Section 163(j) to Tax-Exempt Entities
J. Partnership Investment Income and Corporate Partners
K. Earnings and Profits of a Corporate Partner
VI. Comments on and Changes to Proposed Sec. 1.163(j)-5: General
Rules Governing Disallowed Business Interest Expense Carryforwards
for C Corporations
A. Absorption of Disallowed Business Interest Expense
Carryforwards Before Use of NOLs in Life-Nonlife Groups
B. Carryforwards from Separate Return Limitation Years
C. Offsetting Business Interest Expense With Business Interest
Income and Floor Plan Financing Interest Expense at the Member Level
VII. Comments on and Changes to Section 1.163(j)-6: Application of
the Business Interest Expense Deduction Limitations to Partnerships
and Subchapter S Corporations
A. Partnership-Level Calculation and Allocation of Section
163(j) Excess Items
1. Nonseparately Stated Taxable Income or Loss of the
Partnership
2. Requested Clarifications and Modifications
3. Recommended Alternative Methods
4. Publicly Traded Partnerships
5. Pro Rata Exception
B. Basis Adjustments
1. Basis and Capital Account Adjustments for Excess Business
Interest Expense Allocations
2. Basis Adjustments Upon Disposition of Partnership Interests
Pursuant to Section 163(j)(4)(B)(iii)(II)
3. Intercompany Transfer of a Partnership Interest
C. Debt-Financed Distributions
D. Trading Partnerships
E. Treatment of Excess Business Interest Expense in Tiered
Partnerships
F. Partnership Mergers and Divisions
G. Applicability of Section 382 to S Corporations Regarding
Disallowed Business Interest Expense Carryforwards
H. Separate Application of Section 163(j) Limitation to Short
Taxable Years of S Corporation
I. Partnership or S Corporation Not Subject to Section 163(j)
[[Page 56688]]
J. Trusts
K. Qualified Expenditures
L. CARES Act Partnership Rules
VIII. Comments on and Changes to Proposed Sec. 1.163(j)-7:
Application of the Section 163(j) Limitation to Foreign Corporations
and United States Shareholders
IX. Comments on and Changes to Section 1.163(j)-8: Application of
the Section 163(j) Limitation to Foreign Persons with Effectively
Connected Taxable Income.
X. Comments on and Changes to Proposed Sec. 1.163(j)-9: Elections
for Excepted Trades or Businesses; Safe Harbor for Certain REITs
A. Protective Elections
B. One-Time Late Election or Withdrawal of Election Procedures
C. The Anti-Abuse Rule Under Proposed Sec. 1.163(j)-9(h)
D. Residential Living Facilities and Notice With Proposed
Revenue Procedure
E. Safe Harbor for Certain REITs
F. Real Property Trade or Business
XI. Comments on and Changes to Proposed Sec. 1.163(j)-10:
Allocation of Interest Expense, Interest Income, and Other Items of
Expense and Gross Income to an Excepted Trade or Business.
A. General Method of Allocation: Asset Basis
B. Allocation Between Trades or Businesses and Non-Trades or
Businesses
C. Consolidated Groups
1. Overview
2. Intercompany Transactions
3. Use of Property Derives From an Intercompany Transaction
4. Purchase of Member Stock From a Nonmember
5. Inclusion of Income From Excepted Trades or Businesses in
Consolidated ATI
6. Engaging in Excepted or Non-Excepted Trades or Businesses as
a ``Special Status''
D. Quarterly Asset Testing
E. De Minimis Rules
1. Overview
2. Order in Which the De Minimis Rules Apply
3. Mandatory Application of De Minimis Rules
4. De Minimis Threshold for Electric Cooperatives
5. Standardization of 90 Percent De Minimis Tests
6. Overlapping De Minimis Tests
F. Assets Used in More Than One Trade or Business
1. Overview
2. Consistency Requirement
3. Changing a Taxpayer's Allocation Methodology
4. Mandatory Use of Relative Output for Utility Trades or
Businesses
G. Exclusions From Basis Calculations
H. Look-Through Rules
1. Ownership Thresholds; Direct and Indirect Ownership Interests
2. Application of Look-Through Rules to Partnerships
i. In General
ii. Coordination of Look-Through Rule and Basis Determination
Rules
iii. Applying the Look-Through Rule and Determining Share of
Partnership Basis
iv. Investment Asset Basis Reduction Rule
v. Coordination of Section 752 Basis Reduction Rule and
Investment Asset Basis Reduction Rule
vi. Allocating Basis in a Partnership Interest Between Excepted
and Non-Excepted Trades or Businesses
3. Additional Limitation on Application of Look-Through Rules to
C Corporations
4. Dispositions of Stock in Non-Consolidated C Corporations
5. Application of Look-Through Rules to Small Businesses
6. Application of the Look-Through Rules to Foreign Utilities
I. Deemed Asset Sale
J. Carryforwards of Disallowed Disqualified Interest
K. Anti-Abuse Rule
L. Direct Allocation
1. Overview
2. Expansion of the Direct Allocation Rule
3. Basis Reduction Requirement for Qualified Nonrecourse
Indebtedness
4. Direct Allocation Rule for Financial Services Businesses
XII. Comments on Proposed Changes to Sec. 1.382-2: General Rules
for Ownership Change
XIII. Comments on Proposed Changes to Sec. 1.382-6: Allocation of
Income and Loss to Periods Before and After the Change Date for
Purposes of Section 382
XIV. Comments on and Changes to Proposed Sec. 1.383-1: Special
Limitations on Certain Capital Losses and Excess Credits
XV. Other Comments about Section 382
A. Application of Section 382(l)(5)
B. Application of Section 382(e)(3)
C. Application of Section 382(h)(6)
XVI. Definition of Real Property Trade or Business
This document contains amendments to the Income Tax Regulations (26
CFR part 1) under section 163(j) of the Code. The final regulations
reflect amendments to section 163(j) made by Public Law 115-97, 131
Stat. 2054 (December 22, 2017), commonly referred to as the Tax Cuts
and Jobs Act (the TCJA) and the Coronavirus Aid, Relief, and Economic
Security Act, Public Law 116-136 (2020) (the CARES Act). Section
13301(a) of the TCJA amended section 163(j) by removing prior section
163(j)(1) through (9) and adding section 163(j)(1) through (10) and
significantly changed the limitation for deducting interest on certain
indebtedness. The provisions of section 163(j) as amended by section
13301 of the TCJA are effective for tax years beginning after December
31, 2017. The CARES Act further amended section 163(j) by redesignating
section 163(j)(10), as amended by the TCJA, as new section 163(j)(11),
and adding a new section 163(j)(10) providing special rules for
applying section 163(j) to taxable years beginning in 2019 or 2020. All
references to ``old section 163(j)'' in this document are references to
section 163(j) prior to amendment by the TCJA and the CARES Act, and
all references to ``section 163(j)'' are references to section 163(j)
as amended by the TCJA and the CARES Act.
Old section 163(j) generally disallowed a deduction for
``disqualified interest'' paid or accrued by a corporation in a taxable
year if the payor's debt-to-equity ratio exceeded 1.5 to 1.0, and if
the payor's net interest expense exceeded 50 percent of its adjusted
taxable income. Disqualified interest included interest paid or accrued
to (1) related parties when no Federal income tax was imposed with
respect to such interest; (2) unrelated parties in certain instances in
which a related party guaranteed the debt; or (3) certain real estate
investment trusts (REIT). Interest amounts disallowed for any taxable
year under old section 163(j) were treated as interest paid or accrued
in the succeeding taxable year and could be carried forward
indefinitely. In addition, any excess limitation, the excess of the
taxpayer's net interest expense over 50 percent of its adjusted taxable
income, could be carried forward three years. The interest limitation
under old section 163(j) was designed to prevent a taxpayer from
deducting interest from its U.S. taxable income without a corresponding
inclusion in U.S. taxable income by the recipient, or to prevent the
stripping of earnings from the U.S. tax system.
In contrast, section 163(j) now applies broadly to all business
interest expense regardless of whether the related indebtedness is
between related parties or incurred by a corporation, and regardless of
the taxpayer's debt-to-equity ratio. Section 163(j) provides an
entirely new limitation on the deduction for ``business interest
expense'' of all taxpayers, including, for example, individuals,
corporations, partnerships, S corporations, unless a specific exclusion
applies under section 163(j). Although certain terms are used in both
old section 163(j) and section 163(j), such as ``adjusted taxable
income,'' such terms have been updated in the final regulations to
reflect the new limitation under section 163(j).
Section 163(j) generally limits the amount of business interest
expense that can be deducted in the current taxable year (also referred
to in this preamble as the current year). Under section 163(j)(1), the
amount allowed as a deduction for business interest expense is limited
to the sum of (1) the taxpayer's business interest income for the
taxable year; (2) 30 percent of the taxpayer's adjusted taxable income
(ATI) for the taxable year (30 percent
[[Page 56689]]
ATI limitation); and (3) the taxpayer's floor plan financing interest
expense for the taxable year. As further described later in this
Background section, section 163(j)(10), as amended by the CARES Act,
provides special rules relating to the 30 percent ATI limitation for
taxable years beginning in 2019 or 2020. The section 163(j) limitation
applies to all taxpayers, except for certain small businesses that meet
the gross receipts test in section 448(c) and certain trades or
businesses listed in section 163(j)(7).
Section 163(j)(2) provides that the amount of any business interest
not allowed as a deduction for any taxable year as a result of the
section 163(j) limitation is carried forward and treated as business
interest paid or accrued in the next taxable year. In contrast to old
section 163(j), section 163(j) does not allow the carryforward of any
excess limitation.
Section 163(j)(3) provides that the section 163(j) limitation does
not apply to a taxpayer, other than a tax shelter as described in
section 448(a)(3), with average annual gross receipts of $25 million or
less, determined under section 448(c) (including any adjustment for
inflation under section 448(c)(4)). For taxpayers other than
corporations or partnerships, section 163(j)(3) provides that the gross
receipts test is determined for purposes of section 163(j) as if the
taxpayer were a corporation or partnership.
Section 163(j)(4) provides special rules for applying section
163(j) in the case of partnerships and S corporations. Section
163(j)(4)(A) requires that the limitation on the deduction for business
interest expense be applied at the partnership level, and that a
partner's ATI be increased by the partner's share of the partnership's
excess taxable income, as defined in section 163(j)(4)(C), but not by
the partner's distributive share of the partnership's income, gain,
deduction, or loss. Section 163(j)(4)(B)(i) provides that the amount of
partnership business interest expense limited by section 163(j)(1) is
carried forward at the partner level. Section 163(j)(4)(B)(ii) provides
that excess business interest expense allocated to a partner and
carried forward is available to be deducted in a subsequent year only
if, and to the extent, the partnership allocates excess taxable income
to the partner. As further described later in this Background section,
section 163(j)(10)(A)(ii)(II), as amended by the CARES Act, provides a
special rule for excess business interest expense allocated to a
partner in a taxable year beginning in 2019. Section 163(j)(4)(B)(iii)
provides basis adjustment rules for a partner that is allocated excess
business interest expense. Section 163(j)(4)(D) provides that rules
similar to the rules of section 163(j)(4)(A) and (C) apply to S
corporations and S corporation shareholders.
Section 163(j)(5) and (6) defines ``business interest'' and
``business interest income,'' respectively, for purposes of section
163(j). Generally, these terms include interest expense and interest
includible in gross income that is properly allocable to a trade or
business (as defined in section 163(j)(7)) and do not include
investment income or investment expense within the meaning of section
163(d). The legislative history states that ``a corporation has neither
investment interest nor investment income within the meaning of section
163(d). Thus, interest income and interest expense of a corporation is
properly allocable to a trade or business, unless such trade or
business is otherwise explicitly excluded from the application of the
provision.'' H. Rept. 115-466, at 386, fn. 688 (2017).
Under section 163(j)(7), the limitation on the deduction for
business interest expense in section 163(j)(1) does not apply to
certain trades or businesses (excepted trades or businesses). The
excepted trades or businesses are the trade or business of providing
services as an employee, electing real property businesses, electing
farming businesses, and certain regulated utility businesses.
Section 163(j)(8) defines ATI as the taxable income of the taxpayer
without regard to the following: Items not properly allocable to a
trade or business; business interest and business interest income; net
operating loss (NOL) deductions; and deductions for qualified business
income under section 199A. ATI also generally excludes deductions for
depreciation, amortization, and depletion with respect to taxable years
beginning before January 1, 2022, and it includes other adjustments
provided by the Secretary of the Treasury.
Section 163(j)(9) defines ``floor plan financing interest'' as
interest paid or accrued on ``floor plan financing indebtedness.''
These provisions allow taxpayers incurring interest expense for the
purpose of securing an inventory of motor vehicles held for sale or
lease to deduct the full expense without regard to the section 163(j)
limitation.
Under section 163(j)(10)(A)(i), the amount of business interest
that is deductible under section 163(j)(1) for taxable years beginning
in 2019 or 2020 is computed using 50 percent, rather than 30 percent,
of the taxpayer's ATI for the taxable year (50 percent ATI limitation).
A taxpayer may elect not to apply the 50 percent ATI limitation to any
taxable year beginning in 2019 or 2020, and instead apply the 30
percent ATI limitation. The election must be made separately for each
taxable year. Once the taxpayer makes the election, the election may
not be revoked without the consent of the Secretary of the Treasury or
his delegate. See section 163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and 163(j)(10)(A)(iii) provide that,
in the case of a partnership, the 50 percent ATI limitation does not
apply to partnerships for taxable years beginning in 2019, and the
election to not apply the 50 percent ATI limitation may be made only
for taxable years beginning in 2020. This election may be made only by
the partnership and may not be revoked without the consent of the
Secretary of the Treasury or his delegate. Under section
163(j)(10)(A)(ii)(II), however, a partner treats 50 percent of its
allocable share of a partnership's excess business interest expense for
2019 as a business interest expense in the partner's first taxable year
beginning in 2020 that is not subject to the section 163(j) limitation
(50 percent EBIE rule). The remaining 50 percent of the partner's
allocable share of the partnership's excess business interest expense
remains subject to the section 163(j) limitation applicable to excess
business interest expense carried forward at the partner level. A
partner may elect out of the 50 percent EBIE rule.
Section 163(j)(10)(B)(i) allows a taxpayer to elect to use its ATI
for the last taxable year beginning in 2019 for the taxpayer's ATI in
determining the taxpayer's section 163(j) limitation for any taxable
year beginning in 2020.
Section 163(j)(11) provides cross-references to provisions
requiring that electing farming businesses and electing real property
businesses excepted from the section 163(j) limitation use the
alternative depreciation system (ADS), rather than the general
depreciation system for certain types of property. The required use of
ADS results in the inability of these electing trades or businesses to
use the additional first-year depreciation deduction under section
168(k) for those types of property.
On December 28, 2018, the Treasury Department and the IRS (1)
published proposed regulations under section 163(j) in a notice of
proposed rulemaking (REG-106089-18) (proposed regulations) in the
Federal Register (83 FR 67490), and (2) withdrew the notice of proposed
rulemaking (1991-2 C.B. 1040) published in the Federal Register
[[Page 56690]]
on June 18, 1991 (56 FR 27907) (as corrected by 56 FR 40285 (August 14,
1991)) to implement rules under old section 163(j) (1991 Proposed
Regulations). The proposed regulations were issued following guidance
announcing and describing regulations intended to be issued under
section 163(j). See Notice 2018-28, 2018-16 I.R.B. 492.
A public hearing was held on February 27, 2019. The Treasury
Department and the IRS received written comments responding to the
notice of proposed rulemaking. Comments received before the final
regulations were substantially developed, including all comments
received on or before the deadline for comments on February 26, 2019,
were carefully considered in developing the final regulations.
Copies of the comments received are available for public inspection
at https://www.regulations.gov or upon request. After consideration of
the comments received and the testimony at the public hearing, this
Treasury decision adopts the proposed regulations as revised in
response to such comments and testimony as described in the Summary of
Comments and Explanation of Revisions section. The revisions are
discussed in this preamble. Concurrently with the publication of the
final regulations, the Treasury Department and the IRS are publishing
in the Proposed Rule section of this edition of the Federal Register
(RIN 1545-BO76) a notice of proposed rulemaking providing additional
proposed regulations under section 163(j) (REG-107911-18) (Concurrent
NPRM). The Concurrent NPRM includes proposed regulations relating to
changes made to section 163(j) under the CARES Act.
On September 10, 2019, the Treasury Department and the IRS
published proposed regulations under section 382(h) (REG-125710-18) in
the Federal Register (84 FR 47455) (the September 2019 section 382
proposed regulations). The September 2019 section 382 proposed
regulations included a rule to clarify that section 382 disallowed
business interest carryforwards are not treated as recognized built-in
losses (RBILs). No formal comments were received on this rule during
the comment period for the September 2019 section 382 proposed
regulations.
On April 10, 2020, the Treasury Department and the IRS released
Revenue Procedure 2020-22, 2020-18 I.R.B. 745, to provide the time and
manner of making a late election, or withdrawing an election under
section 163(j)(7)(B) to be an electing real property trade or business,
or under section 163(j)(7)(C) to be an electing farming business, for
taxable years beginning in 2018, 2019, or 2020. Revenue Procedure 2020-
22 also provides the time and manner of making or revoking elections
provided by the CARES Act under section 163(j)(10) for taxable years
beginning in 2019 or 2020. As described earlier in this Background
section, these elections are: (1) To not apply the 50 percent ATI
limitation under section 163(j)(10)(A)(iii); (2) to use the taxpayer's
ATI for the last taxable year beginning in 2019 to calculate the
taxpayer's section 163(j) limitation in 2020 under section
163(j)(10)(B); and (3) for a partner to elect out of the 50 percent
EBIE rule under section 163(j)(10)(A)(ii)(II).
Summary of Comments and Explanation of Revisions
I. Overview
The Treasury Department and the IRS received approximately 120
written comments in response to the notice of proposed rulemaking. Most
of the comments addressing the proposed regulations are summarized in
this Summary of Comments and Explanation of Revisions section. However,
comments merely summarizing or interpreting the proposed regulations or
recommending statutory revisions generally are not discussed in this
preamble. Additionally, comments outside the scope of this rulemaking
are generally not addressed in this Summary of Comments and Explanation
of Revisions section.
The Treasury Department and the IRS continue to study comments on
certain issues related to section 163(j), including issues that are
beyond the scope of the final regulations (or the Concurrent NPRM in
the Proposed Rules section of this issue of the Federal Register), and
may discuss those comments if future guidance on those issues is
published.
The final regulations retain the same basic structure as the
proposed regulations, with certain revisions.
II. Comments on and Changes to Proposed Sec. 1.163(j)-1: Definitions
Section 1.163(j)-1 provides definitions of the terms used in the
final regulations. The following discussion addresses comments relating
to proposed Sec. 1.163(j)-1.
A. Definition and Calculation of Adjusted Taxable Income (ATI)--
Proposed Sec. 1.163(j)-1(b)(1)
1. Taxable Income and Tentative Taxable Income
Consistent with section 163(j)(8), proposed Sec. 1.163(j)-1(b)(1)
defines ATI as the ``taxable income'' of the taxpayer for the taxable
year, with certain specified adjustments. Thus, in calculating ATI, the
proposed regulations begin with taxable income as the amount to which
adjustments are made when calculating ATI. Proposed Sec. 1.163(j)-
1(b)(37)(i) generally provides that the term ``taxable income'' has the
meaning provided in section 63, but for purposes of section 163(j), is
computed without regard to the application of section 163(j) and the
section 163(j) regulations. However, in some instances in the section
163(j) regulations the term ``taxable income'' is used to indicate the
amount calculated under section 63 for purposes other than calculating
ATI.
To prevent confusion from using the term ``taxable income'' in
different contexts (in determining ATI, and for purposes other than
determining ATI), the final regulations use a new term, ``tentative
taxable income,'' to refer to the amount to which adjustments are made
in calculating ATI. See Sec. 1.163(j)-1(b)(43). Tentative taxable
income is generally determined in the same manner as taxable income
under section 63, but is computed without regard to the application of
the section 163(j) limitation, and without regard to any disallowed
business interest expense carryforwards. This definitional change
avoids confusion with section 63 taxable income, avoids creating an
iterative loop that takes into account the section 163(j) limitation,
and ensures that disallowed business interest expense carryforwards are
taken into account only once in testing business interest expense
against the limitation.
Therefore, ``tentative taxable income'' is used in the final
regulations and, where appropriate, in this Summary of Comments and
Explanation of Provisions section, to describe the starting point for
the calculation of ATI in the final regulations. See part II(G)(1) of
this Summary of Comments and Explanation of Revisions section.
2. Adjustments to ATI for Amounts Incurred as Depreciation,
Amortization, and Depletion
Section 163(j)(8)(A)(v) defines ATI as the taxable income of the
taxpayer computed without regard to certain items, including any
deduction allowable for depreciation, amortization, or depletion for
taxable
[[Page 56691]]
years beginning before January 1, 2022. Consistent with section
163(j)(8)(A)(v), proposed Sec. 1.163(j)-1(b)(1)(i) requires an addback
to taxable income of deductions for depreciation, amortization, and
depletion for taxable years beginning before January 1, 2022. In
general, section 263A requires certain taxpayers that manufacture or
produce inventory to capitalize all direct costs and certain indirect
costs into the basis of the property produced or acquired for resale.
Depreciation, amortization or depletion that is capitalized into
inventory under section 263A is recovered through cost of goods sold as
an offset to gross receipts in computing gross income; cost of goods
sold reduces the amount realized upon the sale of goods that is used to
calculate gross income and is technically not a deduction that is
applied against gross income in determining taxable income. See
Sec. Sec. 1.61-3(a) and 1.263A-1(e)(3)(ii)(I) and (J). Thus, proposed
Sec. 1.163(j)-1(b)(1)(iii) provides that depreciation, amortization,
or depletion expense capitalized into inventory under section 263A is
not a depreciation, amortization, or depletion deduction, that may be
added back to taxable income in computing ATI. The preamble to the
proposed regulations further noted that an amount that is incurred as
depreciation, amortization, or depletion, but that is capitalized to
inventory under section 263A and included in costs of goods sold, is
not a deduction for depreciation, amortization, or depletion for
purposes of section 163(j).
Many commenters raised questions and concerns regarding proposed
Sec. 1.163(j)-1(b)(1)(iii) and requested that the addback of
deductions for depreciation, amortization, and depletion include any
amount that is required to be capitalized into inventory under section
263A. First, commenters stated that the provision does not reflect
congressional intent, which was to determine ATI using earnings before
interest, tax, depreciation, and amortization (EBITDA) through taxable
year 2021 and using earnings before interest and tax (EBIT) thereafter.
Commenters noted that the proposed rule would eliminate this
distinction for certain manufacturers or producers of property for
sale. Commenters pointed out that capital-intensive businesses that
manufacture or produce inventory are at a disadvantage in comparison to
other types of businesses because the manufacturers or producers would
have to compute ATI without an addback for a substantial amount of
their depreciation, and that neither section 163(j) nor its legislative
history indicates an intent by Congress to treat manufacturers or
producers of inventory differently from other trades or businesses.
Commenters also contrasted the language in section 163(j)(8)(A)(iv),
which allows an addback of ``the amount of any deduction allowed under
section 199A,'' with section 163(j)(8)(A)(v), which allows an addback
of ``any deduction allowable for depreciation, amortization, or
depletion'' (emphasis added).
The phrase ``allowed or allowable'' is used in other Code
provisions. Section 1016(a)(2) provides that, in calculating tax basis,
adjustments are required for depreciation to the extent such amounts
are allowed as deductions in computing taxable income but not less than
the amounts allowable. Some commenters noted that depreciation
allowable as a deduction for purposes of section 1016(a)(2) should be
read consistently with depreciation allowable as a deduction for
purposes of section 163(j), and that section 1016(a)(2) treats
depreciation capitalized into inventory under section 263A as
deductions allowable. As provided in section 263A(a)(2) and Sec.
1.263A-1(c)(2), an amount is not subject to capitalization under
section 263A unless such cost may be taken into account in computing
taxable income.
The Treasury Department and the IRS have reconsidered proposed
Sec. 1.163(j)-1(b)(1)(iii). Accordingly, under the final regulations,
the amount of any depreciation, amortization, or depletion that is
capitalized into inventory under section 263A during taxable years
beginning before January 1, 2022, is added back to tentative taxable
income as a deduction for depreciation, amortization, or depletion when
calculating ATI for that taxable year, regardless of the period in
which the capitalized amount is recovered through cost of goods sold.
For example, if a taxpayer capitalized an amount of depreciation to
inventory under section 263A in the 2020 taxable year, but the
inventory is not sold until the 2021 taxable year, the entire
capitalized amount of depreciation is added back to tentative taxable
income in the 2020 taxable year, and such capitalized amount of
depreciation is not added back to tentative taxable income when the
inventory is sold and recovered through cost of goods sold in the 2021
taxable year. Under such facts, the entire capitalized amount is deemed
to be included in the calculation of the taxpayer's tentative taxable
income for the 2020 taxable year, regardless of the period in which the
capitalized amount is actually recovered. See Sec. Sec. 1.163(j)-
1(b)(1)(iii) and 1.163(j)-2(h)(3).
Further, in order to treat similarly situated taxpayers similarly,
the final regulations allow taxpayers, and their related parties within
the meaning of sections 267(b) and 707(b)(1), otherwise relying on the
proposed regulations in their entirety under Sec. 1.163(j)-1(c) to
alternatively choose to follow Sec. 1.163(j)-1(b)(1)(iii) rather than
proposed Sec. 1.163(j)-1(b)(1)(iii). See Sec. 1.163(j)-1(c).
The Treasury Department and the IRS note that neither proposed
Sec. 1.163(j)-1(b)(1) nor Sec. 1.163(j)-1(b)(1) determines the amount
of allowed or allowable depreciation, amortization, or depletion for
purposes of any other Code section (for example, sections 167(c),
1016(a)(2), 1245, and 1250). Accordingly, no inference should be drawn
regarding the determination of the amount of allowed or allowable
depreciation, amortization, or depletion under any other Code section
based on proposed Sec. 1.163(j)-1(b)(1) or Sec. 1.163(j)-1(b)(1).
In addition to comments about whether depreciation, amortization,
and depletion include amounts recovered through cost of goods sold, a
commenter requested clarification that section 179 deductions are
depreciation deductions for purposes of section 163(j)(8)(A)(v) and
proposed Sec. 1.163(j)-1(b)(1)(i)(D). Section 179 deductions are
allowed to be added back as amortization under proposed Sec. 1.163(j)-
1(b)(1)(i)(E), which allows an addback of any deduction for the
amortization of intangibles (for example, under section 167 or 197) and
other amortized expenditures (for example, under section 195(b)(1)(B),
248, or 1245(a)(2)(C)), for taxable years beginning before January 1,
2022. Section 1245(a)(2)(C) provides ``any deduction allowable under
sections 179, 179B, 179C, 179D, 179E, 181, 190, 193, or 194 shall be
treated as if it were a deduction allowable for amortization.'' Because
section 179 deductions are included as amortization under proposed
Sec. 1.163(j)-1(b)(1)(i)(E), rather than as depreciation under
proposed Sec. 1.163(j)-1(b)(1)(i)(D), no clarification is necessary in
the final regulations. See Sec. 1.163(j)-1(b)(1)(i)(E).
3. ATI and Floor Plan Financing Interest
Consistent with section 163(j)(8)(A)(ii), the proposed regulations
provide that any business interest expense or business interest income
is added back to (in the case of business interest expense) or
subtracted from (in the case of business interest income) taxable
income in computing ATI. Because business interest expense includes
floor plan financing interest expense, ATI is further adjusted by
[[Page 56692]]
subtracting from it any floor plan financing interest expense under
proposed Sec. 1.163(j)-1(b)(1)(ii)(B). Floor plan financing interest
expense is also separately included in the section 163(j) limitation as
provided in section 163(j)(1)(C).
One commenter suggested that floor plan financing interest expense
should not be subtracted from ATI because such adjustment is
inconsistent with the statute and the ordering implied by section
168(k)(9)(B). The addition of floor plan financing interest expense as
business interest in the calculation of ATI is consistent with section
163(j)(8)(A)(ii). The purpose of subtracting floor plan financing
interest expense from tentative taxable income to compute ATI is to
avoid the double benefit that would result upon separately including
floor plan financing interest expense in the computation of the section
163(j) limitation. If floor plan financing interest expense were
included in ATI without a corresponding subtraction, thus resulting in
an increased ATI, taxpayers with such expense would be able to increase
their section 163(j) limitation not only by the separately stated floor
plan financing interest under section 163(j)(1)(C), but also by the
inclusion of such amount in ATI, which would permit a deduction of
$1.30 (or $1.50, if the 50 percent ATI limitation is applicable) of
business interest expense for each $1 of floor plan financing interest
expense. Although it is clear that Congress did not intend to limit the
deduction for floor plan financing interest expense under section
163(j), there is no indication that Congress also intended to provide
the additional benefit of an increased ATI related to floor plan
financing interest expense. Therefore, under the authority granted in
section 163(j)(8)(B), the final regulations adopt the proposed rule
without change to include a subtraction of floor plan financing
interest expense from tentative taxable income in computing ATI.
Several commenters also requested clarification and submitted
recommendations on the interaction between section 168(k)(9) and
section 163(j). Section 168(k)(9)(B) provides that the additional
first-year depreciation deduction is not allowed for any property used
in a trade or business that has had floor plan financing indebtedness
(as defined in section 163(j)(9)), if the floor plan financing interest
related to such indebtedness was taken into account under section
163(j)(1)(C).
First, commenters requested that floor plan financing indebtedness
not be treated as taken into account if the sum of business interest
income and 30 percent of ATI (the sum of section 163(j)(1)(A) and
section 163(j)(1)(B)) is greater than the business interest expense
paid or accrued in the taxable year. Second, if the sum of business
interest income and 30 percent of ATI is less than the business
interest expense paid or accrued in the taxable year, commenters
requested that taxpayers be given the option to either include floor
plan financing interest to increase the section 163(j) limitation, or
to forgo the use of floor plan financing interest to increase the
section 163(j) limitation (any forgone floor plan financing interest
would be included in the disallowed business interest expense
carryforward under proposed Sec. 1.163(j)-2(c)) in order to utilize
the additional first-year depreciation deduction under section 168(k).
Section 163(j) does not provide any guidance on the availability of
section 168(k) for taxpayers that have had floor plan financing
interest expense. As these comments relate to the operation of section
168(k)(9), taxpayers should look to Treasury Department or IRS guidance
provided under section 168(k) for clarification. On September 24, 2019,
the Treasury Department and the IRS published in the Federal Register
final regulations (TD 9874, 84 FR 50108) and proposed regulations (REG-
106808-19, 84 FR 50152) under section 168(k). The rules regarding when
floor plan financing interest expense is ``taken into account'' for
purposes of 168(k) are in the proposed regulations under Sec.
1.168(k)-2(b)(2)(ii)(G). Accordingly, these final regulations do not
address the interaction between section 163(j) and section 168(k)(9)
regarding floor plan financing interest expense.
4. Adjustments to Taxable Income in Computing ATI Under Section
163(j)(8)(A)
Section 163(j)(8)(A) provides that ATI means taxable income
``computed without regard to'' the specified adjustments. The purpose
of the adjustments listed in section 163(j)(8)(A) is to keep certain
items, such as deductions for depreciation, amortization, depletion, or
NOL carryforward amounts, from directly increasing or decreasing the
amount of the deduction for business interest expense. Therefore, the
Treasury Department and the IRS have determined that the adjustments
listed in section 163(j)(8)(A) should adjust tentative taxable income
for purposes of calculating ATI under Sec. 1.163(j)-1(b)(1) only to
the extent that they have been reflected (or deemed reflected, as in
the case of certain amounts capitalized into inventory under section
263A as discussed in part II(A)(2) of this Summary of Comments and
Explanation of Revisions section) in tentative taxable income under
Sec. 1.163(j)-1(b)(43).
A commenter requested that the definition of ATI not include some
of the adjustments listed in section 163(j)(8)(A), such as the
adjustments for NOL deductions and deductions under section 199A. The
Treasury Department and the IRS do not have authority to ignore these
clear and unambiguous statutory adjustments. Thus, the final
regulations do not incorporate the commenter's suggestion.
5. Certain Adjustments to Tentative Taxable Income in Computing ATI
Under Section 163(j)(8)(B)
Under the authority granted in section 163(j)(8)(B), the proposed
regulations include several adjustments to taxable income in computing
ATI to address certain sales or other dispositions of depreciable
property, stock of a consolidated group member, or interests in a
partnership. Proposed Sec. 1.163(j)-1(b)(1)(ii)(C) provides that, if
property is sold or otherwise disposed of, the lesser of the amount of
gain on the disposition or the amount of depreciation, amortization, or
depletion deductions (collectively, depreciation deductions) with
respect to the property for the taxable years beginning after December
31, 2017 and before January 1, 2022 (such years, the EBITDA period) is
subtracted from taxable income to determine ATI. Proposed Sec.
1.163(j)-1(b)(1)(ii)(D) provides that, with respect to the sale or
other disposition of stock of a member of a consolidated group that
includes the selling member, the investment adjustments (see Sec.
1.1502-32) with respect to such stock that are attributable to
deductions described in proposed Sec. 1.163(j)-1(b)(1)(ii)(C) are
subtracted from taxable income. In turn, proposed Sec. 1.163(j)-
1(b)(1)(ii)(E) provides that, with respect to the sale or other
disposition of an interest in a partnership, the taxpayer's
distributive share of deductions described in proposed Sec. 1.163(j)-
1(b)(1)(ii)(C) with respect to property held by the partnership at the
time of such disposition is subtracted from taxable income to the
extent such deductions were allowable under section 704(d).
In general, when a taxpayer takes depreciation deductions with
respect to an asset, the taxpayer must reduce its adjusted basis in the
asset accordingly. As a result, the taxpayer will realize additional
gain (or less loss) upon the
[[Page 56693]]
subsequent disposition of the asset than the taxpayer would have
realized absent depreciation deductions. Thus, except with regard to
timing (and, in some cases, character), depreciation deductions should
have no net effect on a taxpayer's taxable income.
In order to mitigate the effects of the section 163(j) limitation
during the EBITDA period, Congress provided an adjustment to taxable
income for depreciation deductions. More specifically, as discussed in
part II(A)(2) of this Summary of Comments and Explanation of Revisions
section, depreciation deductions are added back to taxable income
during the EBITDA period, thereby increasing a taxpayer's ATI and its
section 163(j) limitation. Congress intended this adjustment to be a
timing provision that delays the inclusion of depreciation deductions
in calculating a taxpayer's section 163(j) limitation. Stated
differently, Congress intended to allow taxpayers to accelerate the
recognition of gain attributable to depreciation deductions when
computing ATI.
However, if a taxpayer were to sell its depreciable property after
making the foregoing adjustment to ATI, the taxpayer would realize
additional gain (or less loss) on the disposition as a result of its
depreciation deductions, and the taxpayer's ATI would be increased yet
again. Similarly, if the depreciable property were held by a member of
a consolidated group (S), and if another member of the group were to
sell S's stock after making negative adjustments to its basis in S's
stock under Sec. 1.1502-32 to reflect S's depreciation deductions, the
consolidated group's ATI would be increased yet again. A similar double
benefit would arise with respect to interests in a partnership if,
after the partner's basis in its partnership interest is reduced by
depreciation deductions associated with the depreciable property, ATI
were to reflect that reduced basis upon a subsequent sale of the
partnership interest.
Proposed Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and (E) were intended
to address these situations and ensure that the positive adjustment for
depreciation deductions during the EBITDA period merely defers (rather
than permanently excludes) depreciation deductions from a taxpayer's
calculation of the section 163(j) limitation.
Commenters submitted various questions and comments about these
provisions. First, a commenter questioned whether these proposed
subtractions from taxable income are an advisable exercise of the
authority granted in section 163(j)(8)(B) in light of congressional
silence on the issue. However, the 1991 Proposed Regulations contained
similar subtractions from taxable income in computing ATI. The 1991
Proposed Regulations had been outstanding for more than 25 years when
Congress enacted the TCJA. Thus, Congress likely was well aware of
these adjustments when it granted the Secretary of the Treasury the
authority to make adjustments in new section 163(j)(8)(B). Moreover,
there is no indication that Congress intended to preclude the Secretary
from making adjustments similar to those in the 1991 Proposed
Regulations.
Second, commenters asked why the subtraction from taxable income in
proposed Sec. 1.163(j)-1(b)(1)(ii)(D) does not include a ``lesser of''
calculation similar to proposed Sec. 1.163(j)-1(b)(1)(ii)(C), and they
questioned whether the ``lesser of'' calculation in proposed Sec.
1.163(j)-1(b)(1)(ii)(C) captures the correct amount. For example, if a
taxpayer purchased property for $100x, fully depreciated the property,
and then sold the property for $60x, should the amount that is backed
out under proposed Sec. 1.163(j)-1(b)(1)(ii)(C) be $60x or $100x?
Commenters also stated that the presence of a ``lesser of'' limitation
in proposed Sec. 1.163(j)-1(b)(1)(ii)(C) and the absence of such a
limitation in proposed Sec. 1.163(j)-1(b)(1)(ii)(D) can yield
discontinuities. For example, if S (a member of P's consolidated group)
uses $50x to purchase an asset that it fully depreciates under section
168(k) (resulting in a $50x reduction in P's basis in its S stock under
Sec. 1.1502-32), and if S sells the depreciated asset for $25x the
following year, the P group would have to subtract $25x from taxable
income under proposed Sec. 1.163(j)-1(b)(1)(ii)(C), whereas the group
would have had to reduce its taxable income by $50x under proposed
Sec. 1.163(j)-1(b)(1)(ii)(D) if P had sold its S stock instead.
Commenters recommended several solutions to address this discontinuity,
including eliminating the ``lesser of'' test.
Proposed Sec. 1.163(j)-1(b)(1)(ii)(D) does not include a ``lesser
of'' calculation because such a calculation would require consolidated
groups to value their assets each time there is a sale of member stock.
However, the Treasury Department and the IRS recognize the discrepancy
in taxable income adjustments between asset dispositions and member
stock dispositions under the proposed regulations. To eliminate this
discrepancy, the final regulations revise proposed Sec. 1.163(j)-
1(b)(1)(ii)(C) by eliminating the ``lesser of'' standard and requiring
taxpayers to back out depreciation deductions that were allowed or
allowable during the EBITDA period with respect to sales or
dispositions of property. This revised approach is consistent with the
adjustment for asset sales in the 1991 Proposed Regulations, is simpler
for taxpayers to administer than the ``lesser of'' approach in the
proposed regulations, and renders moot questions as to whether that
``lesser of'' calculation captures the correct amount. However, the
Treasury Department and the IRS also recognize that, in certain cases,
a ``lesser of'' computation would not be difficult to administer. Thus,
the Concurrent NPRM provides taxpayers the option to apply the ``lesser
of'' standard, so long as they do so consistently. See proposed Sec.
1.163(j)-1(b)(1)(iv)(E) of the Concurrent NPRM.
Third, commenters asked whether the application of proposed Sec.
1.163(j)-1(b)(1)(ii)(C) and (D) to the same consolidated group member
would result in an inappropriate double inclusion if the asset sale
precedes the stock sale, and whether proposed Sec. 1.163(j)-
1(b)(1)(ii)(C) should continue to apply to a group member if the sale
of member stock precedes the asset sale. For example, S (a member of
P's consolidated group) takes a $50x depreciation deduction in 2020
with respect to asset X, P's basis in its S stock is reduced
accordingly under Sec. 1.1502-32, and $50x is added back to the P
group's tentative taxable income in computing its 2020 ATI. In 2021, S
realizes a $50x gain upon the sale of asset X, P's basis in its S stock
is increased accordingly by $50x under Sec. 1.1502-32, and the P group
subtracts $50x from its tentative taxable income under proposed Sec.
1.163(j)-1(b)(1)(ii)(C) in computing its 2021 ATI. Then, in 2022, P
sells the S stock to an unrelated buyer. Must P subtract another $50x
from its tentative taxable income under proposed Sec. 1.163(j)-
1(b)(1)(ii)(D)? What if the order of sales were reversed (with P
selling its S stock to a member of another consolidated group in 2021
and S selling asset X in 2022)--would both consolidated groups be
required to subtract $50x from tentative taxable income in computing
ATI? To prevent duplicative adjustments under proposed Sec. 1.163(j)-
1(b)(1)(ii)(C) and (D), commenters recommended that these rules ``turn
off'' further subtractions once a subtraction already has been made
under either provision, and that the application of proposed Sec.
1.163(j)-1(b)(1)(ii)(C) be limited to the group in which the
depreciation deductions accrued.
[[Page 56694]]
The Treasury Department and the IRS agree that the application of
Sec. 1.163(j)-1(b)(1)(ii)(C) and (D) to the same consolidated group
member would result in an inappropriate double inclusion, and that
proposed Sec. 1.163(j)-1(b)(1)(ii)(C) should not apply to a former
group member with respect to depreciation deductions claimed by the
member in a former group. Thus, Sec. 1.163(j)-1(b)(1)(iv)(D) provides
anti-duplication rules to ensure that neither Sec. 1.163(j)-
1(b)(1)(ii)(C) nor Sec. 1.163(j)-1(b)(1)(ii)(D) applies if a
subtraction for the same economic amount already has been required
under either provision.
For example, assume that P wholly owns S1, which wholly owns S2,
which owns depreciable asset Q, and that S1 and S2 are members of P's
consolidated group. Further assume that S2's depreciation deductions
with respect to asset Q have resulted in investment adjustments in S1's
stock in S2 and in P's stock in S1. If S1 were to sell its S2 stock to
a third party, adjustments to the P group's tentative taxable income
would be required under proposed Sec. 1.163(j)-1(b)(1)(ii)(D). If P
later were to sell its S1 stock to a third party, an additional
adjustment under proposed Sec. 1.163(j)-1(b)(1)(ii)(D) would not be
required with respect to investment adjustments attributable to asset
Q.
Fourth, commenters observed that these proposed subtractions from
taxable income in computing ATI are required even if the disposition of
the depreciable property, member stock, or partnership interest occurs
many years after the EBITDA period. Commenters expressed concern that
tracking depreciation deductions for purposes of these adjustments
could become burdensome, and a commenter questioned the appropriateness
in proposed Sec. 1.163(j)-1(b)(1)(ii)(C) of treating all gain upon the
disposition of property after the EBITDA period as attributable to
depreciation deductions during the EBITDA period.
Commenters are correct in observing that these proposed adjustments
to taxable income in computing ATI must be made even if the relevant
depreciable asset, member stock, or partnership interest is disposed of
after the EBITDA period. However, the Treasury Department and the IRS
note that members of consolidated groups already must track
depreciation deductions to calculate separate taxable income (see Sec.
1.1502-12) and to preserve the location of tax items (see Sec. 1.1502-
13). Additionally, all taxpayers must track depreciation deductions on
an asset-by-asset basis for purposes of section 1245. Thus, the
Treasury Department and the IRS have determined that the adjustments
proposed in Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and (E) should not
impose a significant administrative burden in many situations. The
Treasury Department and the IRS further note that eliminating the
``lesser of'' standard in proposed Sec. 1.163(j)-1(b)(1)(ii)(C) (see
the response to the second comment in this part of the Summary of
Comments and Explanation of Revisions section) will render moot the
commenter's concern about the calculation of gain.
Fifth, a commenter asked whether the term ``sale or other
disposition'' in proposed Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and (E)
is intended to apply to the transfer of stock of a consolidated group
member in an intercompany transaction (within the meaning of Sec.
1.1502-13(b)(1)(i)) or to the transfer of assets in a nonrecognition
transaction to which section 381 applies (a section 381 transaction).
As provided in proposed Sec. 1.163(j)-4(d)(2), a consolidated
group has a single section 163(j) limitation, and intercompany items
and corresponding items are disregarded for purposes of calculating the
group's ATI to the extent they offset in amount. The Treasury
Department and the IRS have determined that regarding intercompany
items and corresponding items for purposes of Sec. 1.163(j)-
1(b)(1)(ii)(C) and (D) would be inconsistent with this general
approach. Thus, Sec. 1.163(j)-1(b)(1)(iv)(A)(2) provides that an
intercompany transaction should not be treated as a ``sale or other
disposition'' for purposes of Sec. 1.163(j)-1(b)(1)(ii)(C) and (D).
In turn, the transfer of depreciable assets in a section 381
transaction generally should not be treated as a ``sale or other
disposition'' because the transfer does not affect ATI and because the
transferee corporation is the successor to the transferor corporation.
Thus, the final regulations generally provide that a transfer of an
asset to an acquiring corporation in a transaction to which section
381(a) applies is not treated as a ``sale or other disposition'' for
purposes of Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and (E). However, if a
member leaves a consolidated group, that transaction generally is
treated as a sale or other disposition under the final regulations for
purposes of Sec. 1.163(j)-1(b)(1)(ii)(C) and (D), regardless of
whether the transaction is a section 381 transaction, because the
adjustment to ATI under these provisions should be reflected on the tax
return of the group that received the benefit of the earlier increase
in ATI.
Sixth, a commenter asked for clarification as to when the
adjustment in proposed Sec. 1.163(j)-1(b)(1)(ii)(D) is required and
which investment adjustments under Sec. 1.1502-32 are treated as
``attributable to'' depreciation deductions for purposes of this
provision. For example, P wholly and directly owns both S and S1
(members of P's consolidated group). In 2021, S purchases asset X for
$100x and fully depreciates asset X under section 168(k), and P reduces
its basis in its S stock by $100x under Sec. 1.1502-32. In 2022, P
contributes the stock of S to S1 in an intercompany transaction (which,
as noted previously, is not treated as a ``sale or other disposition''
for purposes of proposed Sec. 1.163(j)-1(b)(1)(ii)(C) and (D)). If P
later sells the S1 stock, is the adjustment in proposed Sec. 1.163(j)-
1(b)(1)(ii)(D) required even though no adjustment to P's basis in the
S1 stock under Sec. 1.1502-32 is ``attributable to'' the $100x of
depreciation deductions taken with respect to asset X?
The Treasury Department and the IRS have determined that the
adjustment to tentative taxable income in proposed Sec. 1.163(j)-
1(b)(1)(ii)(D) should apply in the foregoing situation. The final
regulations have been revised to provide that, for these purposes, P's
stock in S1 would be treated as a successor asset (within the meaning
of Sec. 1.1502-13(j)(1)) to P's stock in S.
Seventh, commenters stated that there should be no adjustments to
taxable income under proposed Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and
(E) if and to the extent that adding back depreciation deductions
pursuant to section 163(j)(8)(A)(v) and proposed Sec. 1.163(j)-
1(b)(1)(i) did not increase the amount of business interest expense the
taxpayer could have deducted in the year the deductions were incurred.
For example, in 2021, corporation C has $500x of ATI (computed by
adding back $50x of depreciation deductions with respect to asset X)
and $100x of business interest expense. Without adding back the
depreciation deductions, C's ATI would have been $450x, C's section
163(j) limitation would have been $135x ($450x x 30 percent), and C
still could have deducted all $100x of its business interest expense in
that year. In 2022, C has $90x of business interest expense and $300x
of ATI. C sells asset X for a $50x gain in that year. If C were
required to reduce its ATI by $50x (from $300x to $250x) in 2022 under
proposed Sec. 1.163(j)-1(b)(1)(ii)(C), its section 163(j) limitation
would be reduced to $75x ($250x x 30 percent), and C would not be able
to deduct all $90x of its business interest expense in 2022 even though
C derived no benefit from adding back its depreciation deductions to
taxable income in 2021.
[[Page 56695]]
The Treasury Department and the IRS have determined that
predicating the application of proposed Sec. 1.163(j)-1(b)(1)(ii)(C),
(D), and (E) upon whether a taxpayer derived a benefit under section
163(j) from adding back its depreciation deductions to taxable income
would involve significant additional complexity. In addition, this
approach would have an effect similar to allowing a carryforward of
these amounts to the taxable year in which gain on the related items is
recognized on a sale or other disposition. Such a carryforward is
inconsistent with the general approach of section 163(j), which does
not permit a carryforward of excess ATI to later taxable years. As
noted earlier in this part II(A)(5) of this Summary of Comments and
Explanation of Revisions section, depreciation deductions should have
no net effect on the amount of a taxpayer's taxable income (except with
respect to timing and, perhaps, character). Thus, if a taxpayer sells
an asset with respect to which the taxpayer has taken depreciation
deductions, the increase in gain (or decrease in loss) upon the sale
should be reversed under proposed Sec. 1.163(j)-1(b)(1)(ii)(C).
6. Adjustments to Adjusted Taxable Income in Respect of United States
Shareholders of CFCs
Some commenters argued that United States shareholders, as defined
in section 951(b) (U.S. shareholders), of controlled foreign
corporations, as defined in section 957(a) (CFCs), should be allowed to
include in their ATI the amounts included in gross income under section
951(a) (subpart F inclusions), section 951A(a) global intangible low-
taxed income (GILTI) inclusions, and section 78 ``gross-up'' inclusions
(collectively, CFC income inclusions) attributable to non-excepted
trades or businesses. Because section 163(j) applies to CFCs, the
Treasury Department and the IRS have determined that allowing a U.S.
shareholder to include its CFC income inclusions in its ATI would not
be appropriate. The income of the CFC that gives rise to such income is
taken into account in computing the ATI of the CFC for purposes of
determining its section 163(j) limitation, and allowing the same income
to also be taken into account in computing the ATI of a U.S.
shareholder would result in an inappropriate double-counting of income.
Furthermore, the Treasury Department and the IRS question the
premise of several comments that, if the business interest expense of a
CFC were excluded from the application of section 163(j), including the
income of a CFC in a U.S. shareholder's ATI would be appropriate. Even
if section 163(j) did not apply to CFCs, CFCs are entities that also
may be leveraged. Thus, permitting the income of the CFC that gives
rise to CFC income inclusions attributable to non-excepted trades or
businesses of CFCs to be included in the ATI of U.S. shareholders would
be inconsistent with the principles of section 163(j).
In particular, consider a case in which a CFC has interest expense
of $100x, trade or business gross income of $300x treated as subpart F
income, and no foreign tax liability. In such a case, a U.S.
shareholder that wholly owns the CFC would have a subpart F inclusion
of $200x (if section 163(j) did not apply to CFCs). If the $200x
subpart F inclusion were included in the ATI of the U.S. shareholder,
the U.S. shareholder could deduct an additional $60x of business
interest expense ($200x x 30 percent). As a result, $300x of gross
income could support $160x of interest expense deductions rather than
the $90x permitted under section 163(j)(1).
Finally, under the final regulations (and consistent with proposed
Sec. 1.163(j)-7(d)(1)(ii)), if a domestic partnership includes amounts
in gross income under sections 951(a) and 951A(a) with respect to an
applicable CFC and such amounts are investment income to the
partnership, then, a domestic C corporation partner's distributive
share of such amounts that are properly allocable to a non-excepted
trade or business of the domestic C corporation by reason of Sec. Sec.
1.163(j)-4(b)(3) and 1.163(j)-10(c) are excluded from the domestic C
corporation partner's ATI.
B. Definition of Business Interest Expense--Proposed Sec. 1.163(j)-
1(b)(2)
The proposed regulations provide that business interest expense
includes interest expense allocable to a non-excepted trade or
business, floor plan financing interest expense, and disallowed
business interest expense carryforwards. The Treasury Department and
the IRS received informal questions about the interaction between
section 163(j) and sections 465 and 469, which may operate to disallow
a deduction for business interest expense even if such expense was
allowable after the application of section 163(j). More specifically,
questions have arisen regarding how to treat amounts of business
interest expense that are disallowed under section 465 or 469,
including which amounts carry forward to subsequent taxable years but
keep their character as interest expense, and which amounts, if any,
are business interest expense in such subsequent taxable years.
If amounts of business interest expense that are disallowed under
section 465 or 469 are treated as business interest expense in
subsequent taxable years, the section 163(j) limitation could operate
to disallow a deduction even though such amounts were allowable in the
prior taxable year after application of the section 163(j) limitation.
The Treasury Department and the IRS do not intend such a result.
Therefore, the final regulations clarify that amounts allowable as a
deduction after application of the section 163(j) limitation but
disallowed by section 465 or 469 are not business interest expense
subject to the section 163(j) limitation in subsequent taxable years.
C. Definition of Excepted Regulated Utility Trade or Business--Proposed
Sec. 1.163(j)-1(b)(13)
Numerous comments were submitted concerning the definition of an
``excepted regulated utility trade or business'' under proposed Sec.
1.163(j)-1(b)(13). Proposed Sec. 1.163(j)-1(b)(13), which implements
the exception in section 163(j)(7)(A)(iv) to the definition of a
``trade or business,'' generally provides that an excepted regulated
utility trade or business is a trade or business that sells or
furnishes the items listed in section 163(j)(7)(A)(iv) at rates that
are established or approved by certain regulatory bodies described in
proposed Sec. 1.163(j)-1(b)(13)(i)(B)(1) and (2).
The proposed regulations provide that utilities that sell or
furnish the regulated items at rates that are established or approved
by a regulatory body described in proposed Sec. 1.163(j)-
1(b)(13)(i)(B)(1), other than an electric cooperative, are considered
to be excepted only to the extent that such rates are determined on a
``cost of service and rate of return'' basis. The ``cost of service and
rate of return'' requirement was intended to provide certainty to
taxpayers because many utilities are familiar with the definition of
``cost of service and rate of return,'' which is used to determine
whether a public utility company must use a normalization method of
accounting under section 168 for certain properties.
However, several commenters questioned whether a ``cost of service
and rate of return'' requirement would be satisfied in specific fact
patterns. Commenters questioned whether certain negotiated rates are
established or approved on a ``cost of service and rate of return''
basis if (1) the applicable regulatory body has the authority to
[[Page 56696]]
impose a cost-based rate instead of the negotiated rate, (2) the rates
are computed with reference to cost but discounted from the recourse
(or maximum) rate allowed by the regulatory body, or (3) the rates are
computed with reference to cost and a set rate of return but are
subject to a market-based cap. Commenters also asked whether the
inclusion of certain amounts in determining ``cost of service,''
specifically the costs of affiliates and some revenues attributable to
market-rate sales, would affect the determination of whether rates are
established or approved on a ``cost of service and rate of return''
basis.
One commenter noted that the normalization rules operate logically
only in the ``cost of service and rate of return'' context. The
commenter stated that, because section 163(j)(7)(A)(iv) does not
reference the normalization rules, there is no need to include the
``cost of service and rate of return'' requirement in the section
163(j) regulations.
The Treasury Department and the IRS note that, in private letter
rulings and informal guidance related to section 168(i)(9) and (10),
the IRS has stated that, for purposes of applying the normalization
rules, the definition of ``public utility property'' must contain the
requirement that the regulated rates be established or approved on a
``rate of return'' basis. In this guidance, the IRS explained that the
normalization method, which must be used for public utility property to
be eligible for the depreciation allowance available under section 168,
is defined in terms of the method the taxpayer uses in computing its
tax expense in establishing its ``cost of service'' for ratemaking
purposes and reflecting operating results in its regulated books of
account. Furthermore, the IRS has issued numerous private letter
rulings regarding whether under the specific facts of the taxpayer, the
cost of service and rate of return requirement has been met for
purposes of section 168(i). Thus, it is clear that, in the context of
section 168, the ``cost of service and rate of return'' requirement is
necessary.
Neither the text of section 163(j) nor the legislative history
specifically references the normalization rules or the ``cost of
service and rate of return'' requirement under section 168(i)(10). With
the omission of such references, the exception in section 163(j) for
regulated utility trade or business could be applied broadly without
reference to specific requirements applicable in the normalization
rules. However, the Treasury Department and the IRS note that under
section 168(k)(9), the additional first-year depreciation deduction is
not available to any property that is primarily used in an excepted
regulated utility trade or business. Therefore, to ease the
administrative burden of determining whether businesses qualify as
excepted regulated utility trades or businesses, and to allow taxpayers
the option of claiming the additional first-year depreciation deduction
under section 168(k) in lieu of being treated as an excepted regulated
utility trade or business, the final regulations retain the ``cost of
service and rate of return'' requirement from the proposed regulations,
and also allow taxpayers to make an election to be an excepted
regulated utility trade or business to the extent that the rates for
the furnishing or sale of the items described in Sec. 1.163(j)-
1(b)(15)(i)(A)(1) have been established or approved by a regulatory
body described in Sec. 1.163(j)-1(b)(15)(i)(A)(2), if the rates are
not determined on a ``cost of service and rate of return'' basis. See
Sec. 1.163(j)-1(b)(15)(i) and (iii).
For purposes of the election, the focus of section 163(j)(7)(A)(iv)
is the phrase ``established or approved'' in section 163(j)(7)(A)(iv),
which describes the authority of the regulatory body described in Sec.
1.163(j)-1(b)(15)(i)(A)(2). Ratemaking programs similar to those
described by commenters and discussed previously in this part II(C) of
this Summary of Comments and Explanation of Revisions section,
including discounted rates, negotiated rates, and regulatory rate caps,
are established or approved by a regulatory body if the taxpayer files
a schedule of such rates with a regulatory body that has the power to
approve, disapprove, alter the rates, or substitute a rate determined
in an alternate manner.
Similar to elections for electing real property trades or
businesses and electing farming businesses, the election to be an
excepted regulated utility trade or business is irrevocable. Taxpayers
making the election to be an excepted regulated utility trade or
business are not required to allocate items between regulated utility
trades or businesses that are described in Sec. 1.163(j)-1(b)(15)(i)
and trades or businesses that are described in Sec. 1.163(j)-
1(b)(15)(iii)(A) as to which the taxpayer makes an election because
they are treated as operating an entirely excepted regulated utility
trade or business. Electing taxpayers cannot claim the additional
first-year depreciation deduction under section 168(k).
The rules set forth in the final regulations are limited solely to
the determination of an ``excepted regulated utility trade or
business'' for purposes of section 163(j)(7)(A)(iv). As a result of
this limited application, the rules in the final regulations are not
applicable to the determination of ``public utility property'' or the
application of the normalization rules within the meaning of section
46(f), as in effect on the day before the date of the enactment of the
Revenue Reconciliation Act of 1990, section 168(i)(9) and (10) and the
regulations thereunder, or to the determination of any depreciation
allowance available under sections 167 and 168.
Comments also were received on the application of the rules for
excepted regulated utility trades or businesses to electric
cooperatives. The definition of an ``excepted regulated utility trade
or business'' under proposed Sec. 1.163(j)-1(b)(13) includes trades or
businesses that sell or furnish the items listed in section
163(j)(7)(A)(iv) at rates established or approved by an electric
cooperative. Unlike utility businesses regulated by public authorities,
utilities that sell items at rates regulated by a cooperative are not
described in section 168(i)(10). However, there is a long-standing body
of law regulating the taxation of electric cooperatives. Electric
cooperatives described in section 501(c)(12) are generally exempt from
income tax but are subject to taxation under section 511. The
application of section 163(j) and the section 163(j) regulations with
respect to exempt electric cooperatives is governed by proposed Sec.
1.163(j)-4(b)(5). Other electric cooperatives are subject to taxation
under sections 1381 through 1388 in subchapter T of chapter 1 of
subtitle A of the Code (subchapter T), except for certain rural
electric cooperatives specifically excluded from subchapter T by
section 1381(a)(2)(C).
Generally, the exception in section 163(j)(7)(A)(iv) for the trade
or business of selling or furnishing items at rates established or
approved by the governing or ratemaking body of an electric cooperative
applies both to sales and furnishing by an electric cooperative and to
sales and furnishing to an electric cooperative by another utility
provider, as long as the rates for the sale or furnishing have been
established or approved in the manner required by section 163(j). Thus,
an electric cooperative exempt from Federal income tax under section
501(c)(12) may not be subject to section 163(j) for the sale or
furnishing of electricity due to the operation of proposed Sec.
1.163(j)-4(b)(5), and another utility provider may be in an excepted
regulated utility trade or business to the extent that it sells
electricity to the
[[Page 56697]]
section 501(c)(12) cooperative at rates established or approved by the
governing or ratemaking body of the cooperative.
A commenter asked whether proposed Sec. 1.163(j)-1(b)(13) requires
that, for sales involving electric cooperatives to qualify as an
excepted regulated utility trade or business, the rates for the sales
be established or approved by the governing or ratemaking body of an
electric cooperative on a ``cost of service and rate of return'' basis,
or if all sales made subject to a contract or tariff approved by an
electric cooperative's governing or ratemaking body would qualify.
Under the proposed regulations, the specific requirement that rates for
the sale or furnishing of items listed in proposed Sec. 1.163(j)-
1(b)(13)(i)(A) be established or approved on a ``cost of service and
rate of return'' basis did not extend to rates established or approved
by the governing or ratemaking body of an electric cooperative. These
regulations adopt the proposed rule, and do not impose a requirement
that rates for the sale or furnishing of items listed in Sec.
1.163(j)-1(b)(15)(i)(A) by an electric cooperative be established or
approved on a ``cost of service and rate of return'' basis.
Comments also were submitted regarding the allocation of tax items
between excepted regulated utility trades or businesses and non-
excepted trades or businesses. These comments are discussed with other
comments on proposed Sec. 1.163(j)-10 in part XI of this Summary of
Comments and Explanation of Revisions section.
D. Definition of Floor Plan Financing Interest Expense--Proposed Sec.
1.163(j)-1(b)(17)
Commenters recommended that interest paid on commercial financing
liabilities or trade financing (in which a taxpayer borrows to fund the
purchase or transport of commodities and then sells the inventory to
pay off the debt) should not be subject to section 163(j). Commenters
noted that trade financing is different from normal financing because
it is short-term and backed by inventory that is monetizable (rather
than plant and equipment). Thus, commenters suggested that section
163(j) should not apply to trade financing because there is no
depreciation trade-off for inventory purchased with trade financing.
Commenters compared trade financing to floor plan financing (because
both are used to finance the purchase of inventory), and they noted
that the 1991 Proposed Regulations under old section 163(j) excluded
commercial financing liabilities from debt taken into account for
purposes of applying the debt-equity ratio under old section 163(j).
See 1991 Proposed Regulations Sec. 1.163(j)-3(b)(2)(ii).
The Treasury Department and the IRS decline to exclude commercial
financing liabilities from the section 163(j) limitation. Section
163(j) does not contain a provision analogous to the debt-equity ratio
safe harbor that was present in old section 163(j) and for which rules
were proposed in the 1991 Proposed Regulations. In addition, because
Congress specifically excluded interest paid on floor plan financing
from the section 163(j) limitation, but not all commercial financing
liabilities and trade financing, Congress does not appear to have
intended to exclude all commercial financing liabilities from the
section 163(j) limitation.
E. Definition of Interest--Proposed Sec. 1.163(j)-1(b)(20)
1. In General
Commenters submitted numerous comments on the definition of
``interest'' in the proposed regulations. Proposed Sec. 1.163(j)-
1(b)(20) contains a relatively broad definition of the term
``interest'' for purposes of section 163(j). This definition was
proposed to provide a complete definition of interest that addresses
all transactions that are commonly understood to produce interest
income and expense, including transactions that otherwise may have been
entered into to avoid the application of section 163(j).
Under the proposed regulations, the term ``interest'' means any
amount described in one of four categories. First, proposed Sec.
1.163(j)-1(b)(20)(i) generally provides that interest is an amount
paid, received, or accrued as compensation for the use or forbearance
of money under the terms of an instrument or contractual arrangement,
including a series of transactions, that is treated as a debt
instrument, or an amount that is treated as interest under other
provisions of the Code or the Income Tax Regulations. For example, this
category includes qualified stated interest, original issue discount
(OID), and accrued market discount. Commenters agree that this
definition of interest has long been accepted, is consistent with
longstanding precedent, and reduces the risk of inconsistency within
the Code and regulations. No commenters requested any changes to this
category, and the final regulations adopt this category in the
definition of the term ``interest'' without any substantive changes.
Second, proposed Sec. 1.163(j)-1(b)(20)(ii) treats a swap (other
than a cleared swap) with significant nonperiodic payments as two
separate transactions consisting of an on-market, level payment swap
and a loan. Under the proposed regulations, the time value component of
the loan is recognized as interest expense to the payor and as interest
income to the recipient. Several comments were received on this
category in the definition and are described in part II(E)(2) of this
Summary of Comments and Explanation of Revisions section.
Third, proposed Sec. 1.163(j)-1(b)(20)(iii) treats as interest
certain amounts that are closely related to interest and that affect
the economic yield or cost of funds of a transaction involving
interest, but that may not be compensation for the use or forbearance
of money on a stand-alone basis. For example, this category includes
substitute interest payments, debt issuance costs, commitment fees, and
hedging gains and losses that affect the yield of a debt instrument.
Numerous comments were received on this category and are described in
part II(E)(3) of this Summary of Comments and Explanation of Revisions
section.
Fourth, proposed Sec. 1.163(j)-1(b)(20)(iv) provides an anti-
avoidance rule. Under this rule, an expense or loss predominantly
incurred in consideration of the time value of money in a transaction
or series of integrated or related transactions in which a taxpayer
secures the use of funds for a period of time is treated as interest
expense for purposes of section 163(j). Numerous comments were received
on this category and are described in part II(E)(4) of this Summary of
Comments and Explanation of Revisions section.
2. Swaps With Significant Nonperiodic Payments
The proposed regulations treat a non-cleared swap with significant
nonperiodic payments as two separate transactions consisting of an on-
market, level payment swap and a loan (the embedded loan rule). The
embedded loan rule did not apply to a collateralized swap that was
cleared by a derivatives clearing organization or by a clearing agency
(a cleared swap) because the treatment of cleared swaps was reserved.
In the preamble to the proposed regulations, the Treasury Department
and the IRS requested comments on the proper treatment of
collateralized swaps under the embedded loan rule.
One commenter recommended that the final regulations provide an
[[Page 56698]]
exception to the embedded loan rule for cleared swaps and for non-
cleared swaps that are substantially collateralized. This commenter
further suggested that the final regulations not include any specific
rules regarding the type of collateral that is required to be posted to
qualify for the exception. The commenter also recommended that the
final regulations provide objective rules for determining if a
nonperiodic payment is ``significant'' and if a financial instrument is
treated as a ``swap'' for purposes of these rules.
Another commenter agreed with the embedded loan rule, including use
of the ``significant'' standard, and also recommended exceptions to the
embedded loan rule for both cleared swaps and non-cleared swaps that
are required to be fully collateralized by the terms of the swap
contract or by a federal regulator. However, this commenter interpreted
the embedded loan rule in the proposed regulations to apply solely for
purposes of section 163(j) and recommended that the embedded loan rule,
as well as timing and character rules for nonperiodic payments on
swaps, be issued under section 446. Until that guidance is issued, the
commenter requested that the application of the embedded loan rule for
purposes of section 163(j) be delayed. The proposed regulations provide
that the time value component of the embedded loan is determined in
accordance with Sec. 1.446-3(f)(2)(iii)(A). This commenter questioned
the reference to Sec. 1.446-3(f)(2)(iii)(A) because, under that rule,
the time value component is not treated as interest; rather, the time
value component is only used to compute the amortization of the
nonperiodic payment.
As a result of the cross-reference in proposed Sec. 1.446-3(g)(4)
to proposed Sec. 1.163(j)-1(b)(20)(ii), the embedded loan rule set
forth in the proposed regulations applies for purposes of both sections
163(j) and 446. In addition, and as noted in the preamble to the
proposed regulations, the embedded loan rule set forth in the proposed
regulations applies in the same manner that former Sec. 1.446-3(g)(4)
applied before it was amended by the now expired temporary regulations
in T.D. 9719 (80 FR 26437) (May 8, 2015) (as corrected by 80 FR 61308
(October 13, 2015)). The Treasury Department and the IRS do not adopt
commenters' suggestions to delay finalizing the embedded loan rule or
to provide guidance on determining if a nonperiodic payment is
``significant'' because the same embedded loan rule applied in the
context of section 446 for over 20 years from 1993 to 2015. See T.D.
8491 (58 FR 53125) (October 14, 1993). Instead, subject to the
exceptions discussed in this part II(E)(2) of this Summary of Comments
and Explanation of Revisions section, the final regulations adopt the
embedded loan rule without change. The final regulations retain the
reference to Sec. 1.446-3(f)(2)(iii)(A), which provides a known method
for computing the time value component associated with the loan
component that is treated as interest under Sec. Sec. 1.163(j)-
1(b)(22)(ii) and 1.446-3(g)(4).
Further, to eliminate the possibility of confusion regarding the
application of the embedded loan rule for purposes of sections 163(j)
and 446, the final regulations add the substantive text of the embedded
loan rule and the exceptions to that rule to both Sec. Sec. 1.446-
3(g)(4) and 1.163(j)-1(b)(22)(ii) instead of merely including a cross-
reference in Sec. 1.446-3(g)(4) to Sec. 1.163(j)-1(b)(22)(ii).
In response to comments, the final regulations add two exceptions
to the embedded loan rule. Specifically, the final regulations add
exceptions for cleared swaps and for non-cleared swaps that require the
parties to meet the margin or collateral requirements of a federal
regulator or that provide for margin or collateral requirements that
are substantially similar to a cleared swap or a non-cleared swap
subject to the margin or collateral requirements of a federal
regulator. For purposes of this exception, the term ``federal
regulator'' means the Securities and Exchange Commission (SEC), the
Commodity Futures Trading Commission (CFTC), or a prudential regulator,
as defined in section 1a(39) of the Commodity Exchange Act (7 U.S.C.
1a), as amended by section 721 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010, Public Law 111-203, 124 Stat. 1376,
Title VII (the Dodd-Frank Act). Because federal regulators have adopted
final requirements for non-cleared swaps that permit netting of swap
exposures and specify the types of collateral required to be posted,
the final regulations do not address netting or require that the margin
or collateral be paid or received in cash.
In addition, Sec. 1.163(j)-1(c)(3)(i) delays the applicability
date of the embedded loan rule for purposes of section 163(j) to allow
taxpayers additional time to develop systems to implement these rules
(the delayed applicability date), though taxpayers may choose to apply
the rules to swaps entered into before the delayed applicability date.
See also Sec. 1.446-3(j)(2), which provides applicability date rules
similar to those in Sec. 1.163(j)-1(c)(3)(i). However, the delayed
applicability date does not apply for purposes of the anti-avoidance
rules in Sec. 1.163(j)-1(b)(22)(iv) (described in part II(E)(4) of
this Summary of Comments and Explanation of Revisions section).
Instead, the applicability date in Sec. 1.163(j)-1(c)(3)(ii) applies.
As a result, the anti-avoidance rules in Sec. 1.163(j)-1(b)(22)(iv)
apply to a notional principal contract entered into on or after
September 14, 2020. However, for a notional principal contract entered
into before September 14, 2021, the anti-avoidance rules in Sec.
1.163(j)-1(b)(22)(iv) apply without regard to the references in those
rules to Sec. 1.163(j)-1(b)(22)(ii). For example, if a taxpayer enters
into a swap with a significant nonperiodic payment that does not meet
the exceptions in Sec. 1.163(j)-1(b)(22)(ii)(B) or (C) before the
delayed applicability date, and a principal purpose of the taxpayer is
to reduce the amount that otherwise would be interest expense, the
anti-avoidance rules apply and the taxpayer must treat the time value
component associated with the loan component of the swap as interest
expense.
3. Other Amounts Treated as Interest
i. Items Relating to Premium, Ordinary Income or Loss on Certain Debt
Instruments, Section 1258 Gain, and Factoring Income
Proposed Sec. 1.163(j)-1(b)(20)(iii)(A) treats any bond issuance
premium treated as ordinary income under Sec. 1.163-13(d)(4) as
interest income of the issuer and any amount deductible as a bond
premium deduction under Sec. 1.171-2(a)(4)(i)(A) or (C) as interest
expense of the holder. Proposed Sec. 1.163(j)-1(b)(20)(iii)(B) treats
any ordinary income recognized by an issuer of a debt instrument, and
any ordinary loss recognized by a holder of a debt instrument, under
the rules for a contingent payment debt instrument, a nonfunctional
currency contingent payment debt instrument, or an inflation-indexed
debt instrument, as interest income of the issuer and as interest
expense of the holder, respectively. Proposed Sec. 1.163(j)-
1(b)(20)(iii)(D) treats any ordinary gain under section 1258 as
interest income. Commenters supported treating the amounts in proposed
Sec. 1.163(j)-1(b)(20)(iii)(A), (B), and (D) as interest income or
interest expense for purposes of section 163(j). Accordingly, the final
regulations adopt the rules in the proposed regulations for these three
items without any substantive changes.
Proposed Sec. 1.163(j)-1(b)(20)(iii)(J) treats factoring income as
interest income. Several commenters supported treating factoring income
as interest
[[Page 56699]]
income. However, one commenter questioned the differences between the
provisions related to the inclusion of factoring income and Sec.
1.954-2(h)(4). The inclusion of factoring income in the definition of
interest is generally supported by the commenters, is a taxpayer-
favorable rule, is generally consistent with the rules in Sec. 1.954-
2(h)(4), and is consistent with the treatment of other types of
discount, such as acquisition discount and market discount.
Accordingly, the final regulations adopt the rules in the proposed
regulations for factoring income without any substantive changes. In
the case of a factoring transaction with a principal purpose of
artificially increasing a taxpayer's business interest income, the
anti-avoidance rules in Sec. 1.163(j)-1(b)(22)(iv) (described in part
II(E)(4) of this Summary of Comments and Explanation of Revisions
section) would not permit the taxpayer to treat factoring income as
interest income for purposes of section 163(j).
ii. Substitute Interest Payments
Proposed Sec. 1.163(j)-1(b)(20)(iii)(C) generally provides that a
substitute interest payment described in Sec. 1.861-2(a)(7) and made
in connection with a sale-repurchase or securities lending transaction
is treated as interest expense to the payor and interest income to the
recipient. In general, substitute interest payments are economically
equivalent to interest. A few commenters questioned the inclusion of
substitute interest payments in the definition of interest in the
proposed regulations. Commenters stated that treating these amounts as
interest would be contrary to longstanding tax law, including the
holding in Deputy v. Du Pont, 308 U.S. 488, 498 (1940). However,
commenters recommended that, if the Treasury Department and the IRS
decide to include substitute interest payments in the definition of
interest in the final regulations, the inclusion be limited to the
extent the substitute interest payments relate to transactions that are
economically similar to a borrowing. Commenters recommended that the
following factors be taken into consideration in making this
determination: (a) Whether the taxpayer posted (or has received)
collateral consisting of cash or liquid assets; (b) whether the
borrowed security is due to mature shortly after the scheduled
termination date of the securities borrowing; (c) the type of security
being lent (for example, Treasury bonds as compared to riskier
corporate bonds); and (d) whether the securities borrowing was entered
into in the ordinary course of the taxpayer's trade or business.
The final regulations retain substitute interest payments in the
definition of interest because the payments generally are economically
equivalent to interest and should be treated as such for purposes of
section 163(j). However, in response to comments, the final regulations
provide that a substitute interest payment is treated as interest
expense to the payor only if the payment relates to a sale-repurchase
or securities lending transaction that is not entered into by the payor
in the payor's ordinary course of business, and that a substitute
interest payment is treated as interest income to the recipient only if
the payment relates to a sale-repurchase or securities lending
transaction that is not entered into by the recipient in the
recipient's ordinary course of business. The final regulations do not
adopt the other suggested factors because the Treasury Department and
the IRS have determined that the ordinary course rule in the final
regulations provides an appropriate and effective limit on the scope of
the definition. Specifically, the Treasury Department and the IRS have
determined that these transactions are rarely entered into outside the
payor's ordinary course of business, and that any such non-ordinary
course transactions likely would involve an intention to avoid section
163(j).
iii. Commitment Fees
Proposed Sec. 1.163(j)-1(b)(20)(iii)(G)(1) treats any fees in
respect of a lender commitment to provide financing as interest if any
portion of such financing is actually provided. Commenters recommended
that commitment fees and other debt-related fees not be included in the
definition of interest until general substantive guidance is provided
on the treatment of the fees in the separate fee-related project on the
Office of Tax Policy and IRS 2019-2020 Priority Guidance Plan (REG-
132517-17). According to the commenters, uncertainty exists as to
whether to characterize these fees for Federal income tax purposes as
fees for services or property or for compensation for the use or
forbearance of money. In addition, under existing guidance, commitment
fees are treated differently by the borrower (similar to an option
premium) and the lender (service income). See Rev. Rul. 81-160, 1981-1
C.B. 312, and Rev. Rul. 70-540, 1970-2 C.B. 101, Situation (3). Some
taxpayers, however, argue that a commitment fee should be treated as
creating or increasing discount on a debt instrument and that the fee
should be treated consistently by both the borrower and the lender. If
commitment fees are included in the definition of interest in the final
regulations, commenters recommended that only the portion of the
commitment fee that is proportionate to the amount drawn be treated as
interest.
In response to comments, the final regulations do not include
commitment fees in the definition of interest. The treatment of
commitment fees and other fees paid in connection with lending
transactions will be addressed in future guidance that applies for all
purposes of the Code.
iv. Debt Issuance Costs
Proposed Sec. 1.163(j)-1(b)(20)(iii)(H) treats debt issuance costs
as interest expense of the issuer. Commenters argued that debt issuance
costs should not be treated as interest expense because these costs are
paid to third parties in connection with the issuance of debt and are
not paid or incurred for the use or forbearance of money under a debt
instrument. For tax purposes, these costs are capitalized by the issuer
and are treated as deductible under section 162 over the term of the
debt instrument as if the costs adjust the instrument's yield by
reducing the instrument's issue price by the amount of the costs. See
Sec. 1.446-5.
In response to comments, the final regulations exclude debt
issuance costs from the definition of interest.
v. Guaranteed Payments
Proposed Sec. 1.163(j)-1(b)(20)(iii)(I) provides that any
guaranteed payments for the use of capital under section 707(c) are
treated as interest. Some commenters stated that a guaranteed payment
for the use of capital should not be treated as interest for purposes
of section 163(j) unless the guaranteed payment was structured with a
principal purpose of circumventing section 163(j). Other commenters
stated that section 163(j) never should apply to guaranteed payments
for the use of capital.
In response to comments, the final regulations do not explicitly
include guaranteed payments for the use of capital under section 707(c)
in the definition of interest. However, consistent with the
recommendations of some commenters, the anti-avoidance rules in Sec.
1.163(j)-1(b)(22)(iv) (described in part II(E)(4) of this Summary of
Comments and Explanation of Revisions section) include an example of a
situation in which a guaranteed payment for the use of capital is
treated as interest expense and interest income for purposes of section
163(j). See Sec. 1.163(j)-1(b)(22)(v)(E), Example 5.
[[Page 56700]]
vi. Hedging Transactions
Proposed Sec. 1.163(j)-1(b)(20)(iii)(E) generally treats income,
deduction, gain, or loss from a derivative that alters a taxpayer's
effective cost of borrowing with respect to a liability of the taxpayer
as an adjustment to the taxpayer's interest expense. Proposed Sec.
1.163(j)-1(b)(20)(iii)(F) generally treats income, deduction, gain, or
loss from a derivative that alters a taxpayer's effective yield with
respect to a debt instrument held by the taxpayer as an adjustment to
the taxpayer's interest income. The rules in the two provisions are
referred to as the ``hedging rules'' in this preamble.
Numerous comments were received on the hedging rules. The
commenters questioned the administrability of the broad hedging rules,
especially if the taxpayer hedges on a macro (that is, on an aggregate)
basis. Also, the commenters noted that it is not clear how to apply the
rules in certain situations, including a situation in which the hedge
relates to non-debt items (for example, if the taxpayer hedges the
mismatch or ``gap'' between its assets and liabilities), the debt
instrument is not subject to section 163(j), or the debt instrument is
subject to other interest deferral provisions for Federal tax purposes.
In addition, the commenters noted that the proposed regulations
effectively would require integration, even if the hedge otherwise
would not be integrated with the debt instrument for Federal tax
purposes and the income, deduction, gain, and loss from the hedge
ordinarily would be accounted for separately, which the commenters
suggested would require taxpayers to maintain two sets of books.
Moreover, the commenters stated that, under the proposed regulations,
any gain or loss on the underlying debt instrument (for example, due to
changes in interest rates) would not be treated as an adjustment to
interest income or expense, whereas the corresponding loss or gain on
the hedge would be treated as an adjustment to interest expense or
income. Some commenters stated that the yield on third-party borrowings
reflects the true cost of the borrowing, and that hedges are not
relevant to the cost of the borrowing.
Commenters recommended that, if the hedging rules are retained in
the final regulations as a separate item, the final regulations
precisely define (a) what standard is used to include a derivative in
section 163(j) (for example, a primary purpose or principal motivation
standard), and (b) the standard for determining whether the effect of a
derivative on the cost of borrowing or effective yield is sufficiently
significant for the income, deduction, gain, or loss from the
derivative to be included in the computation. Commenters noted that one
approach would be to apply the hedging rules only to derivatives that
qualify for integration under Sec. 1.988-5 or Sec. 1.1275-6. Another
approach would be to apply the hedging rules to derivatives that have a
sufficiently close connection with the liability to qualify as hedging
transactions under Sec. Sec. 1.446-4 and 1.1221-2. Some commenters
indicated that the hedging rules could apply if the derivative is
treated as a hedge of a borrowing or liability for financial reporting
purposes, and that the hedging rules should not apply to broker-
dealers, active traders in derivatives, and financial institutions
acting in the ordinary course of business.
One commenter recommended that section 163(j) not alter the timing
of taxable items from hedging transactions that are subject to Sec.
1.446-4, regardless of whether interest expense on the hedged item is
deferred under section 163(j). Other commenters noted that the proposed
regulations do not provide guidance on the interaction between the
hedging rules and the straddle rules.
With respect to foreign currency hedging transactions, a commenter
noted that foreign currency gain or loss is due to the time value of
money only to a limited extent; thus, the commenter recommended that
section 163(j) not apply to a taxpayer's foreign currency hedging
transactions (other than an integrable transaction under Sec. 1.988-
5).
In response to comments, the final regulations do not include the
hedging rules in the definition of interest. However, in certain
circumstances, the anti-avoidance rules in Sec. 1.163(j)-1(b)(22)(iv)
(described in part II(E)(4) of this Summary of Comments and Explanation
of Revisions section) may apply to require income, deduction, gain, or
loss from a hedging transaction to be taken into account for purposes
of section 163(j).
vii. Other Items
Commenters recommended other items to be included in, or excluded
from, the definition of interest as follows:
a. Dividends From Regulated Investment Company (RIC) Shares
Some commenters recommended that dividend income from a RIC be
treated as interest income for a shareholder in a RIC, to the extent
that the dividend is attributable to interest income earned by the RIC.
To address this comment, in the Concurrent NPRM, the Treasury
Department and the IRS have proposed rules under which a RIC that earns
business interest income may pay section 163(j) interest dividends that
certain shareholders may treat as interest income for purposes of
section 163(j). See paragraphs (b)(22)(iii)(F) and (b)(35) in proposed
Sec. 1.163(j)-1 in the Concurrent NPRM.
b. MMF Income
A few commenters recommended that the final regulations allow look-
through treatment for earnings from certain foreign entities, such as
foreign money market funds (MMFs), so that dividends from foreign MMFs
would be treated as interest income to the extent the underlying income
derived by a foreign MMF was interest income. According to the
commenters, this treatment would alleviate issues for a CFC that
borrows money from related parties and invests in foreign MMFs. In
general, the commenters stated that any interest limitation under
section 163(j) could lead to unexpected results in this situation, such
as section 952(c) recapture accounts solely generated by the section
163(j) interest expense limitation.
The final regulations do not adopt this recommendation because it
is beyond the scope of the final regulations and because there are
significant differences between the rules governing income inclusions
in respect of passive foreign investment companies (PFICs), such as
foreign MMFs, and RICs. These differences make it difficult to adopt a
rule that would provide for look-through treatment in the context of
dividends or inclusions from a PFIC. In particular, the regime for
taxing income from a PFIC that shareholders have elected to treat as a
qualified electing fund (QEF) under section 1295 generally focuses only
on inclusions related to ordinary income or net capital gain income and
does not separately report amounts of interest income for Federal
income tax purposes. In the case of a PFIC for which a QEF election has
not been made, there would be no information about the underlying
taxable income of the PFIC and no reason or ability to treat an
interest in the PFIC differently from the treatment of stock held in
other C corporations.
c. Negative Interest
One commenter requested clarification on the treatment of negative
interest (an amount that a depositor may owe a bank in a negative
interest rate environment) and inquired whether such payments are more
similar to payments for custodial or service fees rather than for
interest. The final
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regulations do not address this issue because it is beyond the scope of
the final regulations. However, in certain cases (for example, a
Treasury bill acquired with a negative yield), a payment may be treated
as bond premium subject to the rules in section 171, including the
rules in Sec. 1.171-2(a)(4)(i)(C).
d. Leases
A commenter recommended that the Treasury Department and the IRS
adopt rules that clearly describe the circumstances in which fleet
leases are treated as generating interest for purposes of section
163(j). The commenter noted that there is a time-value-of-money portion
of a fleet lease payment similar to the time-value-of-money portion of
other items treated as interest under the proposed regulations, such as
guaranteed payments, commitment fees, debt issuance costs, and items of
income or loss from a derivative instrument that alters a taxpayer's
effective yield or effective cost of borrowing. In addition, to the
extent that the anti-avoidance rule in the proposed regulations is
retained, the commenter asked that the final regulations clearly define
the circumstances (if any) in which the anti-avoidance rule would
operate to recharacterize any portion of a fleet lease payment as
interest expense, and modify the anti-avoidance rule to apply to both
interest expense of the fleet lessee and interest income of the fleet
lessor.
The Treasury Department and the IRS do not adopt the commenter's
suggestions in the final regulations because the suggestions generally
are no longer relevant after the revisions made to the definition of
interest in the final regulations. For example, as explained in this
part II(E)(3) of this Summary of Comments and Explanation of Revisions
section, no portion of the items generally cited by the commenter is
explicitly treated as interest in the final regulations. Moreover,
there are explicit provisions in the Code that determine whether a
portion of a lease payment is treated as interest for Federal income
tax purposes depending on the terms of a lease, such as sections 467
and 483. In addition, as explained in part II(E)(4) of this Summary of
Comments and Explanation of Revisions section, the anti-avoidance rule
in the final regulations is revised to include a principal purpose test
and to generally align the treatment of income and expense, which
should address the commenter's concerns.
4. Anti-Avoidance Rule for Amounts Predominantly Associated With the
Time Value of Money
Proposed Sec. 1.163(j)-1(b)(20)(iv) provides that any expense or
loss, to the extent deductible, incurred by a taxpayer in a transaction
or series of integrated or related transactions in which the taxpayer
secures the use of funds for a period of time is treated as interest
expense of the taxpayer if such expense or loss is predominantly
incurred in consideration of the time value of money. Numerous comments
were received on this anti-avoidance rule in the proposed regulations.
Most commenters recommended that any anti-avoidance rule in the final
regulations contain a requirement that the taxpayer have a principal
purpose to avoid section 163(j). Several commenters asserted that the
anti-avoidance rule should cover only transactions that are
economically equivalent to interest and should set forth examples of
transactions that are and are not covered. Most commenters recommended
that the anti-avoidance rule be symmetrical and apply to income or
gain, as well as to expense or loss. One commenter suggested that,
based on section 1258 concepts, the anti-avoidance rule should apply
only if, at the time of the relevant transaction or series of
transactions that secure the use of funds for a period of time for the
taxpayer, substantially all of the expense or loss was expected to be
attributable to the time value of money. In addition, commenters noted
that it should be clear when a taxpayer should test whether a
transaction falls within the anti-avoidance rule. Other commenters
requested specific rules coordinating this anti-avoidance rule with the
general anti-avoidance rule in proposed Sec. 1.163(j)-2(h).
Some commenters stated that an interest anti-avoidance rule should
not be included in the final regulations because, for example, the rule
would impose substantial compliance costs, the Treasury Department and
the IRS have other tools to combat any abuse, and there already is a
general anti-avoidance rule in proposed Sec. 1.163(j)-2(h). Commenters
also noted that the interest anti-avoidance rule in the proposed
regulations has the potential to capture ordinary market transactions
that possess a time value component but that are not generally treated
as financings with disguised interest for tax purposes.
In response to comments, the Treasury Department and the IRS have
modified the anti-avoidance rule in the final regulations. Under Sec.
1.163(j)-1(b)(22)(iv)(A)(1), any expense or loss economically
equivalent to interest is treated as interest expense for purposes of
section 163(j) if a principal purpose of structuring the transaction(s)
is to reduce an amount incurred by the taxpayer that otherwise would
have been interest expense or treated as interest expense under Sec.
1.163(j)-1(b)(22)(i) through (iii). For this purpose, the fact that the
taxpayer has a business purpose for obtaining the use of funds does not
affect the determination of whether the manner in which the taxpayer
structures the transaction(s) is with a principal purpose of reducing
the taxpayer's interest expense. In addition, the fact that the
taxpayer has obtained funds at a lower pre-tax cost based on the
structure of the transaction(s) does not affect the determination of
whether the manner in which the taxpayer structures the transaction(s)
is with a principal purpose of reducing the taxpayer's interest
expense.
For purposes of Sec. 1.163(j)-1(b)(22)(iv)(A)(1), any expense or
loss is economically equivalent to interest to the extent that the
expense or loss is (1) deductible by the taxpayer; (2) incurred by the
taxpayer in a transaction or series of integrated or related
transactions in which the taxpayer secures the use of funds for a
period of time; (3) substantially incurred in consideration of the time
value of money; and (4) not described in Sec. 1.163(j)-1(b)(22)(i),
(ii), or (iii).
Under Sec. 1.163(j)-1(b)(22)(iv)(A)(2), if a taxpayer knows that
an expense or loss is treated by the payor as interest expense under
Sec. 1.163(j)-1(b)(22)(iv)(A)(1), the taxpayer provides the use of
funds for a period of time in the transaction(s) subject to Sec.
1.163(j)-1(b)(22)(iv)(A)(1), the taxpayer earns income or gain with
respect to the transaction(s), and such income or gain is substantially
earned in consideration of the time value of money provided by the
taxpayer, such income or gain is treated as interest income for
purposes of section 163(j) to the extent of the expense or loss treated
by the payor as interest expense under Sec. 1.163(j)-
1(b)(22)(iv)(A)(1).
Under Sec. 1.163(j)-1(b)(22)(iv)(B), notwithstanding Sec.
1.163(j)-1(b)(22)(i) through (iii), any income realized by a taxpayer
in a transaction or series of integrated or related transactions is not
treated as interest income of the taxpayer for purposes of section
163(j) if and to the extent that a principal purpose for structuring
the transaction(s) is to artificially increase the taxpayer's business
interest income. For this purpose, the fact that the
[[Page 56702]]
taxpayer has a business purpose for holding interest-generating assets
does not affect the determination of whether the manner in which the
taxpayer structures the transaction(s) is with a principal purpose of
artificially increasing the taxpayer's business interest income.
For purposes of the foregoing anti-avoidance rules, Sec. 1.163(j)-
1(b)(22)(iv)(C) provides that whether a transaction or a series of
integrated or related transactions is entered into with a principal
purpose depends on all the facts and circumstances related to the
transaction(s), except that the fact that the taxpayer has obtained
funds at a lower pre-tax cost based on the structure of the
transaction(s) or the fact that the taxpayer has a business purpose
related to the item is ignored for this purpose. A purpose may be a
principal purpose even though it is outweighed by other purposes taken
together or separately. Factors to be taken into account in determining
whether one of the taxpayer's principal purposes for entering into the
transaction(s) include the taxpayer's normal borrowing rate in the
taxpayer's functional currency, whether the taxpayer would enter into
the transaction(s) in the ordinary course of the taxpayer's trade or
business, whether the parties to the transaction(s) are related persons
(within the meaning of section 267(b) or section 707(b)), whether there
is a significant and bona fide business purpose for the structure of
the transaction(s), whether the transactions are transitory, for
example, due to a circular flow of cash or other property, and the
substance of the transaction(s).
In response to comments, Sec. 1.163(j)-1(b)(22)(iv)(D) provides
that the anti-avoidance rules in Sec. 1.163(j)-1(b)(22)(iv), rather
than the general anti-avoidance rules in Sec. 1.163(j)-2(j), apply to
determine whether an item is treated as interest expense or interest
income.
Section 1.163(j)-1(b)(22)(v) contains examples illustrating the
application of the interest anti-avoidance rules in a number of
situations, including examples relating to a hedging transaction
involving a foreign currency swap transaction, a forward contract
involving gold, a loan guaranteed by a related party in which the
related party receives guarantee fees, and guaranteed payments for the
use of capital. However, these examples are not intended to represent
the only situations in which the anti-avoidance rules might apply.
The anti-avoidance rules in Sec. 1.163(j)-1(b)(22)(iv) apply to
transactions entered into on or after September 14, 2020. See Sec.
1.163(j)-1(c)(2).
5. Authority Comments
Most of the commenters on the definition of interest in the
proposed regulations questioned whether the Treasury Department and the
IRS have the authority to expand the definition of interest for
purposes of section 163(j) to include ``interest equivalents'' (the
items listed in proposed Sec. 1.163(j)-1(b)(20)(iii) and the expenses
or losses subject to the anti-avoidance rule in proposed Sec.
1.163(j)-1(b)(20)(iv)). The commenters asserted that the term
``business interest'' in section 163(j)(5) means any interest paid or
accrued on indebtedness properly allocable to a trade or business, and
that expanding the definition to include interest equivalents would
capture amounts that do not fall within the scope of the general rule
in section 163(a) that ``[t]here shall be allowed as a deduction all
interest paid or accrued within the taxable year on indebtedness.''
Even though section 163(j)(1) refers to an ``amount allowed as a
deduction under this chapter for business interest'' when describing
the amounts limited by section 163(j), the commenters argued that the
deduction otherwise allowed must be with respect to ``business
interest'' (which is defined in section 163(j)(5)) and that the phrase
``deduction under this chapter'' does not and should not modify the
definition of ``business interest'' in section 163(j)(5).
The commenters noted that section 163(j), as amended by the TCJA,
does not contain a specific delegation of regulatory authority to
expand the definition of interest. The commenters further asserted that
the Treasury Department and the IRS may issue only ``interpretive
regulations'' under section 7805, and that any such regulations may not
go beyond the stated meaning of the statutory language. The commenters
noted that old section 163(j)(9) provided broad regulatory authority to
prescribe regulations, including regulations appropriate to prevent the
avoidance of old section 163(j). In addition, the commenters noted that
the legislative history for old section 163(j) indicated that the
Treasury Department could issue guidance treating ``items not
denominated as interest but appropriately characterized as equivalent
to interest'' as interest income or interest expense. The commenters
stated that there is no similar regulatory authority or legislative
history relating to section 163(j) as amended by the TCJA.
Commenters also noted that, when Congress has chosen to expand the
definition of interest in other parts of the Code, Congress has done so
explicitly. For example, section 263(g) provides that, ``[for purposes
of section 263(g)(2)(A)], the term `interest' includes any amount paid
or incurred in connection with personal property used in a short
sale.'' As noted in the preamble to the proposed regulations, most of
the rules treating interest equivalent items as interest income or
expense in proposed Sec. 1.163(j)-1(b)(20)(iii) were developed in
Sec. Sec. 1.861-9T and 1.954-2. However, commenters argued that the
use of the interest equivalent provisions in Sec. Sec. 1.861-9T and
1.954-2 by analogy to define interest for purposes of section 163(j) is
inappropriate because different policy considerations underlie those
sections, there is statutory or regulatory authority to address
interest equivalents under those sections (unlike section 163(j)), and
those sections apply only for limited purposes (for example, for
sourcing purposes).
In addition, because the broad definition of interest in the
proposed regulations applies only for purposes of section 163(j),
commenters asserted that there will be additional compliance burdens
and costs for taxpayers to separately track amounts treated as interest
for purposes of section 163(j) and for other purposes. Commenters
asserted that the broad definition of interest for purposes of section
163(j) in the proposed regulations may create uncertainty and confusion
for taxpayers with respect to other sections of the Code.
Contrary to the assertions made by many of the commenters, the
Treasury Department and the IRS have the authority to prescribe rules
relating to interest equivalents and an anti-avoidance rule. As noted
in the preamble to the proposed regulations, there are no generally
applicable regulations or statutory provisions addressing when
financial instruments are treated as indebtedness for Federal income
tax purposes or when a payment is ``interest.'' Therefore, a regulatory
definition of interest is needed in order to implement the statutory
language of section 163(j).
In addition, it would be inconsistent with the purpose of section
163(j) to allow transactions that are essentially financing
transactions to avoid the application of section 163(j). Thus, an anti-
avoidance rule is needed to address situations in which a taxpayer's
principal purpose in structuring a transaction or series of
transactions is to artificially reduce the taxpayer's business interest
expense or to increase the taxpayer's business interest income.
Moreover, at least one commenter suggested the inclusion of the type of
[[Page 56703]]
anti-avoidance rule that is included in the final regulations and that
the Treasury Department and the IRS have the authority to include such
a rule.
Section 7805(a) provides the Treasury Department and the IRS with
the authority to prescribe all rules and regulations needed for
enforcement of the Code, including all rules and regulations as may be
necessary by reason of any alteration of law in relation to internal
revenue. Providing a regulatory definition of interest for purposes of
section 163(j) and the anti-avoidance rule falls within this authority.
The statutory language of section 163(j)(1) (``The amount allowed as a
deduction under this chapter for any taxable year for business interest
. . .'') (emphasis added) also supports the application of section
163(j) to more items than merely items traditionally deducted under
section 163(a).
Although the Treasury Department and the IRS have the authority to
prescribe regulations addressing interest equivalents and anti-
avoidance transactions, as noted earlier in parts II(E)(3) and (4) of
this Summary of Comments and Explanation of Revisions section, in
response to comments, the final regulations nevertheless limit the
interest equivalent items to those items commenters agreed should be
treated as interest expense or interest income, substitute interest
payments made in connection with a sale-repurchase agreement or
securities lending transaction that is not entered into by the taxpayer
in the taxpayer's ordinary course of business, and certain amounts
relating to transaction(s) entered into by a taxpayer with a principal
purpose of artificially reducing interest expense or increasing
interest income.
F. Definition of Motor Vehicle--Proposed Sec. 1.163(j)-1(b)(25)
Proposed Sec. 1.163(j)-1(b)(25) provides that the term ``motor
vehicle'' means a motor vehicle as defined in section 163(j)(9)(C).
Under section 163(j)(9)(C), a motor vehicle means any self-propelled
vehicle designed for transporting persons or property on a public
street, highway, or road; a boat; and farm machinery or equipment. A
few commenters questioned whether towed recreational vehicles and
trailers are included in the definition of ``motor vehicle.'' One
commenter requested that the final regulations define motor vehicle to
include any trailer or camper that is designed to provide temporary
living quarters for recreational, camping, travel, or seasonal use and
is designed to be towed by, or affixed to, a motor vehicle. Another
commenter recommended allowing motor vehicle dealers to deduct floor
plan financing interest on both motor vehicles and trailers that are
offered for sale in integrated or related businesses.
Because section 163(j)(9)(C) specifically defines motor vehicles as
self-propelled vehicles, the Treasury Department and the IRS do not
have the authority to expand the definition of motor vehicles in the
final regulations to include vehicles that are not self-propelled, such
as towed recreational vehicles and trailers. For this reason, the
Treasury Department and the IRS decline to adopt these comments in the
final regulations. Therefore, the definition of motor vehicles in the
final regulations continues to incorporate the definition in section
163(j)(9)(C) by cross-reference.
G. Definition of Taxable Income--Proposed Sec. 1.163(j)-1(b)(37)
1. Calculation of Taxable Income
Proposed Sec. 1.163(j)-1(b)(1)(i)(A) provides that business
interest expense is added to taxable income to determine ATI. Some
commenters noted that this provision could be construed as distorting
ATI if a taxpayer has a disallowed business interest expense
carryforward from a prior taxable year. Under such facts, the proposed
regulations would not have reduced taxable income by the amount of the
carryforward, because proposed Sec. 1.163(j)-1(b)(37) disregards the
carryforward as part of section 163(j) and the section 163(j)
regulations. However, in calculating ATI, taxpayers might argue that
taxable income should be increased by the amount of the disallowed
business interest expense carryforward because the term ``business
interest expense'' in the proposed regulations includes disallowed
business interest expense carryforwards.
The Treasury Department and the IRS did not intend to create a net
positive adjustment to ATI for disallowed business interest expense
carryforwards. To address this potential distortion, the final
regulations clarify that tentative taxable income is computed without
regard to the section 163(j) limitation, and that disallowed business
interest expense carryforwards are not added to tentative taxable
income in computing ATI under Sec. 1.163(j)-1(b)(1).
2. Interaction With Section 250
Proposed Sec. 1.163(j)-1(b)(37)(ii) provides a rule to coordinate
the application of sections 163(j) and 250. Section 250(a)(1) generally
provides a deduction based on the amount of a domestic corporation's
foreign-derived intangible income and GILTI. Section 250(a)(2) limits
the amount of this deduction based on the taxpayer's taxable income--
the greater the amount of a taxpayer's taxable income for purposes of
section 250(a)(2), the greater the amount of the taxpayer's allowable
deduction under section 250(a)(1).
In particular, proposed Sec. 1.163(j)-1(b)(37)(ii) provides that,
if a taxpayer is allowed a deduction for a taxable year under section
250(a)(1) that is properly allocable to a non-excepted trade or
business, then the taxpayer's taxable income for that year is
determined without regard to the limitation in section 250(a)(2). Some
commenters observed that this proposed rule results in a lower ATI and
section 163(j) limitation for the taxpayer than if the limitation in
section 250(a)(2) were taken into account. Commenters also stated that
the rationale for this approach (which does not reflect the taxpayer's
actual taxable income) is unclear, and they recommended that this
provision be withdrawn or made elective for taxpayers.
The Treasury Department and the IRS have determined that further
study is required to determine the appropriate rule for coordinating
sections 250(a)(2), 163(j), and other Code provisions (such as sections
170(b)(2) and 172(a)(2)) that limit the availability of deductions
based, directly or indirectly, upon a taxpayer's taxable income
(taxable income-based provisions). Therefore, the final regulations do
not contain the rule in proposed Sec. 1.163(j)-1(b)(37)(ii). Until
such additional guidance is effective, taxpayers may choose any
reasonable approach (which could include an ordering rule or the use of
simultaneous equations) for coordinating taxable income-based
provisions as long as such approach is applied consistently for all
relevant taxable years. For this purpose, the ordering rule contained
in proposed Sec. Sec. 1.163(j)-1(b)(37)(ii) (83 FR 67490 (Dec. 28,
2018)) and 1.250(a)-1(c)(4) (contained in 84 FR 8188 (March 6, 2019))
is treated as a reasonable approach for coordinating sections 163(j)
and 250. Comments are welcome on what rules should be provided, and
whether an option to use simultaneous equations in lieu of an ordering
rule would be appropriate in order to coordinate taxable income-based
provisions.
3. When Disallowed Business Interest Expense Is ``Paid or Accrued''
As noted in the Background section of this preamble, section
163(j)(2) provides that the amount of any business interest not allowed
as a deduction for any
[[Page 56704]]
taxable year under section 163(j)(1) is treated as business interest
``paid or accrued'' in the succeeding taxable year. Commenters asked
for clarification as to whether disallowed business interest expense
should be treated as ``paid or accrued'' in the taxable year in which
such expense is taken into account for Federal income tax purposes
(without regard to section 163(j)), or whether such expense instead
should be treated as paid or accrued in the succeeding taxable year in
which the expense can be deducted by the taxpayer under section 163(j).
For purposes of section 163(j) and the section 163(j) regulations,
the term ``paid or accrued'' in section 163(j)(2) must be construed in
such a way as to further congressional intent. Although the use of this
term in section 163(j)(2) provides a mechanism for disallowed business
interest expense to be carried forward to and deducted in a subsequent
taxable year, it does not mean that a disallowed business interest
expense carryforward is treated as paid or accrued in a subsequent year
for all purposes. In certain contexts, a disallowed business interest
expense must be treated as paid or accrued in the year the expense was
paid or accrued without regard to section 163(j) to give effect to
congressional intent. For example, if a disallowed business interest
expense were treated as paid or accrued only in a future taxable year
in which such expense could be deducted after the application of
section 163(j), then section 382 never would apply to such expense
(because disallowed business interest expense carryforwards never would
be pre-change losses). This outcome is clearly contrary to
congressional intent (see section 382(d)(3)). Similarly, if a
disallowed business interest expense were treated as paid or accrued in
a future taxable year for purposes of section 163(j)(8)(A)(ii), then
such expense would be added back to tentative taxable income in
determining ATI for that taxable year (and for all future taxable years
to which such expense is carried forward under section 163(j)(2)),
thereby artificially increasing the taxpayer's section 163(j)
limitation. (See part II(A) of this Summary of Comments and Explanation
of Revisions section.) This outcome also is inconsistent with
congressional intent. However, in other contexts, a disallowed business
interest expense must be treated as paid or accrued in a succeeding
taxable year to allow for the deduction of the carryforward in that
year.
The definition of ``disallowed business interest expense'' has been
revised in the final regulations to reflect that, solely for purposes
of section 163(j) and the section 163(j) regulations, disallowed
business interest expense is treated as ``paid or accrued'' in the
taxable year in which the expense is taken into account for Federal
income tax purposes (without regard to section 163(j)), or in a
succeeding taxable year in which the expense can be deducted by the
taxpayer under section 163(j), as the context may require.
4. Interaction With Sections 461(l), 465, and 469--Proposed Sec.
1.163(j)-1(b)(37)
The Treasury Department and the IRS received questions asking for
clarification of the interaction between proposed Sec. 1.163(j)-
1(b)(37) and the limitations in sections 461(l), 465, and 469. The
final regulations clarify that sections 461(l), 465, and 469 are taken
into account when determining tentative taxable income. Then, as
provided in proposed Sec. 1.163(j)-3(b)(4), sections 461(l), 465, and
469 are applied after the application of the section 163(j) limitation.
See part II(B) of this Summary of Comments and Explanation of Revisions
section.
H. Definition of Trade or Business--Proposed Sec. 1.163(j)-1(b)(38)
1. In General
The section 163(j) limitation applies to taxpayers with ``business
interest,'' which is defined in section 163(j)(5) as any interest
properly allocable to a trade or business. Neither section 163(j) nor
the legislative history defines the term ``trade or business.''
However, section 163(j)(7) provides that the term ``trade or business''
does not include the trade or business of performing services as an
employee, as well as electing real property, electing farming, and
certain utility trades or businesses.
As described in the preamble to the proposed regulations, the
proposed regulations define the term ``trade or business'' by reference
to section 162. Section 162(a) permits a deduction for all the ordinary
and necessary expenses paid or incurred in carrying on a trade or
business. Commenters requested additional guidance in determining
whether an activity constitutes a section 162 trade or business.
The rules under section 162 for determining the existence of a
trade or business are well-established and illustrated through a large
body of case law and administrative guidance. Additionally, whether an
activity is a section 162 trade or business is inherently a factual
question. Higgins v. Commissioner, 312 U.S. 212, 217 (1941)
(determining ``whether the activities of a taxpayer are `carrying on a
business' requires an examination of the facts in each case'').
The courts have developed two definitional requirements. One, in
relation to profit motive, requires the taxpayer to enter into and
carry on the activity with a good-faith intention to make a profit or
with the belief that a profit can be made from the activity. The
second, in relation to the scope of the activities, requires
considerable, regular, and continuous activity. See generally
Commissioner v. Groetzinger, 480 U.S. 23 (1987). In the seminal case of
Groetzinger, the Supreme Court stated that, ``[w]e do not overrule or
cut back on the Court's holding in Higgins when we conclude that if
one's gambling activity is pursued full time, in good faith, and with
regularity, to the production of income for a livelihood, and is not a
mere hobby, it is a trade or business within the meaning of the
statutes with which we are here concerned.'' Id. at 35.
2. Multiple Trades or Businesses Within an Entity
Commenters also suggested there should be factors to determine how
to delineate separate section 162 trades or businesses within an entity
and when an entity's combined activities should be considered a single
section 162 trade or business for purposes of section 163(j). One
commenter suggested adopting the rules for separate trades or
businesses provided in section 446 and the regulations thereunder.
The Treasury Department and the IRS decline to adopt these
recommendations because specific guidance under section 162 is beyond
the scope of the final regulations. Further, Sec. 1.446-1(d) does not
provide guidance on when trades or businesses will be considered
separate and distinct. Instead, it provides that a taxpayer may use
different methods of accounting for separate and distinct trades or
businesses, and it specifies two circumstances in which trades or
businesses will not be considered separate and distinct. For example,
Sec. 1.446-1(d)(2) provides that no trade or business will be
considered separate and distinct unless a complete and separable set of
books and records is kept for such trade or business.
The Treasury Department and the IRS recognize that an entity can
conduct more than one trade or business under section 162. This
position is inherent in the allocation rules detailed in proposed Sec.
1.163(j)-10(c)(3), which require a taxpayer with an asset used in more
than one trade or business to allocate its adjusted basis in the asset
to each trade or business using the permissible methodology described
therein. In this
[[Page 56705]]
context, the final regulations provide, consistent with the proposed
regulations, that maintaining separate books and records for all
excepted and non-excepted trades or businesses is one indication that a
particular asset is used in a particular trade or business.
Whether an entity has multiple trades or businesses is a factual
determination, and numerous court decisions that define the meaning of
``trade or business'' also provide taxpayers guidance in determining
whether more than one trade or business exists. See Groetzinger, 480
U.S. at 35. For example, some court decisions discuss whether the
activities have separate books and records, facilities, locations,
employees, management, and capital structures, and whether the
activities are housed in separate legal entities.
Accordingly, the final regulations define ``trade or business'' as
a trade or business within the meaning of section 162, which should aid
taxpayers in the proper allocation of interest expense, interest
income, and other tax items to a trade or business and to an excepted
or non-excepted trade or business.
3. Rental Real Estate Activities as a Trade or Business
See the discussion of elections for real property trades or
businesses that may not qualify as section 162 trades or businesses in
part X of this Summary of Comments and Explanation of Revisions
section.
4. Separate Entities
One commenter requested clarification that the determination of
whether an entity generates interest attributable to a trade or
business within the meaning of section 162 is made at the entity level
without regard to the classification of the entity's owners. Except in
the context of a consolidated group, or if Sec. 1.163(j)-10 provides
otherwise, the determination of whether an entity generates interest
and whether such interest is properly allocable to a trade or business
is determined at the entity level, without regard to the classification
of the entity's owners. See also the discussion of trading partnerships
and CFC groups in the Concurrent NPRM.
I. Applicability Dates
The proposed regulations provide generally that the final
regulations would apply to taxable years ending after the date that
this Treasury Decision is published in the Federal Register. The
proposed applicability date has been changed in the final regulations
to avoid the application of the changes reflected in the final
regulations to a taxpayer at the end of the taxable year, which may
result in unexpected effects on the taxpayer under section 163(j).
Accordingly, the final regulations generally apply to taxable years
beginning on or after the date that is 60 days after the date that this
Treasury Decision is published in the Federal Register.
III. Comments on and Changes to Proposed Sec. 1.163(j)-2: Deduction
for Business Interest Expense Limited
Proposed Sec. 1.163(j)-2 provides general rules regarding the
section 163(j) limitation, including rules on how to calculate the
limitation, how to treat disallowed business interest expense
carryforwards, and how the small business exemption and the aggregation
rules apply with the limitation. The following discussion addresses
comments relating to proposed Sec. 1.163(j)-2.
A. Whether the Section 163(j) Limitation Is a Method of Accounting
A few commenters requested clarification that the section 163(j)
limitation is not a method of accounting under section 446 and the
regulations thereunder. The commenters requested clarification on
whether the application of the section 163(j) limitation is a method of
accounting because the rules under section 163(j) appear to defer,
rather than permanently disallow, a deduction for disallowed business
interest expense and disallowed disqualified interest (as defined in
proposed Sec. 1.163(j)-1(b)(10)). Specifically, section 163(j)(2) and
proposed Sec. 1.163(j)-2(c) allow the carryforward of disallowed
business interest expense, and proposed Sec. 1.163(j)-2(c) allows the
carryforward of disallowed disqualified interest, to succeeding taxable
years.
Section 1.446-1(a)(1) defines the term ``method of accounting'' to
include not only the overall method of accounting of a taxpayer, but
also the accounting treatment of any item of gross income or deduction.
Under Sec. 1.446-1(e)(2)(ii)(a), an accounting method change includes
a change in the overall plan of accounting for gross income or
deductions or a change in the treatment of any material item used in
such overall plan of accounting. Moreover, Sec. 1.446-1(e)(2)(ii)(a)
provides that a ``material item'' is any item that involves the proper
time for the inclusion of the item in income or the taking of a
deduction. The key characteristic of a material item ``is that it
determines the timing of income or deductions.'' Knight-Ridder
Newspapers, Inc. v. United States, 743 F.2d 781, 798 (11th Cir. 1984).
Once a taxpayer has established a method of accounting for an item of
income or expense, the taxpayer must obtain the consent of the
Commissioner under section 446(e) before changing to a different method
of accounting for that item.
For purposes of Sec. 1.446-1(e)(2)(ii)(a), if there is a change in
the application of the section 163(j) limitation, the item involved is
the taxpayer's deduction for business interest expense. The taxpayer is
not changing its treatment of this item; instead, the taxpayer is
changing the limitation placed upon that specific item. The effect of
removing the section 163(j) limitation is that the taxpayer would be
able to recognize the full amount of the interest expense that is
otherwise deductible under its accounting method in a given taxable
year before it was limited by section 163(j).
The Treasury Department and the IRS do not view the section 163(j)
limitation as a method of accounting under section 446(e) and the
regulations thereunder. The determination of whether a taxpayer is
subject to the section 163(j) limitation is determined for each taxable
year. The carryover rules in section 163(j)(2) and proposed Sec.
1.163(j)-2(c) provide that disallowed business interest expense and
disallowed disqualified interest may be carried forward to a future
taxable year. However, section 163(j) does not provide a mechanism to
ensure that, in every situation, a taxpayer will be able to deduct the
business interest expense that the taxpayer was not permitted to deduct
in one taxable year and was required to carry forward to succeeding
taxable years. Thus, the section 163(j) limitation is not a method of
accounting under Sec. 1.446-1(e)(2)(ii)(a) because the change in
practice may result in a permanent change in the taxpayer's lifetime
taxable income. Further, the section 163(j) limitation does not involve
an ``item'' as it is not a recurring element of income or expense.
B. General Gross Receipts Test and Aggregation
As noted in the preamble to the proposed regulations, section
163(j)(3) exempts certain small businesses from the section 163(j)
limitation. See proposed Sec. 1.163(j)-2(d). Under section 163(j), a
small business taxpayer is one that meets the gross receipts test in
section 448(c) and is not a tax shelter under section 448(a)(3). The
gross receipts test is met if a taxpayer has average annual gross
receipts for the three taxable years prior to the current taxable year
of $25 million or less. For
[[Page 56706]]
taxable years beginning after December 31, 2018, the gross receipts
threshold reflects an annual adjustment for inflation as provided for
in section 448(c)(4); thus, the gross receipts threshold for taxable
years beginning in 2020 is $26 million. See section 3.31 of Rev. Proc.
2019-44, 2019-47 I.R.B.1093. Section 448(c)(2) aggregates the gross
receipts of multiple taxpayers that are treated as a single employer
under sections 52(a) and (b) and 414(m) and (o). The gross receipts
test under section 448(c) normally applies only to corporations and to
partnerships with C corporation partners. However, section 163(j)(3)
and proposed Sec. 1.163(j)-2(d)(2)(i) provide that, for a taxpayer
that is not a corporation or a partnership, the gross receipts test of
section 448(c) applies as if the taxpayer were a corporation or a
partnership.
Some commenters noted that the aggregation rules in sections 52(a)
and (b) and sections 414(m) and (o) could be difficult to apply in
certain instances due to their complexity. Other commenters asked that
the final regulations clarify the application of the aggregation rules
to the gross receipts test under section 448(c). Addressing the
application of the aggregation rules to the gross receipts test is
beyond the scope of the final regulations. The section 52(a) and (b)
aggregation rules were enacted as part of the work opportunity tax
credit, but have also been applied to numerous Code provisions,
including sections 45A, 45S, 264, 280C and 448. The affiliated service
group rules under section 414(m) were enacted to address certain abuses
related to qualified retirement plans, but also have been applied to
several other Code provisions, including sections 45R, 162(m), 414(t),
4980H, and 4980I.
However, the Treasury Department and the IRS are aware that the
aggregation rules set forth in sections 52(a) and (b) and sections
414(m) and (o) are complex. Therefore, Frequently Asked Questions that
explain the basic operation of these rules are provided on https://irs.gov/newsroom. See FAQs Regarding the Aggregation Rules Under
Section 448(c)(2) that Apply to the Section 163(j) Small Business
Exemption. The Treasury Department and the IRS continue to study the
application of the aggregation rules to the gross receipts test, and
request comments on issues relating to such application, taking into
account the application of the aggregation rules beyond the gross
receipts test.
The Treasury Department and the IRS continue to review and consider
issues relating to the affiliated service group rules under section
414(m), and a guidance project regarding the aggregation rules under
section 414(m) is listed on the 2019-2020 Priority Guidance Plan (RIN
1545-BO34). As guidance is published relating to the affiliated service
group rules, the FAQs will be updated, taking into account the various
Code provisions to which these aggregation rules apply.
In addition, the Treasury Department and the IRS recognize that
proposed Sec. 1.163(j)-2(d)(2)(i) may generate confusion with respect
to the aggregation rules. Although section 448(c) applies only to
corporations and to partnerships with a C corporation partner, sections
52(a), 52(b), 414(m), and 414(o) apply to a broader array of entities.
These statutes contain different ownership thresholds for different
types of entities that apply in determining whether multiple entities
are treated as a single employer. To resolve potential confusion, the
final regulations remove the reference to the aggregation rules from
proposed Sec. 1.163(j)-2(d)(2)(i). Taxpayers that are not a
corporation or a partnership with a C corporation partner must apply
section 448(c) as if they were a corporation or a partnership in
accordance with section 163(j)(3) and proposed Sec. 1.163(j)-
2(d)(2)(i). However, taxpayers should treat themselves as the type of
entity that they actually are in applying sections 52(a), 52(b),
414(m), and 414(o).
C. Small Business Exemption and Single Employer Aggregation Rules--
Proposed Sec. Sec. 1.163(j)-2(d) and 1.52-1(d)(1)(i)
Section 52(b) treats trades or businesses under common control as a
single employer. Section 1.52-1(b) through (d) defines ``trades or
businesses under common control'' to include parent-subsidiary groups
and brother-sister groups. Commenters noted that the version of Sec.
1.52-1(d)(1)(i) in effect at the time of the proposed regulations
defined ``brother-sister groups'' to include entities a controlling
interest in which is owned by the same 5 or fewer people who are
individuals, estates, or trusts (directly and with the application of
Sec. 1.414(c)-4(b)(1)).
Section 1.414(c)-4(b)(1) provides that, if a person has an option
to purchase an interest in an organization, the person is deemed to own
an interest in that organization. Other provisions under Sec.
1.414(c)-4 apply attribution on a broader scale, such as through
familial relationships and for closely held partnerships and S
corporations.
Commenters questioned whether the cross-reference in Sec. 1.52-
1(d)(1)(i) was correct, and whether the cross-reference should have
been to Sec. 1.414(c)-4 instead of Sec. 1.414(c)-4(b)(1). The
Treasury Department and the IRS agree that there is no discernible
reason why Sec. 1.52-1(d)(1)(i) aggregation should be limited solely
to options holders. Taxpayers need to know how to aggregate gross
receipts properly in order to know if they are subject to section
163(j).
On July 11, 2019, a correcting amendment to T.D. 8179 was published
in the Federal Register to clarify that the cross-reference in Sec.
1.52-1(d)(1)(i) should be to Sec. 1.414(c)-4. See 84 FR 33002. This
correcting amendment should eliminate uncertainty for taxpayers that
need to determine how to aggregate gross receipts in the context of a
brother-sister group under common control.
D. Small Business Exemption and Tax Shelters--Proposed Sec. 1.163(j)-
2(d)(1)
Consistent with section 163(j)(3), proposed Sec. 1.163(j)-2(d)(1)
provides that the exemption for certain small businesses that meet the
gross receipts test of section 448(c) does not apply to a tax shelter
as defined in section 448(d)(3). Several commenters requested
clarification on the application of the small business exemption under
section 163(j)(3) to a tax shelter.
Section 448(d)(3) defines a tax shelter by cross-reference to
section 461(i)(3), which defines a tax shelter, in relevant part, as a
syndicate within the meaning of section 1256(e)(3)(B). Section 1.448-
1T(b)(3) provides, in part, that a syndicate is a partnership or other
entity (other than a C corporation) if more than 35 percent of its
losses during the taxable year are allocated to limited partners or
limited entrepreneurs, whereas section 1256(e)(3)(B) refers to losses
that are allocable to limited partners or limited entrepreneurs. As a
result, the scope of the small business exemption in section 163(j)(3)
is unclear. Commenters requested that an entity be a syndicate in a
taxable year only if it has net losses in that year and more than 35
percent of those net losses are actually allocated to limited partners
or limited entrepreneurs. To provide a consistent definition of the
term ``syndicate'' for purposes of sections 163(j), 448, and 1256, the
Treasury Department and the IRS propose to define the term
``syndicate'' using the actual allocation rule from the definition in
Sec. 1.448-1T(b)(3). This definition is also consistent with the
definition used in a number of private letter rulings under section
1256. See proposed Sec. 1.1256(e)-2(a) in the Concurrent NPRM.
[[Page 56707]]
Commenters also requested specific relief for small business
taxpayers from the definition of a syndicate based on the ``active
management'' exception under section 1256(e)(3)(C). Section
1256(e)(3)(C) lists several examples of interests in an entity that
``shall not be treated as held by a limited partner or a limited
entrepreneur,'' thus excluding the entity from the definition of a
syndicate. In particular, section 1256(e)(3)(C)(v) allows the Secretary
to determine (by regulations or otherwise) ``that such interest should
be treated as held by an individual who actively participates in the
management of such entity, and that such entity and such interest are
not used (or to be used) for tax-avoidance purposes.''
The commenters requested that the Treasury Department use its
authority under section 1256(e)(3)(C)(v) to provide relief from the
definition of a syndicate to small business entities that (1) qualify
under the gross receipts test of section 448(c), (2) meet the
definition of a syndicate, and (3) do not qualify to make an election
as an electing real property business or electing farming business. If
a small business satisfies these three conditions, the commenters
requested that the Treasury Department and the IRS provide a rule that
all interests in the entity are treated as held by partners or owners
who actively participate in the management of such entity.
The Treasury Department and the IRS have determined that the
request deeming limited partners in small partnerships to be active
participants even if those owners would not be treated as active
participants under section 1256(e)(3)(C) is contrary to the statutory
language and legislative history in section 163(j)(3). Therefore, the
Treasury Department and the IRS decline to adopt the comments.
Another commenter asked for clarification on how to compute the
amount of loss to be tested under Sec. 1.448-1T(b)(3) and section
1256(e)(3)(B). The commenter provided a particular fact pattern in
which a small business would be caught in an iterative loop of (a) of
having net losses due to a business interest deduction, (b) which would
trigger disallowance of the exemption for small businesses in section
163(j)(3) if more than 35 percent of the losses were allocated to a
limited partner, (c) which would trigger the application of the section
163(j)(1) limitation to reduce the amount of the interest deduction,
(d) which would then lead to the taxpayer having no net losses and
therefore being eligible for the application of the exemption for small
businesses under section 163(j)(3). To address this fact pattern, in
the Concurrent NPRM, the Treasury Department and the IRS have added an
ordering rule providing that, for purposes of section 1256(e)(3)(B) and
Sec. 1.448-1T(b)(3), losses are determined without regard to section
163(j). See proposed Sec. 1.1256(e)-2(b) and the example provided in
proposed Sec. 1.1256(e)-2(c) in the Concurrent NPRM.
E. Gross Receipts for Partners in Partnerships and Shareholders of S
Corporation Stock--Proposed Sec. 1.163(j)-2(d)(2)(iii)
Proposed Sec. 1.163(j)-2(d)(iii) provides that, in determining
whether a taxpayer meets the gross receipts test of section 448(c),
each partner in a partnership includes a share of partnership gross
receipts in proportion to such partner's distributive share of items of
gross income that were taken into account by the partnership under
section 703. Similarly, shareholders of S corporations include a pro
rata share of the S corporation's gross receipts. See Rev. Rul. 71-455,
1971-2 C.B. 318 (holding that a partner's distributive share of the
partnership's gross receipts is used in applying the passive investment
income test under section 1372(e)(5)).
This approach would be applicable only in situations in which the
partner and the partnership (or a shareholder and the S corporation)
are not treated as one person under the aggregation rules of sections
52(a) and (b) and 414(m) and (o). The Treasury Department and the IRS
requested comments in the preamble to the proposed regulations on this
approach and on whether other approaches to determining the gross
receipts of partners and S corporation shareholders for purposes of
section 163(j) would measure the gross receipts of such partners and
shareholders more accurately.
In response, several commenters suggested different approaches for
determining the gross receipts of partners and S corporation
shareholders. One commenter recommended that a taxpayer should include
gross receipts only from entities eligible for the small business
exemption (exempt entities). In other words, the commenter recommended
that a taxpayer's gross receipts should not include gross receipts from
(1) any electing real property trade or business or electing farming
business; (2) any entities utilizing the floor plan financing interest
exception under section 163(j)(1)(C); and (3) any other entities
subject to section 163(j). The commenter noted that this modification
would simplify the computation of gross receipts and prevent the same
gross receipts from being double-counted both at the entity level and
the partner or S corporation shareholder level. However, the
determination of gross receipts generally is not affected by whether
any other entity is subject to section 163(j).
One commenter noted that passthrough entities generally do not
provide information regarding gross receipts to their partners. As it
is difficult for partners to determine the partnership's gross
receipts, the commenter suggested various approaches, such as a de
minimis rule whereby a less-than-10 percent owner of a passthrough
entity may use the taxable income from such entity rather than gross
receipts; use the current-year gross receipts as a reasonable estimate
of the past three years; or not exclude the gross receipts of the
exempt entity in certain situations.
Another commenter recommended that, in situations in which a
partner and a partnership are not subject to the aggregation rules of
section 448(c), a partner should not be required to include any share
of partnership gross receipts when determining its partner-level
eligibility for the small business exemption. The commenter noted that
section 163(j) is applied at the partnership level. The commenter
stated it is inconsistent to take an aggregate view of partnerships for
purposes of the small business exemption without a specific rule under
section 163(j) requiring such attribution or aggregation. The commenter
also stated that requiring a partner to include a share of partnership
gross receipts would discourage taxpayers who operate small businesses
from investing in partnerships.
The Treasury Department and the IRS understand that passthrough
entities might not have reported gross receipts to their partners or
shareholders in the past. However, the statute is clear that a taxpayer
must meet the gross receipts test of section 448(c), and that, if the
taxpayer is not subject to section 448(c), the section 448(c) rules
must be applied in the same manner as if such taxpayer were a
corporation or partnership. The alternatives presented either do not
have universal application or do not adequately reflect a passthrough
entity's gross receipts.
Additionally, there is no authority under section 448 and the
regulations thereunder to substitute taxable income for gross receipts
or to estimate gross receipts. Accordingly, the Treasury Department and
the IRS do not adopt the suggested approaches, and the
[[Page 56708]]
proposed rules are finalized without any change.
IV. Comments on and Changes to Section Proposed Sec. 1.163(j)-3:
Relationship of Section 163(j) Limitation to Other Provisions Affecting
Interest
Proposed Sec. 1.163(j)-3 provides ordering and operating rules
that control the interaction of the section 163(j) limitation with
other provisions of the Code that defer, capitalize or disallow
interest expense. The ordering and operating rules provide that section
163(j) applies before the operation of the loss limitation rules in
section 465 and 469, and before the application of section 461(l), and
after other provisions of the Code that defer, capitalize, or disallow
interest expense. The ordering and operating rules in proposed Sec.
1.163(j)-3 apply only in determining the amount of interest expense
that could be deducted without regard to the section 163(j) limitation,
and not for other purposes, such as the calculation of ATI. The
following discussion addresses comments relating to proposed Sec.
1.163(j)-3.
A. Capitalized Interest
Proposed Sec. 1.163(j)-3(b)(5) provides that provisions that
require interest to be capitalized, such as sections 263A and 263(g),
apply before section 163(j). Commenters suggested that this section is
too restrictive by referring solely to sections 263(A) and 263(g), and
that other provisions could require interest to be capitalized. The
Treasury Department and the IRS agree with this comment, and an
appropriate revision has been made in the final regulations to account
for any possible additional provisions that could require interest to
be capitalized.
B. Provisions That Characterize Interest Expense as Something Other
Than Business Interest Expense
Proposed Sec. 1.163(j)-3(b)(9) generally provides that provisions
requiring interest expense to be treated as something other than
business interest expense, such as section 163(d) governing investment
interest expense, govern the treatment of the interest expense.
Commenters expressed confusion with the provision, suggesting that, by
virtue of the statute and the proposed regulations, if interest expense
is treated as something other than business interest expense, there is
no need to consult proposed Sec. 1.163(j)-3. The Treasury Department
and the IRS generally agree with the comment and have removed this
section from the final regulations.
C. Section 108
In the preamble to the proposed regulations, the Treasury
Department and the IRS requested comments on the interaction between
section 163(j) and the rules addressing income from the discharge of
indebtedness under section 108. In response, commenters noted, for
example, that it is unclear whether cancellation of indebtedness income
under section 61(a)(11) arises when the taxpayer only receives a
benefit in the form of a disallowed business interest expense
carryforward, or whether any exclusions, such as sections 108(e)(2) or
111, or any tax benefit principles, should apply. In light of the
complex and novel issues raised in these comments, the Treasury
Department and the IRS have determined that the interaction between
section 163(j) and section 108 requires further consideration and may
be the subject of future guidance.
D. Sections 461(l), 465, and 469
The proposed regulations provide that sections 461(l), 465, and 469
apply after the application of section 163(j). The Treasury Department
and the IRS received informal questions about the effect of these
sections on the calculation of ATI. Therefore, the final regulations
clarify whether and how sections 461(l), 465, and 469 are applied when
determining tentative taxable income. The final regulations also
include examples to demonstrate the calculation of ATI if a loss
tentatively is suspended in the calculation of tentative taxable
income, and if a loss is carried forward from a prior taxable year
under section 469.
V. Comments on and Changes to Proposed Sec. 1.163(j)-4: General Rules
Applicable to C Corporations (Including Real Estate Investment Trusts
(REITs), RICs, and Members of Consolidated Groups) and Tax-Exempt
Corporations
Section 1.163(j)-4 provides rules regarding the computation of
items of income and expense under section 163(j) for taxpayers that are
C corporations (including members of a consolidated group, REITs, and
RICs) and tax-exempt corporations. The following discussion addresses
comments relating to proposed Sec. 1.163(j)-4.
A. Aggregating Affiliated but Non-Consolidated Entities
Under the proposed regulations, members of a consolidated group are
aggregated for purposes of section 163(j), and the consolidated group
has a single section 163(j) limitation. In contrast, partnerships that
are wholly owned by members of a consolidated group are not aggregated
with the group for purposes of section 163(j), and members of an
affiliated group that do not file a consolidated return are not
aggregated with each other for purposes of section 163(j).
Several commenters recommended that aggregation rules be applied to
related taxpayers other than consolidated group members. For example,
one commenter recommended that aggregation rules similar to those
provided under section 199A be applied for purposes of the section
163(j) limitation to obviate the need for related entities to shift
debt or business assets around to avoid this limitation. Several other
commenters noted that the 1991 Proposed Regulations applied section
163(j) to an affiliated group of corporations (including all domestic
corporations controlled by the same parent, whether consolidated or
not) and recommended that this ``super-affiliation rule'' be retained
so that affiliated but non-consolidated groups are not disadvantaged
under the section 163(j) regulations. In contrast, another commenter
agreed with the approach taken in the proposed regulations with respect
to affiliated but non-consolidated groups, in part because the
allocation of the section 163(j) limitation among non-consolidated
affiliates can become quite complex.
Commenters also recommended that a partnership owned by members of
an affiliated group (controlled partnership) be treated as an aggregate
rather than an entity so that the section 163(j) limitation would not
apply separately at the partnership level. Instead, each partner would
include its allocable share of the controlled partnership's tax items
in determining its own section 163(j) limitation, and transactions
between the controlled partnership and its controlling partners would
be disregarded. Some commenters would apply this approach to
partnerships wholly owned by members of a controlled group of
corporations (as defined in section 1563). Others would apply this
approach to partnerships wholly owned (or at least 80 percent-owned) by
members of a consolidated group in order to reduce compliance
complexity, to ensure that similarly situated taxpayers (namely,
consolidated groups that conduct business activities directly and those
that conduct such activities through a controlled partnership) are
treated similarly, and to discourage consolidated groups from creating
a controlled partnership to obtain a better result under section
163(j). Commenters observed that the proposed regulations
[[Page 56709]]
apply an aggregate approach to certain controlled partnerships that own
CFCs (see proposed Sec. 1.163(j)-7(f)(6)(ii)(B)), and they recommended
applying this principle more broadly.
As explained in the preamble to the proposed regulations, the
Treasury Department and the IRS have determined that non-consolidated
entities generally should not be aggregated for purposes of applying
the section 163(j) limitation. Whereas old section 163(j)(6)(C)
expressly provided that ``[a]ll members of the same affiliated group
(within the meaning of section 1504(a)) shall be treated as 1
taxpayer,'' section 163(j) no longer contains such language, and
nothing in the legislative history of section 163(j) suggests that
Congress intended non-consolidated entities to be treated as a single
taxpayer for purposes of section 163(j). See the Concurrent NPRM for a
discussion of a proposed exception to this general rule for CFCs.
Moreover, the Treasury Department and the IRS have determined that
controlled partnerships generally should not be treated as aggregates
because section 163(j) clearly applies at the partnership level. See
section 163(j)(4). In other words, Congress decided that partnerships
should be treated as entities rather than aggregates for purposes of
section 163(j). Additionally, revising the regulations to treat
controlled partnerships as aggregates would not necessarily achieve the
objectives sought by commenters because the controlling partners
effectively could ``elect'' entity or aggregate treatment for the
partnership simply by selling or acquiring interests therein (thereby
causing the partnership to satisfy or fail the ownership requirement
for aggregate treatment).
However, the Treasury Department and the IRS are concerned that the
application of section 163(j) on an entity-by-entity basis outside the
consolidated group context could create the potential for abuse in
certain situations by facilitating the separation of excepted and non-
excepted trades or businesses. For example, a consolidated group that
is engaged in both excepted and non-excepted trades or businesses could
transfer its excepted trades or businesses to a controlled partnership,
which in turn could borrow funds from a third party and distribute
those funds to the consolidated group tax-free under section 731
(unless the debt is recharacterized as debt of the consolidated group
in substance; see Plantation Patterns, Inc. v. Commissioner, 462 F.2d
712 (5th Cir. 1972)). Similarly, an individual taxpayer that is engaged
in both excepted and non-excepted trades or businesses could transfer
its excepted trades or businesses to a controlled corporation, which in
turn could borrow funds from a third party and distribute those funds
to the individual tax-free under section 301(c)(2) (assuming the
corporation has no earnings and profits). Additionally, a partnership
with two trades or businesses--one that generates ATI, and another that
generates losses--could separate the two trades or businesses into a
tiered partnership structure solely for the purpose of borrowing
through the partnership that generates ATI and avoiding a section
163(j) limitation.
The anti-avoidance rule in proposed Sec. 1.163(j)-2(h) and the
anti-abuse rule in proposed Sec. 1.163(j)-10(c)(8) would preclude
taxpayers from undertaking the foregoing transfers in certain
circumstances. The final regulations add an example illustrating the
application of the anti-avoidance rule in proposed Sec. 1.163(j)-2(h)
to the use of a controlled corporation to avoid the section 163(j)
limitation, as well as an example illustrating the application of this
anti-avoidance rule to the use of a lower-tier partnership to avoid the
section 163(j) limitation in a similar manner.
Commenters further requested that the Treasury Department and the
IRS simplify the rules applicable to controlled partnerships if the
final regulations do not treat such partnerships as aggregates rather
than entities. For example, commenters recommended (i) eliminating
steps 3 through 10 in proposed Sec. 1.163(j)-6(f)(2) for such
partnerships, (ii) applying the principles of the Sec. 1.469-7 self-
charged interest rules to partnership interest expense and income owed
to or from consolidated group members by treating all members of the
group as a single taxpayer, or (iii) allowing excess taxable income
(ETI) that is allocated by a partnership to one consolidated group
member to offset excess business interest expense allocated by that
partnership to another group member.
The final regulations do not adopt these recommendations. For a
discussion of steps 3 through 10 in proposed Sec. 1.163(j)-6(f)(2),
see part VII(A)(3) of this Summary of Comments and Explanation of
Revisions section. For a discussion of the self-charged interest rules,
see the Concurrent NPRM. For a discussion of the proposal to allow ETI
allocated by a partnership to one member of a consolidated group to
offset excess business interest expense allocated by that partnership
to another group member, see part V(D)(4) of this Summary of Comments
and Explanation of Revisions section.
B. Intercompany Transactions and Intercompany Obligations
Proposed Sec. 1.163(j)-4(d)(2) contains rules governing the
calculation of the section 163(j) limitation for members of a
consolidated group. These rules provide, in part, that: (i) A
consolidated group has a single section 163(j) limitation; (ii) for
purposes of calculating the group's ATI, the relevant taxable income is
the consolidated group's consolidated taxable income, and intercompany
items and corresponding items are disregarded to the extent they offset
in amount; and (iii) for purposes of calculating the group's ATI and
determining the business interest expense and business interest income
of each member, all intercompany obligations (as defined in Sec.
1.1502-13(g)(2)(ii)) are disregarded (thus, interest expense and
interest income from intercompany obligations are not treated as
business interest expense and business interest income for purposes of
section 163(j)).
In turn, proposed Sec. 1.163(j)-5(b)(3) contains rules governing
the treatment of disallowed business interest expense carryforwards for
consolidated groups. These rules provide, in part, that if the
aggregate amount of members' business interest expense (including
disallowed business interest expense carryforwards) exceeds the group's
section 163(j) limitation, then: (i) Each member with current-year
business interest expense and either current-year business interest
income or floor plan financing interest expense deducts current-year
business interest expense to the extent of its current-year business
interest income and floor plan financing interest expense; (ii) if the
group has any remaining section 163(j) limitation, each member with
remaining current-year business interest expense deducts a pro rata
portion of its expense; (iii) if the group has any remaining section
163(j) limitation, disallowed business interest expense carryforwards
are deducted on a pro rata basis in the order of the taxable years in
which they arose; and (iv) each member whose business interest expense
is not fully absorbed by the group in the current taxable year carries
the expense forward to the succeeding taxable year as a disallowed
business interest expense carryforward.
Commenters posed several questions and comments with regard to
these proposed rules. One commenter expressed concern that these
provisions would create noneconomic and distortive allocations of
disallowed business interest expense within consolidated groups. For
example, assume P (the parent of a consolidated
[[Page 56710]]
group) acts as a group's sole external borrower, and P on-lends the
loan proceeds to S (a member of P's consolidated group) for use in S's
business operations. Under the proposed regulations, any disallowed
business interest expense would be allocated to P even though S is the
economic user of the borrowed funds and may generate the income that
supports the external debt. The commenter also expressed concern that,
under the proposed regulations, consolidated groups effectively may
decide which member will carry forward disallowed business interest
expense by having that member borrow funds from third parties,
regardless of whether that member actually uses the funds. The
commenter raised similar concerns about business interest income,
noting that a group may choose which member will loan funds outside the
group and thereby affect which member's business interest expense is
absorbed within the group.
To address the foregoing concerns, the commenter suggested that the
final regulations (i) take intercompany interest income and expense
into account for purposes of section 163(j), (ii) allocate current-year
disallowed business interest expense to members without regard to
whether the interest expense results from intercompany obligations or
external borrowings, and (iii) de-link disallowed business interest
expenses from intercompany interest income for purposes of the rules
under Sec. 1.1502-13. However, the commenter acknowledged that this
approach could introduce unwarranted complexity. Alternatively, the
commenter suggested that taxpayers be permitted to apply any reasonable
approach (apart from tracing) consistent with the economics, subject to
a narrowly tailored anti-avoidance rule.
In the proposed regulations, the Treasury Department and the IRS
determined that intercompany obligations should be disregarded for
purposes of section 163(j) for several reasons. First, section 163(j)
is concerned with interest expense paid to external lenders, not
internal borrowing between divisions of a single corporation (or
between members of a consolidated group). In this regard, the Treasury
Department and the IRS note that treating a member with intercompany
debt but no external debt as having business interest expense could
lead to strange results.
Second, the approach taken in the proposed regulations results in
application of the section 163(j) limitation at the consolidated group
level, consistent with the expressed intent of Congress (see H. Rept.
115-466, at 386 (2017)).
Third, such an approach is simpler for taxpayers to administer than
an approach that would require consolidated groups to track disallowed
business interest expense with regard to intercompany obligations
across taxable years, as further discussed in the following paragraph.
Allowing taxpayers to apply any reasonable approach (and to ignore or
take into account interest expense on intercompany obligations as they
determine to be appropriate) also would further complicate rather than
simplify tax administration, particularly with regard to the
application of section 163(j) to consolidated groups.
Fourth, as the commenter acknowledged, taking intercompany
obligations into account for purposes of section 163(j) would
complicate the application of Sec. 1.1502-13. Section 1.1502-13
achieves single-entity treatment for a consolidated group by preventing
intercompany transactions from creating, accelerating, avoiding, or
deferring consolidated taxable income or liability. To this end, Sec.
1.1502-13(c) ``matches'' the tax items of the members that are parties
to an intercompany transaction. In the case of intercompany interest,
income and deductions do not affect consolidated taxable income or
liability because each side of the transaction ``nets out'' the other
in each taxable year. If section 163(j) applied to intercompany
payments of business interest expense, and if a consolidated group's
section 163(j) limitation did not permit the deduction of all of the
group's intercompany business interest expense, the interest income and
expense would not net out each other. Thus, the group would need to
separately track both the intercompany borrower's non-deductible
expense and the intercompany lender's non-includible income through
future taxable years.
The Treasury Department and the IRS acknowledge that disregarding
intercompany obligations may lead to results in some circumstances that
are less economically accurate than a regime that takes such
obligations into account, but the Treasury Department and the IRS
considered administrability as well as economic accuracy when
promulgating the proposed regulations. Moreover, although disregarding
intercompany obligations may grant consolidated groups the latitude to
decide which member will incur business interest expense, consolidated
groups also would have significant flexibility to allocate business
interest expense within a group using intercompany obligations if such
obligations were regarded for purposes of section 163(j).
Although the proposed rules in the Concurrent NPRM concerning CFC
group elections do regard inter-CFC group net interest expense in
allocating CFC group disallowed business interest expense, the CFC
group setting is materially different from that of a consolidated
group. First, in the context of a CFC group, neither Sec. 1.1502-13
nor similar rules apply. Second, the location of disallowed business
interest expense may have more effect on tax liability. In particular,
disallowed business interest expense may affect the calculation of
foreign tax credits and the amount of qualified business asset
investment within the meaning of section 951A(d)(1) (QBAI) taken into
account in determining a U.S. shareholder's tax liability under section
951A. This effect depends entirely on the particular CFC group member
affected by disallowed business interest expense. Although the location
of disallowed business interest expense has an effect on consolidated
groups, this effect often will be less than in the CFC group context.
For the foregoing reasons, the final regulations do not apply
section 163(j) to business interest expense or business interest income
incurred on intercompany obligations, with one limited exception
related to repurchase premium on obligations that are deemed satisfied
and reissued, which is described in part V(C) of this Summary of
Comments and Explanation of Revisions section.
Commenters also expressed concern that consolidated groups may have
difficulty determining which member is the borrower on external debt if
other group members are co-obligors or guarantors on the debt, and
that, as a result, each member may have difficulty calculating its
business interest expense for each taxable year. Commenters voiced
similar concerns about the lack of parameters for determining the
appropriate location of business interest income and floor plan
financing interest expense within the group.
The Treasury Department and the IRS do not find this comment
persuasive. Consolidated groups (and other related parties) are
required to determine which member is entitled to a deduction for
interest expense. Specifically, a consolidated group must use this
information for purposes of computing consolidated taxable income under
Sec. Sec. 1.1502-11 and 1.1502-12 and making stock basis adjustments
in members under Sec. 1.1502-32. Moreover, consolidated groups must
determine which member has incurred business
[[Page 56711]]
interest expense for purposes of applying section 382 and the separate
return limitation year (SRLY) rules. Consolidated groups must look to
existing law to determine which member should be treated as incurring
business interest expense or business interest income for purposes of
section 163(j).
C. Repurchase Premium on Obligations That Are Deemed Satisfied and
Reissued
As discussed in part V(B) of this Summary of Comments and
Explanation of Revisions section, interest expense on intercompany
obligations generally is disregarded for purposes of section 163(j).
Thus, commenters asked whether repurchase premium that is treated as
interest with respect to intercompany obligations should be subject to
the section 163(j) limitation. In general, if debt that is not an
intercompany obligation becomes an intercompany obligation (for
example, if a member of a consolidated group acquires another member's
debt from a non-member), the debt is treated for all Federal income tax
purposes, immediately after it becomes an intercompany obligation, as
having been satisfied by the issuer for cash in an amount equal to the
holder's basis in the note and as having been reissued as a new
intercompany obligation for the same amount of cash. See Sec. 1.1502-
13(g)(5)(ii)(A). Additionally, if a debt instrument is repurchased by
the issuer for a price in excess of its adjusted issue price (as
defined in Sec. 1.1275-1(b)), the excess (repurchase premium)
generally is deductible as interest for the taxable year in which the
repurchase occurs. See Sec. 1.163-7(c).
For example, S is a member of P's consolidated group, and S has
borrowed $100x from unrelated X. At a time when S's note has increased
in value to $130x due to a decline in prevailing interest rates, P
purchases the note from X for $130x. Under Sec. 1.1502-13(g)(5)(ii),
S's note is treated as satisfied for $130x immediately after it becomes
an intercompany obligation. As a result of the deemed satisfaction of
the note, P has no gain or loss, and S has $30x of repurchase premium
that is deductible as interest. See Sec. 1.1502-13(g)(7)(ii), Example
10. Similarly, if S were to repurchase its note from X for $130x, S
would have $30x of repurchase premium that is deductible as interest.
If S were to repurchase its note from X at a premium, the interest
(in the form of repurchase premium) paid on that note would be subject
to the section 163(j) limitation. See Sec. 1.163(j)-1(b)(22)(i)(H)
(treating repurchase premium that is deductible under Sec. 1.163-7(c)
as interest for purposes of section 163(j)). If section 163(j) does not
apply to repurchase premium paid by S to P after P purchases S's note
from X, the P group would obtain a different (and better) result than
if S were to repurchase its own note. The Treasury Department and the
IRS have determined that achieving different results under section
163(j) depending on which member repurchases external debt would be
inconsistent with treating a consolidated group as a single entity for
purposes of section 163(j) and would undermine the purpose of Sec.
1.1502-13. Thus, the final regulations provide that, for purposes of
section 163(j), if any member of a consolidated group purchases a
member's note from a third party at a premium, the repurchase premium
that is deductible under Sec. 1.163-7(c) is treated as interest
expense for purposes of section 163(j), regardless of whether the
repurchase premium is treated as paid on intercompany indebtedness.
D. Intercompany Transfers of Partnership Interests
1. Overview of Proposed Sec. 1.163(j)-4(d)(4)
Proposed Sec. 1.163(j)-4(d)(4) provides that the transfer of a
partnership interest in an intercompany transaction that does not
result in the termination of the partnership is treated as a
disposition for purposes of section 163(j)(4)(B)(iii)(II), regardless
of whether the transfer is one in which gain or loss is recognized.
Thus, the transferor member's excess business interest expense is
eliminated rather than transferred to the transferee member. Proposed
Sec. 1.163(j)-4(d)(4) further provides that neither the allocation of
excess business interest expense to a member from a partnership (and
the resulting decrease in basis in the partnership interest) nor the
elimination of excess business interest expense of a member upon a
disposition of the partnership interest (and the resulting increase in
basis in the partnership interest) affects basis in the member's stock
for purposes of Sec. 1.1502-32(b)(3)(ii). Instead, investment
adjustments are made under Sec. 1.1502-32(b)(3)(i) when the excess
business interest expense from the partnership is absorbed by the
consolidated group. See Sec. 1.1502-32(b).
2. Intercompany Transfers of Partnership Interests Treated as
Dispositions; Single-Entity Treatment; Application of Sec. 1.1502-13
Commenters posed various questions and comments about the treatment
of intercompany transfers of partnership interests as dispositions for
purposes of section 163(j). For example, commenters asked why, in
applying section 163(j) to consolidated groups, the proposed
regulations treat such transfers as dispositions, rather than simply
disregard the transfers, given that the proposed regulations generally
treat consolidated groups as a single entity and disregard intercompany
transactions for purposes of section 163(j).
The proposed regulations provide that intercompany transfers of
partnership interests are treated as dispositions for purposes of
section 163(j) because each member's separate ownership of interests in
a partnership generally is respected (otherwise, a partnership whose
interests are wholly owned by members of a consolidated group would be
treated as a disregarded entity), and because the term ``disposition''
in section 163(j)(4)(B)(iii)(II) has broad application (for example, it
applies to nonrecognition transactions). Moreover, if an intercompany
transfer of partnership interests were not treated as a disposition
(and if, as a result, basis were not restored to the transferor
member), the amount of the transferor member's gain or loss on the
intercompany transfer would be incorrect. Special rules also would be
needed to account for the transfer of excess business interest expense
from one member to another in a manner consistent with the purposes of
Sec. 1.1502-13 and to comply with the directive of section 1502 to
clearly reflect the income of each member of the group.
Several commenters also noted problems with the approach in
proposed Sec. Sec. 1.163(j)-4(d)(4) and 1.1502-13(c)(7)(ii)(R),
Example 18. These commenters pointed out that the approach in the
proposed regulations does not achieve single-entity treatment because
one member's transfer of its partnership interest to another member
causes the transferor's excess business interest expense to be
eliminated; thus, an intercompany transaction may alter the amount of
business interest expense that is absorbed by the group. One commenter
suggested a different approach under which the transferee could claim
deductions for excess business interest expense to the extent the
transferee is allocated excess taxable income from the same
partnership. However, the commenter acknowledged that this approach
would require additional rules under Sec. 1.1502-13.
Another commenter suggested that intercompany transfers in which
the transferee is the successor to the
[[Page 56712]]
transferor (for example, in transactions to which section 381(a)
applies, or in which the transferee's basis in the partnership interest
is determined by reference to the transferor's basis) should not be
treated as dispositions for purposes of section 163(j)(4)(B)(iii)(II).
However, this approach would not result in an increase in the
transferor member's (S's) basis in its partnership interest immediately
before the transfer; thus, this approach would be inconsistent with
Sec. 1.1502-13, which requires the clear reflection of income at the
level of the consolidated group member. This approach also would be
inconsistent with section 163(j)(4)(B)(iii)(II), which clearly treats
``a transaction in which gain is not recognized in whole or in part''
as a disposition for purposes of that section.
Still another commenter observed that the analysis in proposed
Sec. 1.1502-13(c)(7)(ii)(R), Example 18, does not work in certain
other fact patterns. In proposed Sec. 1.1502-13(c)(7)(ii)(R), Example
18, P wholly owns S and B, both of which are members of P's
consolidated group. S and A (an unrelated third party) are equal
partners in PS1, which allocates $50x of excess business interest
expense to each partner in Year 2. At the end of Year 2, S sells its
PS1 interest to B at a $50x loss (S's excess business interest expense
is eliminated, and S's basis in its PS1 interest is increased by $50x
immediately before the sale). In Year 3, PS1 allocates $25x of excess
taxable income to B. At the end of Year 4, B sells its PS1 interest to
Z (an unrelated third party) for a $10x gain. The example concludes
that S takes into account $25x of its loss in Year 3 as an ordinary
loss, which matches B's inclusion of $25x of ordinary income in Year 3.
The remaining $25x of S's $50x capital loss is taken into account in
Year 4. The commenter noted that, although the analysis in proposed
Sec. 1.1502-13(c)(7)(ii)(R), Example 18, works under the facts
presented, it would not work if, for example, S were to sell the PS1
interest to B at a gain (because S's gain and B's income could not be
offset).
The Treasury Department and the IRS acknowledge the concerns raised
by these commenters. The Treasury Department and the IRS are continuing
to study the proper treatment of intercompany transfers of partnership
interests that do not result in the termination of the partnership
(intercompany partnership interest transfers), including whether such
transfers should be treated as dispositions for purposes of section
163(j)(4)(B)(iii)(II). The final regulations reserve on issues relating
to intercompany partnership interest transfers, and the Treasury
Department and the IRS welcome further comments on such issues.
3. Possible Approach to Intercompany Partnership Interest Transfers
The Treasury Department and the IRS are considering various
possible approaches to intercompany partnership interest transfers.
Under one possible approach, such a transfer would be treated as a
disposition by S; thus, S's excess business interest expense would be
eliminated (and its basis in its partnership interest would be
increased accordingly immediately before the transfer), as would S's
negative section 163(j) expense (within the meaning of Sec. 1.163(j)-
6(h)(1)). However, unlike the approach in proposed Sec. 1.163(j)-
4(d)(4), B would be treated as if B had been allocated excess business
interest expense or negative section 163(j) interest expense from the
partnership in an amount equal to the amount of S's excess business
interest expense or negative section 163(j) expense, respectively,
immediately before the transfer. B's basis in its partnership interest
would be adjusted under section 163(j)(4)(B)(iii)(I) and Sec.
1.163(j)-6(h) to reflect the deemed allocation of excess business
interest expense from the partnership. Similar rules would apply to
intercompany transfers of partnership interests in nonrecognition
transactions.
The foregoing approach would attempt to approximate single-entity
treatment while treating the intercompany transfer of a partnership
interest as a disposition for purposes of section
163(j)(4)(B)(iii)(II). To ensure that B has the same amount of excess
business interest expense, negative section 163(j) expense, and
disallowed business interest expense carryforwards as if S and B were
divisions of a single corporation, this approach also would include
special basis rules. For example, if S transfers its partnership
interest to B at a gain, the excess of B's basis in the partnership
interest at any time after the transfer over S's basis in the
partnership interest immediately before the transfer would not be
available to convert negative section 163(j) expense into excess
business interest expense in the hands of B or to prevent excess
business interest expense from converting into negative section 163(j)
expense in the hands of B. Additionally, if adjustments to B's basis in
its partnership interest under section 163(j)(4)(B)(iii)(I) and Sec.
1.163(j)-6(h) (upon the deemed allocation of excess business interest
expense from the partnership) would exceed B's basis, B would be
treated as having a suspended negative basis adjustment in the
partnership interest (similar to an excess loss account within the
meaning of Sec. 1.1502-19(a)(2)(i)).
The Treasury Department and the IRS request comments on possible
approaches to intercompany partnership interest transfers, including
the approach outlined in this part V(D)(3) of this Summary of Comments
and Explanation of Revisions section.
4. Offsetting Excess Business Interest Expense and Adjusted Taxable
Income Within the Consolidated Group
A commenter also recommended that, if the section 163(j)
regulations do not treat partnerships wholly owned by members of the
same consolidated group as aggregates rather than as entities (see part
V(A) of this Summary of Comments and Explanation of Revisions section),
the rules applicable to such partnerships should be simplified. For
example, the excess taxable income allocated to one member partner
could be made available to offset excess business interest expense
allocated to another member partner.
The commenter's recommendation presents several issues. For
example, the commenter's recommendation would entail disregarding the
location of excess business interest expense and excess taxable income
within a consolidated group. Such an approach would not fully respect
each member's separate interest in a partnership and would not clearly
reflect the taxable income of the members of the group. See section
1502; see also part V(D)(2) of this Summary of Comments and Explanation
of Revisions section. Further, to the extent the ownership structure of
the group is altered by an intercompany transfer of the partnership
interest, substantial additional rules under Sec. 1.1502-13 would be
required.
5. Intercompany Nonrecognition Transactions
In proposed Sec. Sec. 1.163(j)-4(d)(4) and 1.1502-13(c)(7)(ii)(S),
Example 19, the intercompany transfer of a partnership interest in a
nonrecognition transaction is treated as a disposition for purposes of
section 163(j)(4)(B)(iii)(II). In the preamble to the proposed
regulations, the Treasury Department and the IRS requested comments as
to whether such transfers should constitute dispositions for purposes
of section 163(j)(4)(B)(iii)(II) and, if so, how Sec. 1.1502-13(c)
should apply if there is excess taxable income in a succeeding taxable
year. In such a case, S would have no intercompany item from the
intercompany transfer, and B would take a carryover basis in the
partnership
[[Page 56713]]
interest (this amount would include any basis increase to reflect S's
unused excess business interest expense under section
163(j)(4)(B)(iii)(II)).
One commenter agreed that, based on the plain language of section
163(j)(4)(B)(iii)(II), intercompany transfers that are nonrecognition
transactions should be treated as dispositions. Another commenter
stated that such transfers generally should not be treated as
dispositions (if the transferee is the successor to the transferor, as
previously discussed), but that, if such transfers are treated as
dispositions, no redeterminations should be made under Sec. 1.1502-
13(c) with respect to S unless S recognizes gain in the intercompany
transfer.
The Treasury Department and the IRS continue to study the proper
treatment of intercompany partnership interest transfers and welcome
further comments on this issue.
6. Basis Adjustments Under Sec. 1.1502-32
A commenter stated that the approach to basis adjustments under
Sec. 1.1502-32 in the proposed regulations may lead to temporary
inside/outside basis disparities. Although the commenter generally
described this approach as reasonable and consistent with the
application of both section 163(j) and Sec. 1.1502-32, the commenter
suggested that it may lead to anomalous results in certain cases. The
commenter requested an example to illustrate the application of the
matching and acceleration rules in the case of an intercompany transfer
of an interest in a partnership with disallowed business interest
expense.
When S (a member of a consolidated group that is not the common
parent) is allocated excess business interest expense from a
partnership, S's basis in the partnership is reduced under section
163(j)(4)(B)(iii)(I). Although S's basis in the partnership is reduced,
S has excess business interest expense in the same amount, and S's
overall inside attribute amount is unchanged. Because there is no net
change to S's inside attribute amount, Sec. 1.1502-32 does not apply
to reduce other members' basis in S's stock, and there is no inside/
outside disparity. Moreover, nothing in the final regulations affects
the operation of Sec. 1.1502-32(a), which generally requires
adjustments to a member's basis in its S stock to reflect S's
distributions and S's items of income, gain, deduction, and loss that
are taken into account by the group while S is a member. Thus, the
final regulations make no changes in response to this comment.
7. Partnership Terminations
In the preamble to the proposed regulations, the Treasury
Department and the IRS requested comments on the treatment of the
transfer of a partnership interest in an intercompany transaction that
results in the termination of the partnership. Some commenters
recommended that the transfer be treated as a disposition for purposes
of section 163(j)(4)(B)(iii)(II) and proposed Sec. 1.163(j)-6(h)(3).
Other commenters recommended that, under Revenue Ruling 99-6, 1999-1
C.B. 432, if the transferee member (B) also were a partner in the
partnership before the intercompany transfer, B should be viewed as (i)
receiving a distribution of assets from the terminating partnership
with respect to its partnership interest, and (ii) purchasing the
partnership's assets deemed distributed to the transferor member (S).
The Treasury Department and the IRS are continuing to study the
proper treatment of intercompany transfers of partnership interests
that result in the termination of the partnership. But see Sec.
1.163(j)-6(h)(3) with respect to partnership terminations generally.
E. Application of Sec. 1.1502-36 to Excess Business Interest Expense
Under proposed Sec. 1.163(j)-4(d)(4), a partner's change in status
as a member of a consolidated group is not treated as a disposition for
purposes of section 163(j)(4)(B)(iii)(II) and proposed Sec. 1.163(j)-
6(h)(3). In other words, if a corporation becomes or ceases to be a
member of a consolidated group, and if that corporation is a partner in
a partnership, that corporation's entry into or departure from a
consolidated group does not trigger basis adjustments under section
163(j)(4)(B)(iii)(II). However, in the preamble to the proposed
regulations, the Treasury Department and the IRS requested comments as
to whether additional rules are needed to prevent loss duplication upon
the disposition of stock of a subsidiary member (S) holding partnership
interests.
Section 1.1502-36 contains the unified loss rule, which limits the
ability of a consolidated group to recognize non-economic or duplicated
losses on the transfer of S stock. The rule applies when a group member
transfers a loss share of S stock. If Sec. 1.1502-36(d) applies to the
transfer of a loss share, the attributes of S and its lower-tier
subsidiaries generally are reduced as needed to prevent the duplication
of any loss recognized on the transferred stock. Such attributes
include capital loss carryovers, NOL carryovers, deferred deductions,
and basis in assets other than cash and general deposit accounts. See
Sec. 1.1502-36(d)(4).
As noted in the preamble to the proposed regulations, the Treasury
Department and the IRS have determined that disallowed business
interest expenses should be treated as deferred deductions for purposes
of Sec. 1.1502-36 (see proposed Sec. 1.1502-36(f)(2)). A commenter
recommended that excess business interest expense also be treated as a
deferred deduction in determining the net inside attribute amount for
purposes of Sec. 1.1502-36(c) and (d). Additionally, the commenter
recommended that a consolidated group be permitted to elect to
reattribute excess business interest expense from S to the common
parent under Sec. 1.1502-36(d)(6) if the common parent also is a
partner in the partnership that allocated excess business interest
expense to S.
The Treasury Department and the IRS agree that excess business
interest expense should be treated as an attribute that is taken into
account in determining the net inside attribute amount for purposes of
Sec. 1.1502-36(c) and (d). However, the Treasury Department and the
IRS have determined that excess business interest expense is more akin
to basis (a Category D attribute) than to deferred deductions (a
Category C attribute) (see Sec. 1.1502-36(d)(4)(i)). Section 1.163(j)-
4(e)(4) reflects this conclusion.
The Treasury Department and the IRS also have determined that
excess business interest expense should not be eligible for
reattribution under Sec. 1.1502-36(d)(6) because the election is not
available with respect to Category D attributes. Thus, the final
regulations do not adopt this recommendation.
F. Calculating ATI for Cooperatives
Proposed Sec. 1.163(j)-1(b)(1) defines ATI as the taxable income
of the taxpayer for the taxable year, with certain adjustments.
Proposed Sec. 1.163(j)-4(b)(4) provides a special rule for calculating
the ATI of a RIC or REIT, allowing the RIC or REIT not to reduce its
taxable income by the amount of any deduction for dividends paid. The
preamble to the proposed regulations also requested comments on whether
additional special rules are needed for specific types of taxpayers,
including cooperatives.
A commenter asked that the final regulations include a special rule
for calculating the ATI of cooperatives subject to taxation under
subchapter T of the Code. Under this special rule, taxable income would
not be reduced by amounts deducted under section
[[Page 56714]]
1382(b)(1) (patronage dividends), section 1382(b)(2) (amounts paid in
redemption of nonqualified written notices of allocation distributed as
patronage dividends), or section 1382(c) (certain amounts incurred by
farm cooperatives described in sections 521 and 1381(a)(1)). The
commenter reasoned that such amounts are earnings passed on to members
and are therefore analogous to dividends paid by a RIC or REIT to its
investor.
The Treasury Department and the IRS agree that, for purposes of
section 163(j), amounts deducted by cooperatives under sections
1382(b)(1), (b)(2), and (c) are similar to amounts deducted by RICs and
REITs for dividends paid to their investors. The final regulations
adopt a rule providing that, for purposes of calculating ATI, the
tentative taxable income of a cooperative subject to taxation under
sections 1381 through 1388 is not reduced by such amounts. In order to
provide similar treatment to similarly situated taxpayers, the final
regulations also provide that, for purposes of calculating ATI, the
tentative taxable income of cooperatives not subject to taxation under
subchapter T of the Code is not reduced by the amount of deductions
equivalent to the amounts deducted by cooperatives under sections
1382(b)(1), (b)(2), and (c).
G. Calculating ATI for a Consolidated Group
Proposed Sec. 1.163(j)-1(b)(1) defines ATI as the taxable income
of the taxpayer for the taxable year, with certain adjustments. For
example, ATI is computed without regard to the amount of any NOL
deduction under section 172. See proposed Sec. 1.163(j)-1(b)(1)(i)(B).
As noted in part V(B) of this Summary of Comments and Explanation
of Revisions section, for purposes of calculating the ATI of a
consolidated group, the relevant taxable income is the group's
consolidated taxable income, determined under Sec. 1.1502-11 without
regard to any carryforwards or disallowances under section 163(j). See
proposed Sec. 1.163(j)-4(d)(2)(iv). Commenters asked for clarification
that a consolidated group's ATI does not take into account any NOL
deductions available under section 172 and Sec. 1.1502-11(a)(2) that
result from either the carryback or carryforward of NOLs.
Proposed Sec. 1.163(j)-4(d)(2)(iv) does not expressly mention the
adjustments made to ATI in proposed Sec. 1.163(j)-1(b)(1) because
those adjustments are generally applicable (for example, the adjustment
for NOLs applies to all taxpayers to whom section 172 applies,
regardless of whether such taxpayers file a consolidated return).
Moreover, there is no exception in proposed Sec. 1.163(j)-4(d)(2)(iv)
to the adjustment for NOLs in proposed Sec. 1.163(j)-1(b)(1)(i)(B).
Thus, under these provisions, a consolidated group's ATI would not take
into account any NOL deductions resulting from the carryback or
carryforward of NOLs. The Treasury Department and the IRS have
determined that no change to proposed Sec. 1.163(j)-4(d)(2)(iv) is
needed to effectuate this result.
H. Application of Section 163(j) to Life-Nonlife Groups
Proposed Sec. 1.163(j)-4(d)(2) provides that a consolidated group
has a single section 163(j) limitation and that, for purposes of
calculating the group's ATI, the relevant taxable income is the group's
consolidated taxable income. However, Sec. 1.1502-47 requires
consolidated groups whose members include life insurance companies and
other companies (life-nonlife groups) to adopt a subgroup method to
determine consolidated taxable income. (One subgroup is the group's
nonlife companies; the other subgroup is the group's life insurance
companies.) Under the subgroup method, each subgroup initially computes
its own consolidated taxable income, and there are limitations on a
life-nonlife group's ability to offset one subgroup's income with the
other subgroup's loss.
In light of the apparent tension between proposed Sec. 1.163(j)-
4(d)(2) and the subgroup method in Sec. 1.1502-47, one commenter asked
for clarification that there are not separate section 163(j)
limitations for each subgroup in a life-nonlife group.
The subject matter of this comment is beyond the scope of the final
regulations. The Treasury Department and the IRS expect to issue future
guidance regarding the interaction of section 163(j) and Sec. 1.1502-
47 and welcome further comments on this topic.
I. Application of Section 163(j) to Tax-Exempt Entities
Proposed Sec. 1.163(j)-1(b)(36) defines a tax-exempt corporation
but does not define other types of tax-exempt organizations. Thus, a
commenter asked for clarification as to whether section 163(j) applies
solely to tax-exempt corporations or whether it also applies to other
entities subject to tax under section 511. The final regulations
clarify that section 163(j) applies to all entities that are subject to
tax under section 511.
The commenter also suggested that section 163(j) should not apply
to state colleges and universities described in section 511(a)(2)(B).
The Treasury Department and the IRS have found nothing in the statute
or legislative history to suggest that Congress intended special
treatment for state colleges and universities to the extent such
organizations are subject to tax under section 511. Therefore, the
final regulations do not adopt this recommendation.
J. Partnership Investment Income and Corporate Partners
Under the proposed regulations, a partnership's investment interest
income and investment expense are allocated to each partner in
accordance with section 704(b), and the effect of the allocation is
determined at the partner level. In general, any investment interest,
investment income, and investment expense allocated by a partnership to
a C corporation partner is treated by the partner as allocable to a
non-excepted trade or business of the partner for purposes of section
163(j). See proposed Sec. Sec. 1.163(j)-4(b)(3)(i) and 1.163(j)-
10(b)(6).
In light of the statutory restriction against including investment
income in a partner's ATI (see section 163(j)(8)(A)(i)), a commenter
requested confirmation that a partnership's investment income is
treated as properly allocable to a trade or business of (and thus is
included in the ATI of) a corporate partner, perhaps by adding an
example to illustrate the application of this rule.
Proposed Sec. 1.163(j)-10(b)(6) provides that any investment
income or investment expenses that a partnership receives, pays, or
accrues and that is treated as properly allocable to a trade or
business of a C corporation partner under proposed Sec. 1.163(j)-
4(b)(3)(i) is treated as properly allocable to a non-excepted trade or
business of the C corporation partner. Thus, if a partnership incurs
investment interest expense, any portion of that expense that is
allocable to a C corporation partner is treated as a business interest
expense of that partner that is subject to the section 163(j)
limitation. However, if the partnership also has investment interest
income, any portion thereof that is allocable to a C corporation
partner is treated as business interest income of the partner, and any
other investment income of the partnership that is allocable to the C
corporation partner increases the partner's ATI. See Sec. 1.163(j)-
4(b)(7)(ii), Example 2.
To the extent that an investment item or other item of a
partnership is with respect to property for which an election has been
made by the partnership to treat as an electing real
[[Page 56715]]
property trade or business or electing farming business, such item is
treated as properly allocable to an excepted trade or business. This
rule is necessary because the final regulations permit elections for
some assets and activities to be an excepted trade or business even
when such assets and activities are not trades or businesses for
section 162 purposes. See part X(A) of this Summary of Comments and
Explanation of Revisions section.
The final regulations also expand proposed Sec. 1.163(j)-
4(b)(3)(i) to cover not only a partnership's items of investment
interest, investment income, and investment expense, but also a
partnership's other separately stated tax items that are subject to
neither section 163(j) nor section 163(d). Such items might include tax
items allocable to rental activities that do not rise to the level of a
section 162 trade or business that otherwise give rise to allowable
deductions (such as under section 212 as it existed under prior law)
that are subject to section 469. Thus, such items are treated as
properly allocable to a trade or business of a C corporation partner as
well.
K. Earnings and Profits of a Corporate Partner
Proposed Sec. 1.163(j)-4(c)(1) generally provides that the
disallowance and carryforward of a deduction for a C corporation's
business interest expense under proposed Sec. 1.163(j)-2 does not
affect whether or when the business interest expense reduces the
corporation's earnings and profits. Some commenters suggested that, if
the business interest expense in question is incurred by a partnership
rather than by the C corporation partner, the partner should reduce its
earnings and profits twice with respect to that expense--once when the
expense is allocated from the partnership to the partner, and again
when the partner claims a deduction with respect to that expense (after
the excess business interest expense allocated to that partner is
treated as business interest expense and deducted by that partner).
The Treasury Department and the IRS have determined that the
proposed regulations do not permit a C corporation partner to reduce
its earnings and profits twice with respect to business interest
expense incurred by a partnership. The final regulations are modified
to clarify this point.
Proposed Sec. 1.163(j)-4(c)(3) also provides a special earnings
and profits rule for C corporations (other than REITs or RICs) with
respect to excess business interest expense allocated from a
partnership. Under this rule, the C corporation partner must increase
its earnings and profits upon the disposition of the partnership
interest to reflect the amount of excess business interest expense that
the partner did not take into account while it held the partnership
interest. The Treasury Department and the IRS have determined that the
same rule should apply with respect to negative section 163(j) expense,
and the final regulations have been modified accordingly.
VI. Comments on and Changes to Proposed Sec. 1.163(j)-5: General Rules
Governing Disallowed Business Interest Expense Carryforwards for C
Corporations
Section 1.163(j)-5 provides rules regarding disallowed business
interest expense carryforwards for taxpayers that are C corporations,
including members of a consolidated group. The following discussion
addresses comments relating to proposed Sec. 1.163(j)-5.
A. Absorption of Disallowed Business Interest Expense Carryforwards
Before Use of NOLs in Life-Nonlife Groups
Proposed Sec. 1.163(j)-5(b)(3) provides rules regarding the
treatment of disallowed business interest expense carryforwards of a
consolidated group. Commenters asked for confirmation that, in the
context of a life-nonlife group, such carryforwards are factored into
taxable income at the subgroup level before NOLs are carried forward
and limited under section 1503(c)(1).
In general, a consolidated group must determine the amount of
business interest expense (whether current-year or carryforwards) that
can be absorbed in a particular taxable year before determining whether
NOLs can be carried forward or back to that taxable year. However, the
specific subject matter of this comment is beyond the scope of the
final regulations. The Treasury Department and the IRS expect to issue
future guidance regarding the interaction of section 163(j) and Sec.
1.1502-47 and welcome further comments in this regard.
B. Carryforwards From Separate Return Limitation Years
Proposed Sec. 1.163(j)-5(d) contains rules for consolidated groups
regarding disallowed business interest expense carryforwards from a
separate return limitation year (a SRLY; see Sec. 1.1502-1(f)). Under
these rules, the disallowed business interest expense carryforwards of
a member arising in a SRLY that are included in a group's business
interest expense deduction for any taxable year may not exceed the
group's section 163(j) limitation for that year, determined by
reference only to the member's tax items for that year (the section
163(j) SRLY limitation). See proposed Sec. 1.163(j)-5(d)(1).
Additionally, disallowed business interest expense carryforwards of a
member arising in a SRLY would be available for deduction by the
consolidated group in the current year only to the extent the group had
remaining section 163(j) limitation after deducting current-year
business interest expense and disallowed business interest expense
carryforwards from earlier taxable years, and only to the extent the
section 163(j) SRLY limitation for the current year exceeded the amount
of the member's business interest expense already deducted by the group
in that year. In addition, SRLY-limited disallowed business interest
expense carryforwards must be deducted on a pro rata basis with non-
SRLY limited disallowed business interest expense carryforwards from
taxable years ending on the same date. See proposed Sec. 1.163(j)-
5(d)(2).
Commenters asked several questions about the SRLY rules in proposed
Sec. 1.163(j)-5(d). In particular, commenters asked why the section
163(j) SRLY limitation is calculated annually rather than on an
aggregate or cumulative basis, as is the case for NOLs. (Section
1.1502-21(c)(1)(i) generally limits the amount of a member's NOL
carryforwards and carrybacks from a SRLY that may be included in the
group's consolidated net operating loss deduction to the member's
aggregate contribution to the group's consolidated taxable income for
the entire period the member has been a group member, not just for the
taxable year in question). More specifically, a commenter noted that
the SRLY rules in Sec. 1.1502-21(c) were designed to produce a result
that roughly approximates the absorption that would have occurred if
the SRLY member had not joined a consolidated group. In contrast, the
annual section 163(j) limitation in proposed Sec. 1.163(j)-5(d) could
put the SRLY member in a worse position than if such member had not
joined a consolidated group.
For example, if S were a standalone corporation with $100x of
disallowed business interest expense carryforwards at the start of Year
2, and if S's section 163(j) limitation were $30 in Year 2, S could
deduct $30x of its carryforwards. In comparison, if S joined a
consolidated group at the start of Year 2, and if the group's section
163(j) limitation were $0 in Year 2, S could not deduct any of its
$100x of carryforwards in Year 2 even if S's standalone section 163(j)
limitation
[[Page 56716]]
were $30x in that year. This result is correct for the P group for Year
2 given Congress's intent that the section 163(j) limitation apply at
the consolidated group level. However, under the annual measurement
approach in the proposed regulations, S also could not deduct any of
its carryforwards in Year 3 if S had a standalone section 163(j)
limitation of $0 in that year, even if the group's section 163(j)
limitation were positive in that year. Thus, S would be in a worse
position (with respect to the deduction of its disallowed business
interest expense carryforwards) than if S had not joined a consolidated
group.
To put S in roughly the same position as if S were a standalone
corporation, commenters recommended the creation of a cumulative
section 163(j) register under which the amount of a member's SRLY
carryforwards that may be absorbed by the consolidated group in a
taxable year may not exceed (i) the member's contributions (positive
and negative) to the group's section 163(j) limitation in all
consolidated return years, less (ii) the member's business interest
expense (including carryforwards) absorbed by the group in all
consolidated return years. For these purposes, and unlike the general
rule in section 163(j)(1) and proposed Sec. 1.163(j)-2(b)(2), the
adjustment to a member's cumulative section 163(j) SRLY register for
any taxable year or its total register for any taxable year could be
less than zero.
In the preamble to the proposed regulations, the Treasury
Department and the IRS stated that applying an aggregate or cumulative
approach to the section 163(j) SRLY limitation would be inconsistent
with congressional intent because Congress did not retain the excess
limitation carryforward provisions from old section 163(j). One
commenter expressed agreement with this conclusion. However, other
commenters noted that applying a cumulative section 163(j) SRLY
register would not effectuate the carryforward of excess limitation at
the level of the consolidated group. In other words, although the SRLY
member would be able to deduct its SRLY disallowed business interest
expense carryforwards in a taxable year to the extent of that member's
cumulative (rather than annual) contribution to the group's section
163(j) limitation, the SRLY member's ability to deduct such
carryforwards still would be subject to the group's annual section
163(j) limitation.
After considering the comments received, the Treasury Department
and the IRS have determined that a cumulative section 163(j) SRLY
register would better approximate the results under section 163(j) if
the SRLY member had not joined a consolidated group, and that this
approach is not inconsistent with congressional intent. Therefore, the
final regulations adopt a cumulative section 163(j) SRLY register.
The cumulative section 163(j) SRLY register operates in a manner
similar to, but is separate and distinct from, the cumulative register
for NOLs described in Sec. 1.1502-21(c). In computing a member's
section 163(j) SRLY register, the intercompany transaction rules of
Sec. 1.1502-13 generally continue to apply; thus, for example,
intercompany income items and intercompany deductions and losses (to
the extent absorbed by the group) generally are taken into account in
computing the section 163(j) SRLY register. However, interest income
and expense from intercompany obligations are not taken into account in
computing the section 163(j) SRLY register. This approach approximates
the SRLY member's capacity to utilize carryforwards on a standalone
basis while harmonizing with the single-entity application of section
163(j) to consolidated groups. Under this approach, intercompany
interest income and expense items will neither increase nor decrease
the SRLY register.
In the preamble to the proposed regulations, the Treasury
Department and the IRS requested comments on another alternative to
both an annual register and a cumulative register--removing the SRLY
limitation from a member's SRLY-limited disallowed business interest
expense carryforwards, to the extent of the member's standalone section
163(j) limitation, in taxable years in which the member's standalone
section 163(j) limitation exceeds the consolidated group's section
163(j) limitation. A commenter endorsed this approach. However, other
commenters expressed concern that this approach would be more
distortive than a cumulative register approach. The Treasury Department
and the IRS agree that a cumulative register more closely approximates
the results on a standalone basis than this alternative approach. Thus,
the final regulations adopt a cumulative register approach rather than
this alternative approach.
Commenters also expressed concern that proposed Sec. 1.163(j)-
5(d)(2) would treat SRLY carryforwards as available for deduction only
to the extent the amount of the SRLY member's business interest expense
already deducted by the group in the current year does not exceed the
member's annual section 163(j) SRLY limitation. The adoption of the
cumulative section 163(j) SRLY limitation mechanism, with the
associated reduction to reflect all business interest expense of that
member that is absorbed by the group, obviates the issues highlighted
in the comment. The final regulations retain the other SRLY limitations
in proposed Sec. 1.163(j)-5(d)(2).
C. Offsetting Business Interest Expense With Business Interest Income
and Floor Plan Financing Interest Expense at the Member Level
As described in part V(B) of this Summary of Comments and
Explanation of Revisions section, proposed Sec. 1.163(j)-5(b)(3)
provides, in part, that if the aggregate amount of members' business
interest expense (including carryforwards) exceeds the consolidated
group's section 163(j) limitation for the current year, then each
member with current-year business interest expense and current-year
business interest income or floor plan financing interest expense
deducts current-year business interest expense to the extent of its
current-year business interest income and floor plan financing interest
expense. Thereafter, if the group has any remaining section 163(j)
limitation, each member with remaining current-year business interest
expense deducts a pro rata portion thereof.
A commenter stated that offsetting business interest expense with
business interest income or floor plan financing interest expense at
the member level seems inconsistent with the single-entity principles
adopted by the proposed regulations. Moreover, the commenter expressed
concern that a consolidated group could choose where to incur business
interest income within a group and thereby affect which member has
disallowed business interest expense carryforwards. In addition, the
commenter asserted that a group may have difficulty determining which
member has incurred business interest income and floor plan financing
interest expense (see the discussion in part V(B) of this Summary of
Comments and Explanation of Revisions section). Thus, the commenter
recommended an alternative approach that does not require such
offsetting at the member level.
The Treasury Department and the IRS acknowledge that netting
business interest income and floor plan financing interest expense
against business interest expense at the member level deviates from a
``pure'' single-entity approach. This approach was adopted in the
proposed regulations to give effect to section 163(j)(1) (which allows
taxpayers to deduct business interest expense to the full extent of
business interest income and floor plan financing
[[Page 56717]]
interest expense) and to ensure that income tax liability is clearly
reflected at the member level in accordance with section 1502 and Sec.
1.1502-13. Further, because consolidated groups are under common
control by definition (see section 1504), a consolidated group largely
has control over the location of interest expense, even before the
application of section 163(j). With regard to the comment regarding the
difficulty of determining which member actually has incurred an
interest expense, section 61 provides that interest income is
includible in gross income, and section 163 provides rules by which
interest expense is deductible in computing the taxable income. Section
1.1502-12 also requires consolidated group members to report interest
income and expense at the member level for purposes of computing
separate taxable income. Thus, the final regulations do not adopt the
commenter's recommendation.
VII. Comments on and Changes to Section 1.163(j)-6: Application of the
Business Interest Expense Deduction Limitations to Partnerships and
Subchapter S Corporations
As discussed in the preamble to the proposed regulations, Sec.
1.163(j)-6 provides general rules regarding the application of section
163(j)(4) to partnerships, S corporations, and their owners, including
rules on how to calculate the limitation and how to treat disallowed
business interest expense carryforwards. The following discussion
addresses comments relating to proposed Sec. 1.163(j)-6.
A. Partnership-Level Calculation and Allocation of Section 163(j)
Excess Items
1. Nonseparately Stated Taxable Income or Loss of the Partnership
Section 163(j)(4)(A)(ii)(II) states that a partner's excess taxable
income is determined in the same manner as the nonseparately stated
taxable income or loss of the partnership. Section 163(j)(4)(B)(i)(II)
states that excess business interest expense is allocated to each
partner in the same manner as the non-separately stated taxable income
or loss of the partnership. Similarly, excess business interest income
is allocated to each partner in the same manner as the nonseparately
stated taxable income or loss of the partnership.
As highlighted in the proposed regulations, the phrase
``nonseparately stated taxable income or loss of the partnership'' is
not defined in section 163(j), and it has not previously been defined
by statute or regulations.\1\ The phrase ``in the same manner as'' is
also undefined. The proposed regulations interpreted the phrase
``nonseparately stated taxable income or loss,'' as it is used in
sections 163(j)(4)(A)(ii)(II) and 163(j)(4)(B)(i)(II), as meaning the
items comprising adjusted taxable income, business interest income, and
business interest expense of the partnership. The legislative history
and structure of the statute suggest the purpose of the phrase
``nonseparately stated taxable income or loss of the partnership'' is
to help coordinate the section 163(j) limit imposed at the partnership
and partner levels.
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\1\ Sections 163(j)(4)(A)(i) and (B)(i)(II) use the word
``nonseparately'' (no hyphen), but section 163(j)(4)(A)(ii)(II) uses
the word ``non-separately'' (hyphen). For purposes of consistency,
these final regulations use ``nonseparately'' when discussing the
phrase at issue.
---------------------------------------------------------------------------
Section 163(j)(4)(A)(i) uses this phrase when describing business
interest expense that already has been tested at the partnership level.
In general, an item included in nonseparately stated taxable income or
loss of a partnership under section 702(a)(8) loses its tax character
in the hands of the partner to whom it is allocated. By providing that
such business interest expense is treated as a nonseparately stated
item, section 163(j)(4)(A)(i) causes such business interest expense to
lose its character as business interest expense, thus preventing it
from being subject to retesting at the partner level under section
163(j). Although it does not use the same phrase, section
163(j)(4)(A)(ii)(I), in conjunction with section 163(j)(4)(C),
similarly provides that, to the extent the partnership's adjusted
taxable income was used in its section 163(j) calculation, such
adjusted taxable income is not included in a partner's section 163(j)
calculation. Consistent with this principle, proposed Sec. 1.163(j)-
6(e)(4) provided similar rules to prevent the double counting of
business interest income. Therefore, interpreting the phrase
``nonseparately stated taxable income or loss of the partnership,'' as
it is used in section 163(j)(4) as meaning the items comprising
adjusted taxable income, business interest income, and business
interest expense of the partnership (hereinafter, ``section 163(j)
items'') is supported by the statute, which requires each of these
items to be taken into account at the partnership level and prohibits
the double counting of such items in the partner's section 163(j)
calculation.
To allocate excess taxable income, excess business interest income,
and excess business interest expense (hereinafter, ``section 163(j)
excess items'') ``in the same manner'' as the ``nonseparately stated
taxable income or loss of the partnership'' (that is, the section
163(j) items), proposed Sec. 1.163(j)-6(f)(2) provided an 11-step
calculation that, when completed by the partnership, provides the
partnership with an allocation of each of its section 163(j) excess
items to each of its partners. This resulting array of allocations is
consistent with the Treasury Department and the IRS's resolution of the
three descriptive (1 through 3) and two normative (4 through 5) issues
outlined in part 6(D)(1) of the Explanation of Provisions section in
the proposed regulations: (1) Section 163(j) is applied at the
partnership level; (2) a partnership cannot have both excess taxable
income (or excess business interest income) and excess business
interest expense in the same taxable year; (3) parity must be preserved
between a partnership's deductible business interest expense and
section 163(j) excess items and the aggregate of each partner's share
of deductible business interest expense and section 163(j) excess items
from such partnership; (4) if, in a given year, a partnership has both
deductible business interest expense and excess business interest
expense, a partnership should not allocate excess business interest
expense to a partner to the extent such partner was allocated the items
comprising ATI (or business interest income) that supported the
partnership's deductible business interest expense; and (5) if, in a
given year, a partnership has excess taxable income (or excess business
interest income), only partners allocated more items comprising ATI (or
business interest income) than necessary to support their allocation of
business interest expense should be allocated a share of excess taxable
income (or excess business interest income).
In general, the 11-step calculation preserves the entity-level
calculation required in section 163(j)(4) while also preserving the
economics of the partnership, including respecting any special
allocations made in accordance with section 704 and the regulations
under section 704 of the Code. Stated otherwise, the allocations of
section 163(j) excess items prescribed by the 11-step calculation
attempt to reflect the aggregate nature of partnerships under
subchapter K of the Code while remaining consistent with the
application of section 163(j) at the partnership level.
The Treasury Department and the IRS requested comments on the 11-
step calculation in the preamble to the
[[Page 56718]]
proposed regulations. Specifically, the Treasury Department and the IRS
requested comments regarding alternative methods for allocating
deductible business interest expense and section 163(j) excess items in
a manner that permits partners that bear the taxable income supporting
the deductible business interest expense to be allocated a
disproportionate share of deductible business interest expense and
excess taxable income.
2. Requested Clarifications and Modifications
Commenters requested several clarifications of and modifications to
the 11-step calculation. First, commenters requested confirmation that
a partnership's allocations of section 163(j) excess items pursuant to
the 11-step calculation will be considered to meet the requirements of
section 704(b). The final regulations confirm that allocations pursuant
to the 11-step calculation meet the requirements of section 704(b).
Nothing in the 11-step calculation prohibits a partnership from making
an allocation to a partner of any section 163(j) item that is otherwise
permitted under section 704 and the regulations thereunder.
Accordingly, any calculations in the 11-step calculation are solely for
the purpose of determining each partner's section 163(j) excess items,
and do not otherwise affect any other provision under the Code, such as
section 704(b). Further, the statement in the proposed regulations that
the 11-step calculation is solely for section 163(j) purposes and does
not apply for any other purposes of the Code does not mean that section
163(j) excess items have no effect on either outside basis or capital
accounts. To illustrate this point, Sec. 1.163(j)-6(o)(17), Example 17
has been revised to show the beginning and ending outside basis and
capital accounts after applying the 11-step calculation.
To further clarify that the allocation of section 163(j) excess
items pursuant to the 11-step calculation will be sustained under
section 704, a special rule has been added to Sec. 1.704-1(b)(4). The
allocation of deductible and nondeductible business interest expense
does not have economic effect because classifying a portion of the
interest expense as nondeductible merely changes the tax character of
the item. Accordingly, Sec. 1.704-1(b)(4)(xi) is added to clarify
that, if Sec. 1.163(j)-6(f) is satisfied, the allocation of section
163(j) excess items will be deemed to be in accordance with the
partners' interests in the partnership.
Second, commenters recommended the 11-step calculation take
remedial allocations into account. Commenters noted that the exclusion
of remedial allocations from the partnership-level computation could
frustrate the ability of the 11-step calculation to reach the most
equitable result given its purpose. The Treasury Department and the IRS
acknowledge that taking remedial allocations into account in the 11-
step calculation after 2021 might produce an equitable result. However,
because remedial income would not always be offset by remedial losses
prior to 2022 for purposes of computing ATI, the Treasury Department
and that IRS have determined that taking remedial allocations into
account in the 11-step calculation would not achieve appropriate
results in all circumstances. Therefore, the Treasury Department and
the IRS decline to accept the recommendation.
Third, a commenter recommended that the final regulations allow
partnerships to make remedial allocations of excess taxable income.
Under this recommended modification to the 11-step calculation, if a
partner receives an allocation of taxable income in excess of such
partner's allocation of excess taxable income, the partnership could
elect to create positive remedial excess taxable income in the amount
of the excess and allocate such positive remedial excess taxable income
to the affected partner. The partnership also would create an
offsetting negative remedial excess taxable income item in an equal
amount that would be allocated to the other partners. The Treasury
Department and the IRS do not adopt this recommendation in the final
regulations in light of the fact that the definition of ``excess
taxable income'' is statutory and the statute does not appear to
contemplate negative excess taxable income.
3. Recommended Alternative Methods
Commenters recommended the final regulations retain the 11-step
calculation. Additionally, commenters recommended that the final
regulations provide alternative methods for allocating section 163(j)
excess items in addition to the 11-step calculation. The commenters
seeking an alternative method expressed concern about the complexity of
the 11-step calculation--specifically, that the required computations
and recordkeeping are excessive for many taxpayers. Commenters argued
that the attempted precision of the 11-step calculation should be
weighed against its complexity and compared to the reduced precision
that could be achieved through simpler methods.
As an alternative to the 11-step calculation, commenters
recommended the final regulations allow taxpayers to adopt any
reasonable method for allocating section 163(j) excess items, provided
the method does not produce results inconsistent with the Treasury
Department and the IRS's resolution of the five issues articulated in
the preamble to the proposed regulations. See part VII(A)(1) of this
Summary of Comments and Explanation of Revisions section. Commenters
provided multiple examples of reasonable methods, and they recommended
that the final regulations treat section 163(j) excess item allocations
as reasonable if the allocations are: (1) Reasonably consistent with
the allocations of the corresponding items under section 704(b); (2) in
proportion to the allocation of the underlying section 163(j) item; (3)
in proportion to the manner in which the partners bear liability for
the debt or, in the case of non-recourse debt, in proportion to the
manner in which profits will be allocated in order to repay the debt;
or (4) the result of arms-length bargaining among partners with adverse
tax interests.
The Treasury Department and the IRS do not adopt any of these
alternatives in the final regulations. Each of the alternatives
recommended by commenters requires an application of section 163(j) at
the partnership level, a determination of each partner's share of the
partnership's section 163(j) items, and a final determination of each
partner's section 163(j) excess items that takes into account each
partner's share of the partnership's section 163(j) items. These three
determinations mirror steps 1, 2, and 11 (respectively) of the 11-step
calculation. The Treasury Department and the IRS recognize the
complexity of the computations and recordkeeping imposed by the statute
on partnerships, but the Treasury Department and the IRS have concluded
that the computations and recordkeeping associated with steps 1, 2, and
11 of the 11-step calculation are unavoidable under any approach. As
such, the commenters' recommendation is, in effect, that the final
regulations allow alternatives to steps 3 through 10 of the 11-step
calculation.
With respect to steps 3 through 10, the Treasury Department and the
IRS agree that these computations add to the complexity already
required by the statute; thus, a worksheet and multiple examples have
been provided to aid in the completion of these computations. However,
the Treasury Department and the IRS have concluded that these
computations are not overly
[[Page 56719]]
burdensome given that the partnerships required to perform these
calculations already are experienced with handling the complexities
associated with special allocations or section 704(c) allocations. In
terms of recordkeeping, taxpayers are not required to keep records of
steps 3 through 10 because compliance with the 11-step calculation can
be determined solely based on the records associated with steps 1, 2,
and 11. Moreover, in terms of accuracy, the alternatives fall short of
achieving the purpose of steps 3 through 10, which is to align
deductible business interest expense with the ATI and business interest
income that supported such deduction at the partnership level.
For example, consider the recommended alternative of allocating
section 163(j) excess items in proportion to the allocation of the
underlying section 163(j) item. If partnership AB's sole items of
income, gain, loss, and deduction were $30 of business interest income,
which it allocated solely to A, and $40 of business interest expense,
which it allocated $20 to each of A and B, then A and B each would have
$15 of deductible business interest expense and $5 of excess business
interest expense. In situations where, as in this case, the partnership
does not allocate all of its section 163(j) items pro rata this method
could require a partnership to allocate its section 163(j) excess items
in a manner inconsistent with the Treasury Department and the IRS's
resolution of issues four and five. See part VII(A)(1) of this Summary
of Comments and Explanation of Revisions section.
Applying the 11-step calculation to the previous example, A would
have $20 of deductible business interest expense, and B would have $10
of deductible business interest expense and $10 of excess business
interest expense. This result is consistent with the Treasury
Department and the IRS's resolution of the five issues described in
part VII(A)(1) of this Summary of Comments and Explanation of Revisions
section. Because the alternative of allocating section 163(j) excess
items in proportion to the allocation of the underlying section 163(j)
item could require a partnership to allocate section 163(j) excess
items to its partners in a manner that does not attempt to align
deductible business interest expense with the ATI and business interest
income that supported it at the partnership level (which is
inconsistent with the resolution of the five issues described in part
VII(A)(1) of this Summary of Comments and Explanation of Revisions
section), this alternative is not adopted in the final regulations.
Other commenters' similar alternatives were considered and were
rejected on the same grounds based on the foregoing analysis.
One commenter recommended another alternative method that, in a
more general way than the 11-step calculation, attempts to align
deductible business interest expense with the ATI and business interest
income that supported such deduction at the partnership level. The
commenter stated that this objective could be accomplished as follows.
For each partner that is allocated business interest expense, determine
the portion of the business interest expense allocated to such partner
that would be considered deductible business interest expense, taking
into account only the business interest income and ATI allocated to
such partner. If the aggregate amount determined for all partners is
equal to, or less than, the amount of the partnership's deductible
business interest expense, then each partner would be allocated
deductible business interest expense in the amount determined in the
first step. If the first step produced deductible business interest
expense in excess of the limitation determined at the partnership
level, each partner's allocation of deductible business interest
expense would equal the proportion of the partnership's total
deductible business interest expense that the deductible amount
determined in the first step for such partner constitutes of the
deductible amount determined for all partners. Also, any deductible
business interest expense as determined at the partnership level that
is not allocated through the first step then would be allocated among
the partners that have been allocated business interest deductions in
proportion to the amount of business interest expense of each partner
remaining after the first step.
The Treasury Department and the IRS do not adopt this alternative
method in the final regulations. The commenter's approach provides a
method for allocating excess business interest expense, but it does not
provide any guidance on allocating excess taxable income or excess
business interest income. Further, it is not possible to infer a manner
for allocating excess taxable income and excess business interest
income from this approach because it fails to distinguish each
partner's ATI from its business interest income. By comingling ATI and
business interest income in its first step, this method fails to
account for the ordering of ATI and business interest income in the
partnership context as required by the statute. Section 163(j)(4)(C)
provides that partnership ATI does not begin offsetting partnership
business interest expense until partnership business interest income
has been fully utilized. Because this method is only capable of
addressing fact patterns in which there is excess business interest
expense, it is not adopted in the final regulations.
Moreover, the Treasury Department and the IRS have concluded that
this method for allocating excess business interest expense does not
sufficiently reduce taxpayer burden given the trade-off in precision
and administrability. To illustrate, the commenter applied its
recommended method to the facts of Example 14 of Sec. 1.163(j)-6(o) of
the proposed regulations. In that example, partnership PRS has $140 of
business interest expense, $200 of ATI, and no business interest
income. Accordingly, PRS has $60 of deductible business interest
expense. PRS allocates its items of ATI such that A, B, and C have
income of $100, $100, and $400 respectively, while D has a loss of
$400. PRS allocates its business interest expense $40 to B, $60 to C,
and $40 to D.
Under the suggested method, PRS first would determine for each of
B, C, and D the amount of the business interest expense allocated to
each partner that would be deductible under section 163(j) taking into
account solely the ATI and business interest income allocated to such
partner. In this case, the entire $60 of business interest expense
allocated to C would have been deductible, $30 of the business interest
expense allocated to B would have been deductible, and no amount of
business interest expense allocable to D would have been deductible.
The total amount of business interest expense determined in the first
step (or $90) exceeds the total amount deductible under section 163(j)
applied at the partnership level (or $60). PRS then would determine the
proportion of the business interest expense allocated to each partner
that is determined to be deductible in the first step and allocate the
total deduction in those proportions. Thus, C would be entitled to two-
thirds ($60/$90) of the $60 deduction ($40 of deductible business
interest expense) and B would be entitled to one-third ($30/$90) of the
$60 deduction ($20 of deductible business interest expense). D would
not be entitled to any business interest expense deduction.
Accordingly, B would have $20 of excess business interest expense, C
would have $20 of excess business interest expense, and D would have
$40 of excess business interest expense.
[[Page 56720]]
In contrast, applying the 11-step calculation to the same example
results in an allocation of more deductible business interest expense
to C ($48) than to B ($12) because C was allocated more ATI ($400) from
PRS than B ($100). Unlike the commenter's method, the 11-step
calculation increases a partner's amount of deductible business
interest expense in response to an increased allocation of ATI and
business interest income. The commenter's method allocates deductible
business interest expense based on a ratio that does not take into
account the fact that C was allocated significantly more ATI from PRS
than B. To illustrate this point, consider what would happen in the
previous example if the facts were changed so that C was allocated
$1,100 of ATI and D was allocated ($1,100) of ATI. Applying the 11-step
calculation, C would have $55 of deductible business interest expense.
Applying the commenter's method, C's increased allocation of ATI from
PRS would have no effect on C's deductible business interest expense--C
still would have $40 of deductible business interest expense and $20 of
excess business interest expense.
The Treasury Department and the IRS have determined that the 11-
step calculation produces the result that is most consistent with the
normative principle in the statute that the amount of business interest
expense a taxpayer is capable of deducting should increase as its ATI
and business interest income increase. Further, the Treasury Department
and the IRS view methods that do not increase a partner's amount of
deductible business interest expense in response to an increased
allocation of ATI from the partnership as less intuitive, and therefore
more burdensome in application. Therefore, the final regulations do not
adopt commenters' suggested alternative methods.
4. Publicly Traded Partnerships
The Treasury Department and the IRS received comments raising
concerns about the continued fungibility of publicly traded partnership
(PTP) units if PTPs are required to allocate section 163(j) excess
items pursuant to the 11-step calculation. The effect of section 163(j)
on the fungibility of PTP units is being addressed in the Concurrent
NPRM. Therefore, these issues are not addressed in the final
regulations.
5. Pro Rata Exception
Multiple commenters recommended that partnerships that allocate all
items of income and expense on a pro rata basis (similar to S
corporations) be exempt from the 11-step calculation. Commenters stated
that these partnerships by nature do not make the kinds of allocations
the 11-step calculation is designed to address. Commenters asserted
that simplifying the 11-step calculation for these pro-rata
partnerships would reduce complexity and reduce their administrative
burden.
The Treasury Department and the IRS agree with these comments.
Accordingly, the final regulations provide an exception (pro rata
exception) from steps 3 through 11 of the 11-step calculation for
partnerships that allocate all section 163(j) items in step 2
proportionately. This pro rata exception will not result in allocations
of section 163(j) excess items that vary from the array of allocations
of section 163(j) excess items that would have resulted had steps 3
through 11 been performed. See Sec. 1.163(j)-6(f)(2)(ii) and Example 1
through Example 16 of Sec. 1.163(j)-6(o).
B. Basis Adjustments
1. Basis and Capital Account Adjustments for Excess Business Interest
Expense Allocations
Pursuant to proposed Sec. 1.163(j)-6(f)(2), the adjusted basis of
a partner's interest in a partnership is reduced, but not below zero,
by the amount of excess business interest expense allocated to the
partner. If a partner is subject to a loss limitation under section
704(d) and the partner is allocated losses from a partnership in a
taxable year, the limited losses are grouped based on the character of
each loss (each grouping of losses based on character, a ``section
704(d) loss class''). If there are multiple section 704(d) loss classes
in a given year, the partner apportions the limitation to each section
704(d) loss class proportionately. For purposes of applying this
proportionate rule, any deductible business interest expense and
business interest expense of an exempt entity (whether allocated to the
partner in the current taxable year or suspended under section 704(d)
in a prior taxable year), any excess business interest expense
allocated to the partner in the current taxable year, and any excess
business interest expense from a prior taxable year that was suspended
under section 704(d) (negative section 163(j) expense) makes up the
same section 704(d) loss class (section 163(j) loss class). Moreover,
once the partner determines the amount of limitation on losses
apportioned to the section 163(j) loss class, any deductible business
interest expense is taken into account before any excess business
interest expense or negative section 163(j) expense.
Proposed Sec. 1.163(j)-6(h)(2) provides that negative section
163(j) expense is not treated as excess business interest expense in
any subsequent year until such negative section 163(j) expense is no
longer suspended under section 704(d). Consequently, an allocation of
excess taxable income or excess business interest income does not
result in the negative section 163(j) expense being treated as business
interest expense paid or accrued by the partner. Further, unlike excess
business interest expense, which prevents a partner from including
excess taxable income in its ATI as described in section
163(j)(4)(B)(ii) (flush language), negative section 163(j) expense does
not affect, and is not affected by, any allocation of excess taxable
income to the partner. Accordingly, any excess taxable income allocated
to a partner from a partnership while the partner still has a negative
section 163(j) expense will be included in the partner's ATI. However,
once the negative section 163(j) expense is no longer suspended under
section 704(d), it becomes excess business interest expense, which is
subject to the general rules in proposed Sec. 1.163(j)-6(g).
Commenters noted that the rule in proposed Sec. 1.163(j)-6(h)(2)
is helpful and should be retained in the final regulations. However,
commenters further noted that partners with no business interest
expense from other sources generally would prefer to treat their
negative section 163(j) expense as deductible business interest expense
suspended under section 704(d) and utilize excess taxable income in the
current year for that purpose, even though the resulting deductible
business interest expense would continue to be non-deductible because
of a section 704(d) limit. Thus, commenters recommended allowing a
partner to use excess taxable income to treat negative section 163(j)
expense as deductible business interest expense suspended under section
704(d) instead of using it to increase partner ATI.
The final regulations do not adopt this recommendation. No
precedent exists for allowing items suspended under section 704(d) to
preemptively clear limitations that apply after section 704(d) while
remaining suspended under section 704(d). For example, in the section
469 context, a non-materially participating partner allocated passive
income cannot use such passive income to recharacterize passive losses
allocated in a previous year as non-passive while those losses remain
suspended under section 704(d).
[[Page 56721]]
One commenter also recommended adopting a silo approach under
section 704(d). Under this approach, if a partner had a section 704(d)
limitation, it could bifurcate its items between non-excepted and
excepted partnership business items. If the non-excepted portion was
net positive, none of the excess business interest expense allocated
from the partnership would be negative section 163(j) expense.
However, this approach would be a significant departure from the
current rule under section 704(d), which generally requires the
limitation on losses under section 704(d) to be allocated to a
partner's distributive share of each loss proportionately, regardless
of whether such loss is from an excepted or non-excepted trade or
business under section 163(j). Moreover, nothing in section 163(j)
indicates Congress intended to give excess business interest expense
suspended under section 704(d) a better result than any other
partnership losses suspended under section 704(d). For that reason, the
final regulations do not adopt this recommendation.
2. Basis Adjustments Upon Disposition of Partnership Interests Pursuant
to Section 163(j)(4)(B)(iii)(II)
Under the proposed regulations, if a partner disposes of all or
substantially all of its partnership interest, the adjusted basis of
the partnership interest is increased immediately before the
disposition by the entire amount of the remaining excess business
interest expense. Following such a disposition, no deduction is
permitted to either the transferor or the transferee with respect to
the excess business interest expense resulting in the basis increase.
If a partner disposes of less than substantially all of its interest in
a partnership, the partner cannot increase its basis by any portion of
the remaining excess business interest expense. The Treasury Department
and the IRS requested comments on this approach in the preamble to the
proposed regulations.
Commenters cited multiple concerns with the approach adopted in the
proposed regulations. First, commenters claimed that the absence of an
excess business interest expense basis addback for a partial
disposition of a partnership interest could result in tax gain in
excess of economic gain in connection with the sale of a partial
interest, while the addition of the entire adjustment to outside basis
in connection with a complete disposition could result in economic gain
in excess of tax gain. Commenters suggested this timing difference
between economic gain and tax gain inappropriately disconnects taxable
income from economic income. Second, commenters expressed concern that,
because a partial disposition would result in a partner holding a
smaller interest in a partnership than it held prior to the partial
disposition, the partner would receive smaller allocations of excess
taxable income (and excess business interest income) in subsequent
years. If none of the excess business interest expense of the partner
is affected by the partial disposition, this could extend the amount of
time needed for a partner to convert its excess business interest
expense to business interest expense treated as paid or accrued. Third,
commenters noted that, in the event of a partial disposition of a
partnership interest, the proposed regulations may cause a discrepancy
between the capital accounts of the transferor and the transferee and
the excess business interest expense associated with each partner's
interest.
Commenters stated that neither the statute nor its policy of
limiting business interest expense deductions calls for the potentially
harsh results that could be imposed by the approach provided in the
proposed regulations. The main purpose of the excess business interest
expense carryover rule is to limit the partner's ability to claim a
business interest expense deduction that exceeds the statutory
threshold under section 163(j)(1). Commenters stated that this
statutory purpose can be accomplished by denying the business interest
expense deduction and eliminating the carryforward upon a partial
disposition of the partnership interest. In other words, to the extent
that a partner foregoes its business interest expense deduction, the
purpose of the statute is fulfilled. Thus, a proportionate approach
would fulfill the purpose of the statute while not subjecting taxpayers
to outcomes that are not plainly contemplated by the statue.
As a solution, commenters recommended that a partial disposition of
a partnership interest trigger a proportionate excess business interest
expense basis addback and corresponding decrease in such partner's
excess business interest expense carryover (proportionate approach).
Under the proportionate approach, the partner would be required to
track its basis in its partnership interest in a manner similar to that
set forth in Revenue Ruling 84-53, 1984-1 C.B. 159 (April 9, 1984).
Commenters advocating for a proportionate addback rule varied in their
recommendations regarding where the addback should occur. In general,
commenters suggested three options: (1) Increase the basis of the
partnership interest retained; (2) apportion the basis increase
proportionally between the partnership interest retained and the
partnership interest being disposed of; and (3) increase the basis of
the partnership interest being disposed of.
As described in the preamble to the proposed regulations, the
Treasury Department and the IRS originally considered and rejected the
proportionate approach. One reason the Treasury Department and the IRS
adopted the all or substantially all approach in the proposed
regulations over the proportionate approach was because the former
appeared more taxpayer-favorable in certain circumstances. Under the
all or substantially all approach in the proposed regulations, the
excess business interest expense basis addback is delayed for the
maximum amount of time (until a partner disposes of all or
substantially all of its interest), giving taxpayers more time to
receive excess taxable income (and excess business interest income) and
thus potentially take an ordinary deduction. However, as commenters
pointed out, a smaller partnership interest likely will result in a
correspondingly smaller allocation of excess taxable income (and excess
business interest income) from the partnership. For this reason,
commenters did not perceive the proposed approach as taxpayer-favorable
for preserving the possibility of a future ordinary deduction, but
rather as taxpayer-unfavorable for delaying what likely will be a
capital loss.
Accordingly, the Treasury Department and the IRS adopt the
recommended proportionate approach in the final regulations. In the
preamble to the proposed regulations, the Treasury Department and the
IRS indicated that, if final regulations were to adopt a proportionate
approach, such approach would increase the basis of the partnership
interest being retained by the amount of the excess business interest
expense basis addback. However, upon further consideration, the
Treasury Department and the IRS agree with commenters that the basis
addback should instead increase the basis of the partnership interest
being disposed of. Thus, the final regulations adopt a proportionate
approach that increases the basis of the partnership interest being
disposed of.
For purposes of Sec. 1.163(j)-6(h)(3), a disposition includes a
distribution of money or other property by the partnership to a partner
in complete liquidation of its interest in the
[[Page 56722]]
partnership. The Treasury Department and the IRS request comments on
whether a current distribution of money or other property by the
partnership to a continuing partner as consideration for an interest in
the partnership should also trigger an addback and, if so, how to
determine the appropriate amount of the addback. Additionally, the
final regulations clarify that each partner is considered to have
disposed of its partnership interest within the meaning of Sec.
1.163(j)-6(h)(3) if the partnership terminates under section 708(b)(1).
The proportionate rule adopted in the final regulations applies the
equitable apportionment principles of Sec. 1.61-6 (referenced in
Revenue Ruling 84-53) to determine the amount of excess business
interest expense attributable to the partner's interest sold. In
Example 1 of Sec. 1.61-6, basis is apportioned among properties based
on the fair market value of the property and is treated as equitably
apportioned. Similarly, in Situations 1 and 3 of Revenue Ruling 84-53,
the IRS ruled that a selling partner's basis in the transferred portion
of the interest generally equals an amount that bears the same relation
to the partner's basis in the partner's entire interest as the fair
market value of the transferred portion of the interest bears to the
fair market value of the entire interest (the pro rata approach to
equitable apportionment). However, if a partnership has liabilities,
special adjustments must be made to take into account the effect of the
liabilities on the basis of the partner's interest. Accordingly, the
final regulations adopt the pro rata approach to equitable
apportionment and generally provide that the adjusted basis of the
partnership interest being disposed of is increased immediately before
the disposition by the amount of the excess business interest expense
that is proportionate to the interest disposed of in the transaction.
The Treasury Department and the IRS also received comments
recommending the final regulations treat a sale of all or substantially
all of a partnership's assets as a deemed disposition of each partner's
interest in the partnership within the meaning of section
163(j)(4)(B)(iii)(II). Because the statute requires a disposition of a
partnership interest to trigger the basis adjustment described in
section 163(j)(4)(B)(iii)(II), the final regulations do not adopt this
recommendation.
3. Intercompany Transfer of a Partnership Interest
For a discussion of comments received on intercompany transfers of
partnership interests, see part V(D) of this Summary of Comments and
Explanation of Revisions section.
C. Debt-Financed Distributions
The treatment of interest expense associated with debt incurred by
a partnership or S corporation to finance distributions to owners
(debt-financed distributions) is being addressed in the Concurrent
NPRM. Therefore, these issues are not addressed in the final
regulations.
D. Trading Partnerships
The preamble to the proposed regulations stated that the business
interest expense of certain passthrough entities, including S
corporations, that are engaged in trades or businesses that are per se
non-passive activities and in which one or more owners of the entities
do not materially participate within the meaning of section 469, as
described in section 163(d)(5)(A)(ii) and as illustrated in Revenue
Ruling 2008-12, 2008-1 C.B. 520 (March 10, 2008), will be subject to
section 163(j) at the entity level (even if the interest expense is
also subject to limitation under section 163(d) at the individual
partner level). With respect to partnerships, to the extent that such
business interest expense is limited under section 163(j)(4) and
becomes a carryover item of partners who do not materially participate
with respect to such trades or businesses, those items will be treated
as items of investment interest expense in the hands of those owners
for purposes of section 163(d) once those carryover items are treated
as paid or accrued in a succeeding taxable year. This rule does not
apply to corporate partners.
The Treasury Department and the IRS received multiple comments
questioning this interpretation of section 163(j)(5) and its
interaction with section 163(d)(5)(A)(ii). The interaction of section
163(j)(5) with section 163(d)(5)(A)(ii) is being addressed in the
Concurrent NPRM. Therefore, this issue is not addressed in the final
regulations.
E. Treatment of Excess Business Interest Expense in Tiered Partnerships
The preamble to the proposed regulations requested comments
regarding the application of section 163(j) to tiered partnership
structures, and the proposed regulations reserved on this topic.
Specifically, the preamble requested comments on whether excess
business interest expense should be allocated through upper-tier
partnerships and how or when an upper-tier partner's basis should be
adjusted when a lower-tier partnership is subject to a section 163(j)
limitation. This issue is being addressed in the Concurrent NPRM.
Therefore, this issue is not addressed in the final regulations.
F. Partnership Mergers and Divisions
The proposed regulations reserve on guidance regarding the
application of section 163(j) to partnership mergers and divisions, and
the Treasury Department and the IRS requested comments in the preamble
to the proposed regulations on the effect of partnership mergers and
divisions on excess business interest expense, excess taxable income,
and excepted trade or business elections in the context of section
163(j).
In response to this request, one commenter recommended that: (i)
The carryforward rule in proposed Sec. 1.163(j)-6(g) apply to partners
of a partnership treated as a continuing partnership in a partnership
merger or division; (ii) the disposition rule of proposed Sec.
1.163(j)-6(h)(3)(i) apply to partnership interests that are treated as
liquidated in a partnership merger or division; and (iii) the final
regulations confirm, perhaps through examples, the application of the
excepted trade or business election and termination rules in proposed
Sec. 1.163(j)-9 in the context of a partnership merger or division.
The partnership merger and division rules under section 708 may
treat a partnership as terminating or continuing, and the regulations
under Sec. 1.708-1(c) and (d) provide a construct for analyzing the
tax effects of a partnership merger or division. The Treasury
Department and the IRS have determined that, in most situations, a
partnership merger or division can be analyzed appropriately under the
rules of Sec. 1.708-1(c) and (d). As a result, the Treasury Department
and the IRS are not providing special rules in the final regulations to
analyze the consequences of a partnership merger or division in the
context of section 163(j) at this time. However, the Treasury
Department and the IRS continue to study these issues.
G. Applicability of Section 382 to S Corporations Regarding Disallowed
Business Interest Expense Carryforwards
The proposed regulations provide that sections 381(c)(20) and
382(d)(3) and (k)(1) apply to S corporations with respect to disallowed
business expense carryforwards. Proposed Sec. 1.163(j)-6(l)(5)
provides that the amount of any business interest expense not allowed
as a deduction for any taxable year by reason of the section 163(j)
limitation is carried forward in the succeeding taxable year as a
disallowed business interest expense carryforward. Proposed
[[Page 56723]]
Sec. 1.163(j)-6(l)(1) provides that any disallowed business interest
expense is not allocated to the S corporation's shareholders until such
business interest expense is allowed as a deduction under section
163(j). Similarly, under proposed Sec. 1.163(j)-6(l)(6) and (7), an S
corporation shareholder's stock basis is reduced, but not below zero,
and an S corporation's accumulated adjustments account (AAA) balance is
adjusted, when a disallowed business interest expense becomes
deductible under section 163(j).
The preamble to the proposed regulations requested comments
regarding the proper integration of section 163(j) and section 382 and
subchapter S of the Code (subchapter S). In addition, the preamble to
the proposed regulations requested comments regarding the treatment of
disallowed business interest expense carryforwards as an attribute of
the S corporation subject to the section 382 limitation, as opposed to
an attribute of the shareholders, and regarding the timing for any
adjustments to shareholder basis and the corporation's AAA.
In response, one commenter recommended that the final regulations
retain the approach as set forth in the proposed regulations. In
particular, the commenter recommended that section 382 (and the
comparable provisions of section 383) be applied only to those
attributes that are carried forward and taken into account at the
corporate level. The commenter contended that it would be appropriate
to treat disallowed business interest expense of an S corporation as a
``pre-change loss'' such that the corporation would be a loss
corporation pursuant to section 382(k)(1).
The Treasury Department and the IRS agree with the commenter.
Because disallowed business interest expense is treated as an attribute
of the S corporation, the S corporation's disallowed business interest
expense carryforwards will be treated as pre-change losses subject to a
section 382 limitation under section 382(d)(3) following an S
corporation's ownership change (within the meaning of section 382(g)).
Accordingly, consistent with the treatment of C corporations under
section 382, the final regulations provide that a disallowed business
interest expense carryforward of an S corporation is treated as pre-
change loss and will be subject to a section 382 limitation only if an
S corporation undergoes an ownership change within the meaning of
section 382(g). For example, under the final regulations, a
``qualifying disposition'' by a shareholder that results in a 20-
percent ownership change of the S corporation, on its own, will not
cause section 382 to apply to an S corporation upon such qualifying
disposition. See Sec. 1.1368-1(g)(2)(i)(A). See also Sec. 1.1368-
1(g)(2) (defining the term ``qualifying disposition'').
A commenter also recommended that section 382 not be applied to any
item of deduction, loss, or credit that is allocated to shareholders on
a current basis and taken into account at the shareholder level. As
expressed in the preamble to the proposed regulations, the Treasury
Department and the IRS continue to consider the extent to which section
382 should apply to S corporations for purposes other than section
163(j). The application of section 382 to S corporations for purposes
of section 163(j) should not be construed as creating any inference
regarding the application of section 382 to S corporations for other
purposes. The Treasury Department and the IRS continue to seek comments
regarding the proper integration of these two Code sections and
subchapter S.
H. Separate Application of Section 163(j) Limitation to Short Taxable
Years of S Corporation
An S corporation's items of income and loss generally are allocated
on a pro rata, per-day basis to all shareholders that hold the
corporation's stock during the corporation's taxable year. See section
1377(a)(1). However, subchapter S provides limited exceptions to that
general allocation rule. For example, in the event that a shareholder
completely terminates its interest, the S corporation and affected
shareholders can elect to treat its taxable year ``as if the taxable
year consisted of 2 taxable years the first of which ends on the date
of the termination'' (each, a hypothetical short taxable year). Section
1377(a)(2)(A). In addition, an S corporation may make such an election
if a shareholder has made a qualifying disposition. See Sec. 1.1368-
1(g)(2). With regard to each of these instances, the S corporation may
elect to ``close the books'' even though the corporation will file one
Federal income tax return for the taxable year covering both separate
taxable periods.
Subchapter S also specifies instances in which an S corporation may
elect, or is required, to file a Federal income tax return for a short
taxable year (actual short taxable year). For example, an S corporation
may elect to determine taxable income or loss based on a closing-of-
the-books method with respect to an S termination year. See section
1362(e)(3) (providing an election to have items assigned to each short
taxable year under normal Federal income tax accounting rules).
However, if a sale or exchange of at least 50 percent of the S
corporation's stock occurs during that S termination year, the S
corporation must utilize the closing-of-the-books method. See section
1362(e)(6)(D). See also section 1362(e)(6)(C) (requiring the use of the
closing-of-the-books method with respect to any item resulting from the
application of section 338).
Based on a request from a commenter, the Treasury Department and
the IRS have considered whether the section 163(j) limitation should
apply separately with respect to each hypothetical or actual short
taxable year. Specifically, the commenter recommended that, if an S
corporation (1) has an actual short taxable year, or (2) determines its
taxable income or loss as if its taxable year consisted of separate
taxable years (that is, hypothetical short taxable years), the final
regulations should clarify that a separate section 163(j) limitation
should be calculated for, and applied to, each actual or hypothetical
short taxable year. To support that recommendation, the commenter
emphasized ``sound policy reasons'' for ensuring that owners of the
corporation during the first short taxable period are not affected by
the fortunes of the corporation during the second short period, and
vice versa.
The Treasury Department and the IRS agree that a separate section
163(j) limitation should be calculated for, and applied to, each actual
or hypothetical short taxable year. Section 163(j)(1) limits the amount
of business interest expense allowed as a deduction ``for any taxable
year.'' Accordingly, the Treasury Department and the IRS have
determined that a separate section 163(j) limitation should apply to
each actual short taxable year. See Sec. 1.1362-3(c)(3) (setting forth
the general rule that ``the S and C short years are treated as two
separate years for purposes of all provisions of the Internal Revenue
Code''). In addition, subchapter S and the regulations in this part
under subchapter S explicitly treat hypothetical short taxable years as
separate taxable years. See section 1377(a)(2)(A) (providing that an S
corporation can treat its taxable year ``as if the taxable year
consisted of 2 taxable years'') and Sec. 1.1368-1(g)(1) (providing
that the ``section applies as if the taxable year consisted of separate
taxable years''). As a result, the Treasury Department and the IRS also
have determined that a separate section 163(j) limitation should apply
to each
[[Page 56724]]
hypothetical short taxable year and sections 1.1362-3(c), 1.1368-
1(g)(2), and 1.1377-1(b)(3) have been amended accordingly.
I. Partnership or S Corporation Not Subject to Section 163(j)
Under proposed Sec. 1.163(j)-6(m)(1), if a partner or S
corporation shareholder is allocated business interest expense from an
exempt entity, that allocated business interest expense will be subject
to the partner's or S corporation shareholder's section 163(j)
limitations. Commenters recommended that proposed Sec. 1.163(j)-
6(m)(1) be modified so that business interest expense incurred by a
partnership that is an exempt entity is not subject to section 163(j)
at the partner level. Commenters argued that proposed Sec. 1.163(j)-
6(m)(1) was inconsistent with section 163(j)(4)(A), which requires the
testing of partnership-level business interest expense at the
partnership level, not the partner level. The Treasury Department and
the IRS agree, and have determined that the same argument naturally
should apply to S corporations and their shareholders. See section
163(j)(4)(D) (in relevant part, providing that rules similar to section
163(j)(4)(A) shall apply with respect to any S corporation and its
shareholders). Accordingly, the final regulations provide that business
interest expense of an exempt partnership, or exempt S corporation,
pursuant to section 163(j)(3) does not retain its character as business
interest expense and, as a result, is not subject to the section 163(j)
limitation at the partner or S corporation shareholder level.
One commenter requested clarification as to whether proposed Sec.
1.163(j)-6(m)(3) applies only to exempt entities or also could apply to
trades or businesses that become not subject to the requirements of
section 163(j) by reason of engaging in excepted trades or businesses.
The final regulations clarify that Sec. 1.163(j)-6(m)(3) does not
apply when a partnership engages in excepted trades or businesses.
Accordingly, if a partner is allocated excess business interest expense
from a partnership and, in a succeeding taxable year, such partnership
engages in excepted trades or businesses, then the partner shall not
treat any of its excess business interest expense that was previously
allocated from such partnership as business interest expense paid or
accrued by the partner in such succeeding taxable year by reason of the
partnership engaging in excepted trades or businesses. Rather, such
excess business interest expense shall remain as excess business
interest expense until such time as it is treated as business interest
expense paid or accrued by the partner pursuant to Sec. 1.163(j)-
6(g)(2) or by reason of the partnership becoming an exempt entity. The
final regulations provide a similar clarification for S corporations in
Sec. 1.163(j)-6(m)(4).
J. Trusts
For purposes of determining ATI for trusts, one commenter noted
that the definition of ATI does not contain an addback for deductible
trust distributions. Trusts and decedents' estates taxable under
section 641 are permitted to deduct under sections 651 and 661 certain
distributions made to beneficiaries. The commenter suggested that
section 163(j) should apply before a trust takes a deduction for
distributions to beneficiaries, and that, if a deductible trust or
estate distribution is added back to the trust's ATI and thus is taken
into account in determining the amount of interest expense allowable to
the trust under section 163(j), such trust or estate distribution
should be excluded from the recipient beneficiaries' calculation of
ATI. Thus, under the commenter's approach, a beneficiary of a trust or
a decedent's estate would not be able to utilize a trust distribution
to deduct additional business interest expense at the beneficiary
level.
The Treasury Department and the IRS agree with this comment.
Proposed Regulation Sec. 1.163(j)-2(f) is consistent with this result.
However, in order to clarify that trusts and decedents' estates taxable
under section 641 compute ATI without regard to deductions under
sections 651 and 661, the final regulations explicitly provide for this
positive ATI adjustment. Additionally, the Treasury Department and the
IRS have determined that a similar rule should apply for charitable
deductions of a trust or a decedent's estate under section 642(c).
K. Qualified Expenditures
The ATI of a partnership is generally determined in accordance with
proposed Sec. 1.163(j)-1(b)(1). Partnership ATI is therefore reduced
by deductions claimed under sections 173 (relating to circulation
expenditures), 174(a) (relating to research and experimental
expenditures), 263(c) (relating to intangible drilling and development
expenditures), 616(a) (relating to mine development expenditures), and
617(a) (relating to mining exploration expenditures) (collectively,
``qualified expenditures''). As a result, deductions for qualified
expenditures will reduce a partnership's section 163(j) limitation
pursuant to proposed Sec. 1.163(j)-2(b). Deductions for those items
also will reduce the amount of excess taxable income that may be
allocated to the partners and thus reduce the amount by which partner-
level ATI may be increased under proposed Sec. 1.163(j)-6(e)(1).
A partner may elect to capitalize its distributive share of any
qualified expenditures of a partnership under section 59(e)(4)(C) or
may be required to capitalize a portion of its distributive share of
certain qualified expenditures of a partnership under section 291(b).
As a result, the taxable income reported by a partner in a taxable year
attributable to the ownership of a partnership interest may exceed the
amount of taxable income reported to the partner on a Schedule K-1.
Commenters recommended that a distributive share of partnership
deductions capitalized by a partner under section 59(e) or section
291(b) increase the ATI of the partner because qualified expenditures
reduce both partnership ATI and excess taxable income but may not
reduce the taxable income of a partner. Commenters suggested two
different approaches for achieving this result: (1) Adjust the excess
taxable income of the partnership, resulting in an increase to partner
ATI; and (2) increase the ATI of the partner directly, without making
any adjustments to partnership excess taxable income. The interaction
of qualified expenditures with section 163(j)(4) is being addressed in
the Concurrent NPRM. Therefore, this issue is not addressed in the
final regulations.
L. CARES Act Partnership Rules
As discussed in the Background section to this preamble, section
163(j)(10), as amended by the CARES Act, provides a special rule for
excess business interest expense allocated to a partner in a taxable
year beginning in 2019 (50 percent EBIE Rule). See section
163(j)(10)(a)(ii). The 50 percent EBIE rule is addressed in proposed
Sec. 1.163(j)-6(g)(4) of the Concurrent NPRM. The application of the
2019 ATI rule, as provided in section 163(j)(10)(B), in the partnership
context is also addressed in proposed Sec. 1.163(j)-6(g)(4) of the
Concurrent NPRM. Therefore, the 50 percent EBIE rule and the
application of the 2019 ATI rule to partnerships are not addressed in
the final regulations.
[[Page 56725]]
VIII. Comments on and Changes to Proposed Sec. 1.163(j)-7: Application
of the Section 163(j) Limitation to Foreign Corporations and United
States Shareholders
Section 1.163(j)-7 provides general rules regarding the application
of the section 163(j) limitation to foreign corporations and U.S.
shareholders. The following discussion addresses comments relating to
proposed Sec. 1.163(j)-7.
The proposed regulations generally apply section 163(j) and the
section 163(j) regulations to determine the deductibility of an
applicable CFC's business interest expense in the same manner as these
provisions apply to determine the deductibility of a domestic C
corporation's business interest expense. See proposed Sec. 1.163(j)-
7(b)(2). The proposed regulations define an applicable CFC as a CFC in
which at least one U.S. shareholder owns stock, within the meaning of
section 958(a). However, in certain cases, the proposed regulations
limit the amount of an applicable CFC's business interest expense
subject to the section 163(j) limitation and modify the computation of
an applicable CFC's ATI, respectively. Thus, under the proposed
regulations, an applicable CFC with business interest expense applies
section 163(j) to determine the extent to which that expense is
deductible for purposes of computing subpart F income as defined under
section 952, tested income as defined under section 951A(c)(2)(A), and
income that is effectively connected with the conduct of a U.S. trade
or business (ECI), as applicable. The proposed regulations provide
additional guidance for an applicable CFC (and other foreign persons)
with ECI in proposed Sec. 1.163(j)-8, as discussed in part IX of this
Summary of Comments and Explanation of Revisions section.
The Treasury Department and the IRS requested comments in the
preamble to the proposed regulations regarding whether it would be
appropriate to provide additional modifications to the application of
section 163(j) to applicable CFCs and whether there are particular
circumstances in which it may be appropriate to exempt an applicable
CFC from the application of section 163(j).
Some commenters recommended that section 163(j) generally should
not apply to applicable CFCs. Other commenters suggested that section
163(j) should apply to applicable CFCs only to the extent that they
have ECI or, if an income tax treaty applies, business profits
attributable to a United States permanent establishment, or to the
extent that debt was introduced to an applicable CFC with a principal
purpose of avoiding U.S. income taxes. Some commenters argued that the
Treasury Department and the IRS lack the authority to apply section
163(j) to applicable CFCs because section 163(j) applies to taxpayers
and, they argue, applicable CFCs are not taxpayers. Furthermore, some
commenters argued that old section 163(j) did not apply to applicable
CFCs and that Congress expressed no intent to change that. Some
commenters also argued that applying section 163(j) to applicable CFCs
creates significant complexity and an administrative burden.
Furthermore, some commenters suggested that applying section 163(j) to
applicable CFCs may have a limited effect on tax revenue or that
applying section 163(j) to applicable CFCs could, in some cases, result
in a net tax benefit to U.S. shareholders.
The Treasury Department and the IRS have determined that, under
current law, section 163(j) applies to applicable CFCs and other
foreign corporations whose income is relevant for U.S. tax purposes. As
a general matter, application of U.S. tax principles to a foreign
corporation for purposes of determining its income for U.S. tax
purposes is within the authority of the Treasury Department and the
IRS. For example, a U.S. shareholder of an applicable CFC takes into
account its pro rata share of the subpart F income and net tested
income of an applicable CFC. Accordingly, in order to determine the
U.S. shareholder's pro rata share, the income of the applicable CFC
must be determined. Section 1.952-2(a)(1) provides that, ``[e]xcept as
provided in subparagraph (2) of this paragraph [relating to insurance
gross income], the gross income of a foreign corporation for any
taxable year shall, subject to the special rules of paragraph (c) of
this section, be determined by treating such foreign corporation as a
domestic corporation taxable under section 11 and by applying the
principles of section 61 and the regulations thereunder.'' Neither
Sec. 1.952-2(a)(2) nor (c) implicates section 163(j). Accordingly,
pursuant to Sec. 1.952-2, a foreign corporation is treated as a
domestic corporation for U.S. tax purposes when calculating its taxable
income, including by application of section 163(j).
The exclusion of CFCs from the application of old section 163(j)
under the 1991 Proposed Regulations is not determinative as to whether
applicable CFCs and other foreign corporations should be excluded from
the application of section 163(j). Although both old section 163(j) and
section 163(j) limit deductions for business interest expense, the
policies of each provision are significantly different. Old section
163(j) was a narrower provision that limited a corporation's ability to
use interest expense deductions to move earnings out of the United
States tax base. Section 163(j) focuses on limiting the potential tax
benefit of overleveraged businesses. Because Congress wholly repealed
and replaced old section 163(j), the provisions of old section 163(j)
and the 1991 Proposed Regulations are not determinative as to the
application of section 163(j).
Furthermore, nothing in the Code or legislative history indicates
that Congress intended to exclude applicable CFCs or other foreign
corporations from the application of section 163(j). Congress expressly
provided that section 163(j) should not apply to certain small
businesses or to certain excepted trades or businesses. Congress did
not exempt applicable CFCs or other foreign corporations from the
application of section 163(j).
Accordingly, the final regulations clarify that section 163(j)
applies to foreign corporations whose income is relevant for U.S. tax
purposes, other than by reason of section 881 or 882 (relevant foreign
corporations). Section 1.163(j)-7(b). Furthermore, no comments were
received on the application of Sec. 1.952-2 or section 882 for
purposes of determining the income, including ECI, of an applicable CFC
or on the reduction of an applicable CFC's taxable income by the amount
of any dividend received from a related person for purposes of
determining ATI. In addition to clarifying that these rules apply to
all relevant foreign corporations, the final regulations otherwise
adopt these rules unchanged. Sec. 1.163(j)-7(g)(1).
The Treasury Department and the IRS acknowledge that the
application of section 163(j) to applicable CFCs and other relevant
foreign corporations, like many other tax provisions, will increase the
complexity of determining the taxable income of a relevant foreign
corporation. Similarly, section 163(j) may have a significant effect on
the amount of taxable income of some relevant foreign corporations and
have limited or no effect on the amount of taxable income of others.
The Treasury Department and the IRS do not view the complexity of a
provision of the Code or its net effect on tax revenue as determinative
as to whether the provision applies to CFCs. Nonetheless, the Treasury
Department and the IRS have determined that it is appropriate to
[[Page 56726]]
reduce the compliance and administrative burdens of applying section
163(j) to certain applicable CFCs.
Accordingly, the Treasury Department and the IRS have developed new
rules, taking into account comments received, that substantially modify
the rules contained in proposed Sec. 1.163(j)-7. The Treasury
Department and the IRS anticipate that, in many cases, these
modifications will significantly reduce the compliance and
administrative burdens of applying section 163(j) to applicable CFCs.
However, because the operation of these new rules is sufficiently
different from the operation of the rules in proposed Sec. 1.163(j)-7,
the Treasury Department and the IRS have determined that these rules
should be proposed in order to provide taxpayers the opportunity to
comment before their finalization. These rules and a discussion of
their operation are contained in the Concurrent NPRM.
IX. Comments on and Changes to Section 1.163(j)-8: Application of the
Section 163(j) Limitation to Foreign Persons With Effectively Connected
Taxable Income.
Proposed Sec. 1.163(j)-8 provides rules for applying section
163(j) to a nonresident alien individual or foreign corporation with
ECI. Although no comments were received on proposed Sec. 1.163(j)-8,
the Treasury Department and the IRS continue to study methods of
determining the amount of deductible business interest expense and
disallowed business interest expense carryforwards that are allocable
to ECI. Accordingly, the final regulations reserve on the application
of the business interest expense deduction limitation to foreign
persons with ECI.
In the Concurrent NPRM, the Treasury Department and the IRS are
proposing rules for determining the amount of deductible business
interest expense and disallowed business interest expense carryforward
of a nonresident alien, foreign corporation, or partnership that is
properly allocable to ECI. The Treasury Department and the IRS request
comments on appropriate methods of making this determination. These
comments should consider the appropriate method for determining the
extent to which business interest expense determined under Sec. 1.882-
5 should be treated as attributable to a partnership and subject to the
section 163(j) limitation at the partnership level.
X. Comments on and Changes to Proposed Sec. 1.163(j)-9: Elections for
Excepted Trades or Businesses; Safe Harbor for Certain REITs
Section 1.163(j)-9 provides general rules and procedures for making
an election for a trade or business to be an electing real property
trade or business under section 163(j)(7)(B) and an election for a
trade or business to be an electing farming business under section
163(j)(7)(C). The following discussion addresses some of the provisions
in Sec. 1.163(j)-9 and the comments received.
A. Protective Elections
Section 163(j)(3) provides that the section 163(j) limitation does
not apply to taxpayers that meet the gross receipts test of section
448(c). The small business exemption applies automatically if the
requirements are met; thus, no election is necessary to ensure that the
section 163(j) limitation does not apply. However, for real property
trades or businesses under section 163(j)(7)(B), and for farming
businesses under section 163(j)(7)(C), the section 163(j) limitation
does not apply only if the taxpayer is eligible for and makes an
election.
The preamble to the proposed regulations provides that a taxpayer
that qualifies for the small business exemption is not eligible to make
an election for a trade or business to be an electing real property
trade or business or an electing farming business, in part because the
taxpayer is already not subject to the section 163(j) limitation, and
in part because an electing real property trade or business or an
electing farming business is required to use ADS for certain types of
property under section 163(j)(10) and cannot claim the additional
first-year depreciation deduction under section 168(k) for those types
of property. The Treasury Department and the IRS were concerned that
certain small business taxpayers might make the election without
realizing that the election could have adverse effects on their
deduction for depreciation expense and their method of accounting for
depreciation.
Commenters suggested that, in some situations, making an annual
gross receipts determination, to determine whether a taxpayer should
make an election or is already exempt from the limitation, could be
burdensome. For example, a taxpayer that has to request the average
annual gross receipts of numerous unrelated entities under section 448
aggregation principles in order to make the gross receipts
determination may choose to forgo making that determination if the
taxpayer knows that its trade or business qualifies to be an electing
real property trade or business or an electing farming business. These
commenters requested that taxpayers be allowed to make such an election
without regard to whether the gross receipts test of section 448(c) has
been tested or is met, notwithstanding the potentially adverse
depreciation expense implications.
The Treasury Department and the IRS agree with the commenters.
Accordingly, the final regulations provide that taxpayers may make an
election for a trade or business to be an electing real property trade
or business or an electing farming business, provided that they qualify
to make such elections, even if the gross receipts test under section
448(c) may be satisfied by the electing trades or businesses in the
taxable year in which the election is made. As is the case for all
other electing real property trades or businesses and electing farming
businesses, the elections are irrevocable and affect depreciation as
provided in section 163(j)(11). However, this rule also benefits
taxpayers subject to section 163(j) that are owners of small businesses
because treating these small businesses as engaged in an excepted trade
or business may result in the allocation of more owner interest expense
to excepted trades or businesses under Sec. 1.163(j)-10(c).
Commenters also requested a protective election for taxpayers
engaged in rental real estate activities if it is unclear whether the
activities rise to the level of a trade or business under section 162.
The protective election is necessary, according to some commenters,
because the definition of an ``electing real property trade or
business'' in section 163(j)(7)(B) and proposed Sec. 1.163(j)-1(b)(14)
allows a trade or business described in section 469(c)(7)(C) to make
the election, and a real property trade or business as defined in
section 469(c)(7)(C) can include rental real estate that does not rise
to the level of a section 162 trade or business.
Generally, interest expense associated with an activity that does
not rise to the level of a section 162 trade or business is not subject
to the section 163(j) limitation. The section 163(j) limitation applies
to taxpayers with business interest, which is defined under section
163(j)(5) as any interest properly allocable to a trade or business.
Proposed Sec. 1.163(j)-1(b)(38) defines a ``trade or business'' as a
trade or business under section 162. In contrast, an electing real
property trade or business must be described in section 469(c)(7)(C).
Section 1.469-9(b)(1)
[[Page 56727]]
provides that, for purposes of section 469(c)(7), the term ``trade or
business'' is defined as ``any trade or business determined by treating
the types of activities in Sec. 1.469-4(b)(1) as if they involved the
conduct of a trade or business; and any interest in rental real estate,
including any interest in rental real estate that gives rise to
deductions under section 212.''
Thus, section 469(c)(7)(C) includes all rental real estate (as
defined in Sec. 1.469-9(b)(3)) and adopts a broader definition of a
``trade or business'' than section 162. Under this broader definition,
taxpayers with rental real estate may be able to qualify as ``real
estate professionals'' through work performed in their rental real
estate, even if the rental real estate activities otherwise do not rise
to the level of a section 162 trade or business.
For example, for purposes of section 469(c)(7)(C), a taxpayer who
owns real property and rents to tenants under a triple net lease
arrangement will be treated as engaged in a real property trade or
business even though the renting under the terms of a triple net lease
arrangement may not rise to the level of a section 162 trade or
business. The triple net lease arrangement is included in the broader
definition of a trade or business under Sec. 1.469-9(b)(1) because the
arrangement represents an interest in rental real estate. Accordingly,
renting real property under a triple net lease arrangement generally
will fall within the definition of a ``rental real property trade or
business'' in section 469(c)(7)(C) and proposed Sec. 1.469-9(b)(2). As
a result, the taxpayer with such a rental arrangement should be able to
make an election to treat this activity as an electing real property
trade or business, if the taxpayer so chooses, even though the renting
of real property under a triple net lease arrangement might not be a
section 162 trade or business. This result is simply a consequence of
Congress cross-referencing the broader section 469 definition of a
``real property trade or business'' for purposes of section 163(j).
Thus, the commenters stated that, although taxpayers who are
certain they are not engaged in a section 162 trade or business do not
need to make an election out of the section 163(j) limitation because
they are not subject to this limitation, taxpayers engaged in rental
real estate activities who are not certain whether their rental real
estate activities rise to the level of a section 162 trade or business
should be given the ability to obtain certainty by making a protective
election to treat their rental real estate activities as an electing
real property trade or business.
The Treasury Department and the IRS agree with the recommendation
for a protective election under these circumstances. Thus, the final
regulations provide that an election to treat rental real estate
activities as an electing real property trade or business is available
regardless of whether the taxpayer making the election is engaged in a
trade or business within the meaning of section 162. Under the
protective election, a taxpayer engaged in activities described in
section 469(c)(7)(C) and Sec. 1.469-9(b)(2), as required in proposed
Sec. 1.163(j)-1(b)(14)(i), but unsure whether its activities rise to
the level of a section 162 trade or business, may make an election for
a trade or business to be an electing real property trade or business.
As with all other electing real property trades or businesses, once
the election is made, all other consequences of the election outlined
in Sec. 1.163(j)-9 apply, such as the irrevocability of the election
and the required use of the alternative depreciation system for certain
assets.
B. One-Time Late Election or Withdrawal of Election Procedures
Commenters requested a one-time automatic extension of time for
certain taxpayers to file an election under section 163(j)(7)(B) or
section 163(j)(7)(C) due to uncertainty about the effect of a decision
to make or not make such an election and about which taxpayers are
eligible to make such an election prior to the publication of the final
regulations. Additionally, commenters requested a one-time opportunity
to withdraw an election made under section 163(j)(7)(B) or section
163(j)(7)(C) prior to the publication of the final regulations. The
Treasury Department and the IRS agree with the commenters' concerns.
Thus, in order to address the commenters' concerns, and to provide
immediate transition guidance under section 163(j) for taxpayers
affected by the various amendments to the Code made by the CARES Act
(including, for example, the technical corrections to section 168(e) of
the Code relating to the classification of qualified improvement
property), Revenue Procedure 2020-22 was issued to provide an automatic
extension of time to make, or an opportunity to withdraw, an election
for taxable years beginning in 2018, 2019, or 2020. The revenue
procedure also provides the time and manner of making or revoking the
three elections provided by the CARES Act under section 163(j)(10) for
taxable years beginning in 2019 or 2020.
C. The Anti-Abuse Rule Under Proposed Sec. 1.163(j)-9(h)
Numerous comments were received concerning the anti-abuse rule in
proposed Sec. 1.163(j)-9(h)(1) (proposed -9(h) anti-abuse rule). The
proposed -9(h) anti-abuse rule prohibits an otherwise qualifying real
property trade or business from making an election under section
163(j)(7)(B) if at least 80 percent of the business's real property,
determined by fair market value, is leased to a trade or business under
common control (that is, 50 percent of the direct and indirect
ownership of both businesses is held by related parties within the
meaning of sections 267(b) and 707(b)) with the real property trade or
business. Proposed Sec. 1.163(j)-9(h)(2) provides an exception to the
proposed -9(h) anti-abuse rule for REITs that lease qualified lodging
facilities (defined in section 856(d)(9)(D)) and qualified health care
properties (defined in section 856(e)(6)(D)) (REIT exception).
The preamble to the proposed regulations explains that it would be
inappropriate to allow an election under section 163(j)(7)(B) to be an
excepted real property trade or business for a trade or business that
leases substantially all of its real property to the owner of the real
property trade or business, or to a related party of the owner: ``To
permit such an election would encourage a taxpayer to enter into non-
economic structures where the real estate components of non-real estate
businesses are separated from the rest of such businesses in order to
artificially reduce the application of section 163(j) by leasing the
real property to the taxpayer or a related party of the taxpayer and
electing for this ``business'' to be an excepted real property trade or
business. As a result, these proposed regulations would also contain an
anti-abuse rule.'' The preamble further explains the reasoning for the
REIT exception by stating that, because REITs that lease qualified
lodging facilities and qualified healthcare properties are generally
permitted (pursuant to section 856(d)(8)(B)) to lease these properties
to a taxable REIT subsidiary (TRS), this anti-abuse rule does not apply
to these types of REITs. The Treasury Department and the IRS requested
comments in the preamble to the proposed regulations on whether other
exceptions to the anti-abuse rule (such as, for example, an exception
for certain fact patterns where real property that is leased from a
related party is ultimately sub-leased to a third party) would be
appropriate.
[[Page 56728]]
Commenters suggested eliminating or modifying the proposed -9(h)
anti-abuse rule because of the concern that, as currently written, this
rule applies to non-abusive lease arrangements between commonly
controlled trades or businesses. Specifically, commenters raised
concerns about the applicability of the proposed -9(h) anti-abuse rule
to specific types of business structures where the real property is
owned by one legal entity (referred to as property company, or PropCo)
and leased to a separate but commonly controlled legal entity that
operates and manages a business (referred to as operating company, or
OpCo). According to commenters, this PropCo/OpCo structure has valid
business protection, lending, and regulatory purposes in certain
industries. Commenters also claimed that this structure was in
existence for many years prior to the enactment of the section 163(j)
limitation and was not created in an attempt to circumvent application
of the section 163(j) limitation.
For example, the PropCo/OpCo structure is used by some hotels in
the following manner: PropCo generally owns the real property subject
to significant debt, services such debt, and leases the real property
to OpCo, which operates a real property trade or business by licensing
the property to unrelated third parties (guests). This structure is
used to limit legal liability, manage state and local tax burdens, plan
for family wealth transfers, and for other business objectives. One
commenter recommended a ``look-through'' exception to the proposed -
9(h) anti-abuse rule where the real property is ultimately leased (or
licensed) to unrelated third parties in a PropCo/OpCo structure. This
exception would allow a real property trade or business owning real
property, or PropCo, to make an election to be an electing real
property trade or business if it leases real property to a commonly
controlled real property trade or business, or OpCo, if OpCo subleases
(or licenses) the real property to unrelated third parties.
Similarly, commenters noted that the property ownership, mortgage,
and resulting interest expense for trades or businesses described as
nursing homes, continuing care retirement communities, independent
living facilities, assisted living facilities, memory care facilities,
and skilled nursing facilities (collectively, ``residential living
facilities'') is often contained in one legal entity, or PropCo, and
the operation and management of the residential living facility is
contained in another, commonly controlled legal entity, or OpCo.
Commenters explained that the Department of Housing and Urban
Development, which is a major lender in the residential living
industry, and many other lenders often require the use of single-asset
or separate legal entities for lending purposes.
To prevent the application of the proposed -9(h) anti-abuse rule to
a PropCo that leases real property to a residential living facility,
some commenters suggested that the anti-abuse rule should not apply to
a trade or business that leases real property to a residential living
facility (1) regardless of whether the lessor and lessee are under
common control, or (2) if both the lessor trade or business and the
commonly controlled lessee independently qualify as electing real
property trades or businesses. Commenters noted that the proposed -9(h)
anti-abuse rule should not apply to situations where the entities, if
combined or aggregated and without taking the lease into account, would
each qualify as real property trades or businesses. Without
modification to the proposed -9(h) anti-abuse rule, the PropCo in a
PropCo/OpCo structure would be prohibited from making a real property
trade or business election even though all of its lease income is
derived from a real property trade or business. Commenters suggested
that proposed Sec. 1.163(j)-9(h)(2), which provides an exception for
REITs, should apply to similarly situated taxpayers that are privately
owned but use a commonly controlled entity in a PropCo/OpCo structure
rather than a REIT.
Other suggestions made by commenters include (1) eliminating the
proposed -9(h) anti-abuse rule and instead relying on the more general
proposed Sec. 1.163(j)-2(h) anti-avoidance rule to disregard or
recharacterize the types of non-economic structures targeted by the
proposed -9(h) anti-abuse rule, (2) clarifying that the proposed -9(h)
anti-abuse rule would apply only if there is a ``principal purpose of
tax avoidance,'' (3) providing exceptions to the proposed -9(h) anti-
abuse rule if the taxpayer demonstrates a substantial economic purpose
for the PropCo/OpCo structures unrelated to avoiding section 163(j), or
if the PropCo/OpCo structure was in place prior to enactment of the
TCJA, and (4) expanding the REIT exception to include all real property
trades or businesses that lease to residential living facilities.
The operation of two separate, but commonly controlled, legal
entities is also common in the cattle and beef industry--one entity
owns all of the land and the buildings used by the operating entity,
whereas the operating entity owns inventory (cattle or crops) and
equipment and operates the farm, ranch, or feed yard. Commenters
recommended providing an exception from the proposed -9(h) anti-abuse
rule for farming businesses or, alternatively, clarifying that the
allocation rules under proposed Sec. 1.163(j)-10 do not apply to
separate out the real property to real property businesses included
under the proposed -9(h) anti-abuse rule.
The Treasury Department and the IRS agree with commenters that
certain exceptions should be added to the proposed -9(h) anti-abuse
rule. The final regulations provide two additional exceptions to the
anti-abuse rule. Under the first exception, if at least 90 percent of a
lessor's real property, determined by fair market rental value, is
leased to a related party that operates an excepted trade or business
and/or to unrelated parties, the lessor is eligible to make an election
to be an electing real property trade or business for its entire trade
or business (de minimis exception). The de minimis exception
accommodates taxpayers that, by law or for valid business reasons,
divide their real property holding and leasing activities from their
operating trade or business that qualifies as an excepted trade or
business, while still maintaining an anti-abuse rule to prevent non-
economic business structures designed to circumvent the section 163(j)
limitation. See Sec. 1.163(j)-9(j).
The second exception is a look-through rule that modifies the
proposed -9(h) anti-abuse rule by allowing taxpayers to make an
election for a certain portion of their real property trade or business
(look-through exception). Under the look-through exception, if a lessor
trade or business leases to a trade or business under common control
(lessee), the lessor is eligible to make an election to be an electing
real property trade or business to the extent that the lessor leases to
an unrelated party or to an electing trade or business under common
control with the lessor or lessee, and to the extent that the lessee
trade or business under common control subleases (or licenses) to
unrelated third parties and/or related parties that operate an excepted
trade or business. Accordingly, the lessor can make an election for the
portion of its trade or business that is equivalent to the portion of
the real property that is ultimately leased to unrelated parties and/or
related parties that operate an excepted trade or business. A lessor
that makes an election under the look-through exception must allocate
the basis of assets used in its trades or
[[Page 56729]]
businesses under the rules provided in Sec. 1.163(j)-10(c)(3)(iii)(D).
D. Residential Living Facilities and Notice With Proposed Revenue
Procedure
The PropCo/OpCo structure, discussed previously in part X(C) of
this Summary of Comments and Explanation of Revisions section, is used
extensively by certain residential living facilities that provide
residential housing along with supplemental assistive, nursing, and
other routine medical services. The commonly controlled lessees in the
PropCo/OpCo structure expressed concern about whether the residential
living facility trades or businesses qualify as real property trades or
businesses under section 469 and Sec. 1.469-9(b)(2), and are thus
eligible to make an election under section 163(j)(7)(B), because of the
supplemental services that they provide. Accordingly, Notice 2020--
[INSERT NOTICE #], 2020--[INSERT CB/IRB GUIDANCE NUMBERS], released
concurrently with these final regulations, provides notice of a
proposed revenue procedure detailing a proposed safe harbor under which
a taxpayer engaged in a trade or business that manages or operates a
residential living facility and that also provides supplemental
assistive, nursing, and other routine medical services may elect to
treat such trade or business as a real property trade or business
within the meaning of section 469(c)(7)(C), solely for purposes of
qualifying as an electing real property trade or business under section
163(j)(7)(B). Thus, if a lessor leases real property to a commonly
controlled lessee that operates a residential living facility, which
qualifies as and makes an election to be an excepted trade or business
under the proposed safe harbor in Notice 2020--[INSERT NOTICE #], the
lessor may qualify to use the de minimis exception or the look-through
exception.
The Treasury Department and the IRS request comments in Notice
2020--[INSERT NOTICE #] on the proposed revenue procedure. Interested
parties are invited to submit comments on the proposed revenue
procedure by [INSERT DATE 90 DAYS AFTER PUBLICATION of Notice 2020--
[INSERT NOTICE #] IN the IRB].
The proposed revenue procedure is proposed to apply to taxpayers
with taxable years ending after December 31, 2017. Until such time that
the proposed revenue procedure is published in final form, taxpayers
may use the safe harbor described in the proposed revenue procedure for
purposes of determining whether a residential living facility, as
defined in the proposed revenue procedure, may be treated as a real
property trade or business solely for purposes of section 163(j).
Future guidance might be needed to determine whether a particular
trade or business can make an election. Accordingly, the definitions of
electing real property trade or business in Sec. 1.163(j)-1(b)(14) and
electing farming business in Sec. 1.163(j)-1(b)(13) include a new
provision noting that the Secretary may issue guidance on whether a
trade or business can be an electing real property trade or business or
electing farming business.
E. Safe Harbor for Certain REITs
Proposed Sec. 1.163(j)-9(g) provides a special safe harbor for
REITs. The safe harbor provides that, if a REIT holds real property,
interests in partnerships holding real property, or shares in other
REITs holding real property, the REIT is eligible to make an election
to be an electing real property trade or business for all or part of
its assets. If a REIT makes an election to be an electing real property
trade or business, and if the value of the REIT's real property
financing assets (as defined in proposed Sec. 1.163(j)-9(g)(5) and
(6)) at the close of the taxable year is 10 percent or less of the
value of the REIT's total assets at the close of the taxable year,
then, under the safe harbor in the proposed regulations, all of the
REIT's assets are treated as assets of an excepted trade or business.
If a REIT makes an election to be an electing real property trade or
business, and if the value of the REIT's real property financing assets
at the close of the taxable year is more than 10 percent of the value
of the REIT's total assets, then, under the safe harbor in the proposed
regulations, the REIT's business interest income, business interest
expense, and other items of expense and gross income are allocated
between excepted and non-excepted trades or businesses under the rules
set forth in proposed Sec. 1.163(j)-10, as modified by proposed Sec.
1.163(j)-9(g)(4). The safe harbor also allows REITs to use Sec. 1.856-
10 for the definition of ``real property'' in determining which assets
are assets of an excepted trade or business. The final regulations
generally adopt the safe harbor for REITs in the proposed regulations,
with modifications in response to comments discussed in this part X(E)
of the Summary of Comments and Explanation of Revisions section.
One commenter recommended that the Treasury Department and the IRS
revise proposed Sec. 1.163(j)-9(g)(1) to clarify that a REIT may make
the safe harbor election if the REIT owns an interest in one or more
partnerships holding real property or stock in one or more REITs
holding real property. The commenter indicated that the use of the
plural ``interests in partnerships'' and ``shares in other REITs''
could imply that a REIT cannot make the safe harbor election if the
REIT owns an interest in a single partnership or shares in a single
REIT. The Treasury Department and the IRS agree that the regulations
should not preclude a REIT that owns an interest in a single
partnership or shares in a single REIT from applying the safe harbor.
This commenter also recommended that the final regulations clarify
that the safe harbor election may be made if the electing REIT owns a
direct interest in a partnership or lower-tier REIT that does not
directly hold real property, but that holds an interest in another
partnership or lower-tier REIT that directly holds real property.
The determination of whether a REIT is eligible to make the safe
harbor election under the proposed regulations was intended to mirror
the determination of whether the REIT holds real property (as defined
under Sec. 1.856-10) when testing the value of the REIT's real estate
assets under section 856(c)(4)(A). If a REIT is a partner in a
partnership that holds real property (as defined under Sec. 1.856-10),
the REIT is deemed to own its proportionate share of the partnership's
real property for purposes of section 856(c)(4). The Treasury
Department and the IRS also recognize that, for purposes of section
856(c)(4), a REIT is deemed to own a share of real property from any
partnership interest held through an upper-tier partnership.
Moreover, under section 856(c)(5)(B), shares in other REITs qualify
as real estate assets. Although a REIT (shareholder REIT) that holds
shares in another REIT would not need to determine whether the other
REIT holds real property for purposes of testing the value of the
shareholder REIT's real estate assets under section 856(c)(4), the
proposed regulations allowed the shareholder REIT to make the safe
harbor election as long as it determines that the other REIT holds real
property. The Treasury Department and the IRS recognize that the other
REIT in this situation may not necessarily hold real property but
instead may hold shares in a lower-tier REIT (which is a real estate
asset in the hands of the other REIT).
Because the shareholder REIT can hold shares in another REIT that
holds shares in a lower-tier REIT that holds real property, the
Treasury Department and the IRS have concluded that a shareholder REIT
may make the safe harbor election if it determines that it
[[Page 56730]]
holds an indirect interest in a REIT that holds real property.
Accordingly, the final regulations clarify that a REIT may elect to be
an electing real property trade or business if the REIT holds real
property, interests in one or more partnerships holding real property
either directly or indirectly through interests in other partnerships
or shares in other REITs, or shares in one or more other REITs holding
real property either directly or indirectly through interests in
partnerships or shares in other REITs.
Several commenters also requested that certain partnerships with a
REIT as a partner be allowed to apply the REIT safe harbor election at
the partnership level. Commenters noted that many REITs own interests
in partnerships that directly or indirectly hold real property, and
these partnerships incur the debt that is secured by the real property
and claim the interest expense deductions. Commenters recommended that
the REIT safe harbor election be made available to partnerships if: (1)
At least one partner is a REIT that owns, directly or indirectly, at
least 50 percent of the partnership's capital or profits; (2) the
partnership meets the requirements of section 856(c)(2), (3), and (4)
as if the partnership were a REIT; and (3) the partnership satisfies
the requirements of proposed Sec. 1.163(j)-9(g)(1) as if the
partnership were a REIT.
The Treasury Department and the IRS agree that a partnership that
is controlled by a REIT or REITs and that would meet the REIT gross
income and asset tests in section 856(c)(2), (3), and (4) (as if the
partnership were a REIT) is sufficiently similar to a REIT for this
purpose. Accordingly, the final regulations provide that a partnership
may apply the REIT safe harbor election at the partnership level if one
or more REITs own, directly or indirectly, at least 50 percent of the
partnership's capital and profits, the partnership meets the
requirements of section 856(c)(2), (3), and (4) as if the partnership
were a REIT, and the partnership satisfies the requirements described
in Sec. 1.163(j)-9(h)(1) as if the partnership were a REIT.
A commenter also recommended that the REIT exception to the
proposed Sec. 1.163(j)-9(h) anti-abuse rule be clarified to apply to
any partnership in which a REIT owns a 50 percent or greater direct or
indirect capital or profits interest, if the partnership leases a
qualified lodging facility or qualified health care property to a TRS
or a partnership in which a TRS is a 50 percent or greater direct or
indirect partner. The REIT exception was intended to allow REITs that
lease qualified lodging facilities and qualified healthcare properties
pursuant to the related party rental exception in section 856(d)(8)(B)
to make a real property trade or business election because these leases
are explicitly authorized by the Code. In response to comments, the
final regulations clarify that the REIT exception also applies to
partnerships making the REIT safe harbor election that lease qualified
lodging facilities and qualified healthcare properties. However, the
final regulations do not specify the related party to which the REIT
must lease the qualified lodging facility or qualified healthcare
property in order to qualify for the REIT exception and, therefore,
Treasury and the IRS did not include a provision for partnerships in
which a TRS is a partner.
A commenter requested clarification regarding the application of
the real property trade or business election to a rental real estate
partnership and its REIT partners if the partnership holds real
property and is not engaged in a trade or business within the meaning
of section 162. Part XVI of this Summary of Comments and Explanation of
Revision section clarifies that taxpayers engaged in rental real estate
activities that do not necessarily rise to the level of a section 162
trade or business nevertheless are treated as engaged in real property
trades or businesses within the meaning of section 469(c)(7)(C) (and
for purposes of section 163(j) by reference). As such, a partnership
engaged in a rental real estate activity (regardless of whether that
activity rises to the level of a section 162 trade or business) will be
permitted to make the election under section 163(j)(7)(B) with respect
to the rental real estate activity to be an electing real property
trade or business for purposes of section 163(j), and any interest
expense that is allocable to that rental real estate activity and that
is allocable to a REIT partner will not be investment interest (within
the meaning of section 163(d)) that is treated as interest expense
allocable to a trade or business of a C corporation partner under Sec.
1.163(j)-4(b)(3).
For purposes of valuing a REIT's assets, the proposed regulations
provide that REIT real property financing assets also include the
portion of a shareholder REIT's interest in another REIT attributable
to that other REIT's real property financing assets. The final
regulations clarify that this rule also applies in the context of
tiered-REIT structures.
The proposed regulations provide that no portion of the value of a
shareholder REIT's shares in another REIT is included in the value of
the shareholder REIT's real property financing assets if all of the
other REIT's assets are treated as assets of an excepted trade or
business under proposed Sec. 1.163-9(g)(2). The proposed regulations
provide that if a shareholder REIT does not receive from the other REIT
the information necessary to determine whether and the extent that the
assets of the other REIT are investments in real property financing
assets, then the shareholder REIT's shares in the other REIT are
treated as real property financing assets.
A commenter requested that the final regulations clarify how a
shareholder REIT determines whether the value of the other REIT's real
property financing assets is 10 percent or less of the other REIT's
total asset value for purposes of determining whether the electing
shareholder REIT must allocate interest expense between excepted and
non-excepted businesses. The commenter recommended that the final
regulations provide an example to clarify this point or specify that
the shareholder REIT may make this determination based on all of the
facts available to the shareholder REIT. The commenter proposed that a
shareholder REIT that makes an incorrect determination in good faith
that the other REIT qualifies under proposed Sec. 1.163-9(g)(2)
nevertheless be permitted to treat all of the value of the lower REIT's
shares as assets other than real property financing assets.
In response to this comment, the final regulations allow a
shareholder REIT to use an applicable financial statement (within the
meaning of section 451(b)) of the other REIT to determine whether and
the extent that the assets of the other REIT are investments in real
property financing assets (rather than having to receive the
information directly from the other REIT). However, the final
regulations do not permit a shareholder REIT to treat the shares in the
other REIT as assets other than real property financing assets when the
shareholder REIT's determination is based on information other than an
applicable financial statement or information received directly from
the other REIT.
In the event that a REIT is required to allocate its interest
expense between excepted and non-excepted trades or businesses under
Sec. 1.163(j)-10, a commenter requested clarification regarding the
application of the look-through rules to tiered entities. Under the
proposed regulations, if a REIT holds an interest in a partnership, in
applying the partnership look-through rule in proposed Sec. 1.163(j)-
10(c)(5)(ii)(A)(2), the REIT also applies
[[Page 56731]]
the definition of real property under Sec. 1.856-10 to determine
whether the partnership's assets are allocable to an excepted trade or
business. In addition, under the proposed regulations, if a shareholder
REIT holds shares in another REIT and all of the other REIT's assets
are not treated as assets of an excepted trade or business, the
proposed regulations provide that the shareholder REIT applies the same
partnership look-through rule (as if the other REIT were a partnership)
in determining the extent to which the shareholder REIT's adjusted
basis in the shares of the other REIT is properly allocable to an
excepted trade or business of the shareholder REIT.
In response to comments, the final regulations provide that, when
applying the partnership look-through rule in the case of tiered
entities, a REIT applies the definition of real property in Sec.
1.856-10 to each partnership in the chain to determine whether the
partnership's assets are allocable to an excepted trade or business.
Furthermore, because shares in other REITs qualify as real estate
assets under section 856(c)(5)(B), the final regulations provide that,
when applying the look-through rule to REITs within a tiered-entity
structure, a shareholder REIT may apply the partnership look-through
rule in Sec. 1.163(j)-10(c)(5)(ii)(A)(2) to all REITs in the chain.
In response to an informal inquiry, the final regulations also
clarify that a REIT or a partnership that is eligible but chooses not
to apply the REIT safe harbor election may still elect, under Sec.
1.163(j)-9(b)(1), for one or more of its trades or businesses to be an
electing real property trade or business, provided that such trade or
business is otherwise eligible to elect under Sec. 1.163(j)-9(b)(1). A
REIT or partnership that makes the election under Sec. 1.163(j)-
9(b)(1) without utilizing the REIT safe harbor provisions may not rely
on any portion of Sec. 1.163(j)-9(h)(1) through (7).
F. Real Property Trade or Business
Proposed Sec. 1.163(j)-10(a)(1)(i) provides that the amount of a
taxpayer's interest expense that is properly allocable to excepted
trades or businesses is not subject to the section 163(j) limitation,
and the amount of a taxpayer's other items of income, gain, deduction,
or loss, including interest income, that is properly allocable to
excepted trades or businesses is excluded from the calculation of the
taxpayer's section 163(j) limitation. Commenters suggested that, for
purposes of allocating interest between a non-excepted trade or
business and an excepted trade or business, a corporate partner in a
partnership that conducts a real property trade or business should be
allowed to treat its share of the partnership's real property trade or
business as an electing real property trade or business even if the
partnership does not make the election.
The Treasury Department and the IRS have rejected this comment
because an election under section 163(j)(7)(B) has certain
consequences--for example, the use of ADS rather than the general
depreciation system for certain types of property, which results in the
inability of electing real property trades or businesses to claim the
additional first-year depreciation deduction under section 168(k) for
those types of property. Therefore, the Treasury Department and the IRS
have determined that a corporate partner in a partnership that conducts
a real property trade or business should be allowed to treat its share
of the partnership's real property trade or business as an electing
real property trade or business only if the partnership makes the
election. However, see part X(A) of this Summary of Comments and
Explanation of Revisions section regarding taxpayers that are eligible
to make an election to be an electing real property trade or business
but are not certain whether they are engaged in a trade or business
under section 162.
XI. Comments on and Changes To Proposed Sec. 1.163(j)-10: Allocation
of Interest Expense, Interest Income, and Other Items of Expense and
Gross Income to an Excepted Trade or Business.
Section 1.163(j)-10 provides rules for allocating tax items that
are properly allocable to a trade or business between excepted trades
or businesses and non-excepted trades or businesses for purposes of
section 163(j). The following discussion addresses comments relating to
proposed Sec. 1.163(j)-10.
A. General Method of Allocation: Asset Basis
Proposed Sec. 1.163(j)-10(c) sets forth the general rule for
allocating interest expense and interest income between excepted and
non-excepted trades or businesses. Under this general rule, interest
expense and interest income is allocated between excepted and non-
excepted trades or businesses based upon the relative amounts of the
taxpayer's adjusted basis in the assets used in its trades or
businesses. As noted in the preamble to the proposed regulations, this
general method of allocation reflects the fact that money is fungible
and the view that interest expense is attributable to all activities
and property, regardless of any specific purpose for incurring an
obligation on which interest is paid. Many commenters expressed support
for this proposed allocation method.
However, some commenters argued that taxpayers should be permitted
to allocate interest expense and income between excepted and non-
excepted trades or businesses based on the earnings or gross income of
each business, for various reasons. For example, some commenters
posited that asset basis may bear little connection to a corporation's
borrowing capacity, whereas earnings or revenue are useful indicators
of a taxpayer's ability to meet its debt obligations, and earnings are
a key factor in determining the amount of debt the taxpayer may borrow
and the interest rate the taxpayer will be charged. These commenters
also noted that an asset-basis allocation method could yield
inconsistent results across industries (for example, industries whose
asset mix is heavily skewed towards self-created intangibles will have
low asset basis) or within similarly situated industries (if assets are
purchased at different times). One commenter also suggested that an
earnings-based approach would be easier for the IRS and taxpayers to
administer because ATI already must be calculated by each taxpayer that
is subject to a section 163(j) limitation.
Although the foregoing arguments have merit, adopting an earnings-
based approach would raise many additional considerations, such as
taxpayers' ability to time income recognition to affect allocation and
create other distortions (as in the case of a trade or business that
requires capital investment for a period of years before earning
significant gross income). Thus, after further consideration, the
Treasury Department and the IRS have decided to retain the asset-basis
allocation approach contained in proposed Sec. 1.163(j)-10(c).
However, the Treasury Department and the IRS continue to study these
comments and may provide future guidance on this issue.
B. Allocation Between Trades or Businesses and Non-Trades or Businesses
Proposed Sec. 1.163(j)-10(a)(2)(i) coordinates the rules under
proposed Sec. 1.163(j)-10 with other Federal income tax rules. For
example, proposed Sec. 1.163(j)-10(a)(2)(i) provides that, before a
taxpayer may determine the amount of interest expense, interest income,
or other tax items that is properly allocable to excepted or non-
excepted trades or businesses, the
[[Page 56732]]
taxpayer first must apply Sec. 1.163-8T to determine which tax items
are allocable to non-trades or businesses rather than to trades or
businesses. Some commenters recommended that non-corporate partners be
permitted to allocate tax items between a trade or business and a non-
trade or business based on an approach that looks to the earnings of
the trade or business and non-trade or business. The commenters argued
that an earnings-based approach to determining when debt is properly
allocable between a trade or business and a non-trade or business is
consistent with determining whether the earnings of a taxpayer can
support the level of debt incurred.
After further consideration, the Treasury Department and the IRS
have decided to retain the Sec. 1.163-8T tracing approach contained in
proposed Sec. 1.163(j)-10(a)(2)(i). However, the Treasury Department
and the IRS continue to study these comments and may provide future
guidance on this issue. Additionally, the Treasury Department and the
IRS are considering issuing additional guidance related to the
allocation of interest expense by partnerships or S corporations. See
proposed Sec. 1.163-14 in the Concurrent NPRM.
Commenters also recommended that no allocation between business and
nonbusiness interest expense be required when a partnership is wholly
owned by corporate partners because a corporation can have only
business interest income and expense and cannot have investment
interest income and expense (see proposed Sec. 1.163(j)-4(b)(3)(i)).
The Treasury Department and the IRS have rejected this comment because
the recommended approach is inconsistent with the entity approach taken
with respect to partnerships in section 163(j)(4). Moreover, a separate
rule for partnerships that are wholly owned by corporate partners is
subject to manipulation because the partnership could alter the rules
to which it is subject simply by admitting a non-corporate partner with
a small economic interest in the partnership.
C. Consolidated Groups
1. Overview
As provided in proposed Sec. 1.163(j)-10(a)(4)(i), the
computations required by section 163(j) and the section 163(j)
regulations generally are made for a consolidated group on a
consolidated basis. Thus, for purposes of applying the allocation rules
of proposed Sec. 1.163(j)-10, all members of a consolidated group are
treated as a single corporation. For example, the group (rather than a
particular member) is treated as engaged in excepted or non-excepted
trades or businesses. Moreover, intercompany transactions (as defined
in Sec. 1.1502-13(b)(1)(i)) are disregarded for purposes of these
allocation rules, and property is not treated as used in a trade or
business to the extent the use of such property in that trade or
business derives from an intercompany transaction. Additionally, stock
of a member that is owned by another member of the same consolidated
group is not treated as an asset for purposes of Sec. 1.163(j)-10, and
the transfer of any amount of member stock to a non-member is treated
by the group as a transfer of the member's assets proportionate to the
amount of member stock transferred.
After a consolidated group has determined the percentage of the
group's interest expense allocable to excepted trades or businesses for
the taxable year, this exempt percentage is applied to the interest
paid or accrued by each member during the taxable year to any lender
that is not a group member. Thus, except to the extent proposed Sec.
1.163(j)-10(d) (providing rules for direct allocation in certain
limited circumstances) applies, the same percentage of interest paid or
accrued by each member to a lender that is not a member is treated as
allocable to excepted trades or businesses, regardless of whether any
particular member actually engaged in an excepted trade or business.
2. Intercompany Transactions
Commenters observed that ignoring all intercompany transactions and
intercompany obligations for purposes of proposed Sec. 1.163(j)-10 is
theoretically simple and generally furthers the single-entity approach
adopted elsewhere in the proposed regulations. However, a commenter
recommended that taxpayers be permitted to take into account basis from
certain intercompany transactions, so long as adequate safeguards are
put in place against abuse (for example, to prevent taxpayers from
using intercompany transactions to increase the consolidated group's
ATI or to shift asset basis to excepted trades or businesses), in order
to reduce the administrative burden of tracking asset basis separately
for purposes of section 163(j). The commenter also recommended that the
Treasury Department and the IRS reconsider whether, in certain
circumstances, items from intercompany transactions (other than
business interest expense and business interest income) should affect
the amount of the consolidated group's ATI.
The Treasury Department and the IRS acknowledge that the approach
in proposed Sec. 1.163(j)-10(a)(4)(i) creates an administrative burden
for members of consolidated groups. However, this approach is
consistent with Sec. 1.1502-13, the stated purpose of which is to
prevent intercompany transactions from creating, accelerating,
avoiding, or deferring consolidated taxable income or consolidated tax
liability (see Sec. 1.1502-13(a)(1)). Allowing tax items from
intercompany transactions to affect the calculation of a consolidated
group's tentative taxable income and ATI would be inconsistent with the
single-entity principles of Sec. 1.1502-13(a). Moreover, taxpayers
already must track asset basis information for purposes of Sec.
1.1502-13. Additionally, giving effect to intercompany transactions for
purposes of section 163(j) would create other administrative burdens
for consolidated group members. See the discussion in part V(B) of this
Summary of Comments and Explanation of Revisions section. Thus, the
final regulations continue to disregard intercompany transactions for
purposes of the allocation rules in proposed Sec. 1.163(j)-10.
3. Use of Property Derives From an Intercompany Transaction
A commenter observed that the meaning of the phrase ``property is
not treated as used in a trade or business to the extent the use of
such property derives from an intercompany transaction'' is unclear.
For example, one member of a consolidated group (S) leases property to
another member of the group (B), which uses the property in its trade
or business. B's lease with S entitles B to use the property. Should
B's use of the property in its trade or business be disregarded for
purposes of proposed Sec. 1.163(j)-10 because such use ``derives from
an intercompany transaction''?
The Treasury Department and the IRS did not intend for B's use of
the property in the foregoing scenario to be disregarded for purposes
of the allocation rules in proposed Sec. 1.163(j)-10. If S and B were
treated as disregarded entities owned by the same corporation, the
lease would be ignored, and the leased property would be treated as an
asset used in B's trade or business. The final regulations clarify
proposed Sec. 1.163(j)-10(a)(4)(i) to better reflect this intended
result.
The commenter also requested confirmation that the same allocation
principle applies to third-party costs incurred by members of the group
(in other words, that such costs are allocated based on the use of
assets in excepted or non-excepted trades or
[[Page 56733]]
businesses). However, proposed Sec. 1.163(j)-10(b)(5) already provides
special rules for the allocation of expenses other than interest
expenses. Thus, the final regulations do not adopt this recommendation.
4. Purchase of Member Stock From a Nonmember
A commenter recommended that a purchase by one consolidated group
member (S) of stock of another member (or of an entity that becomes a
member as a result of the purchase) (in either case, T) from a non-
member (X) be treated as a purchase of a proportionate amount of T's
assets for purposes of proposed Sec. 1.163(j)-10. Although the
proposed regulations treat the transfer of the stock of a member to a
non-member as a transfer of a proportionate amount of the member's
assets, the proposed regulations do not expressly address the
acquisition of the stock of a member (or of a corporation that becomes
a member as a result of the acquisition). The commenter noted that, if
such acquisitions are not treated as asset purchases, the amount of
adjusted basis allocated to an excepted or non-excepted trade or
business may differ significantly depending on whether S and T file a
consolidated return.
For example, T (which is engaged solely in an excepted trade or
business) has assets with a fair market value of $100x and $0 adjusted
basis, and $0 liabilities. S (which is engaged solely in a non-excepted
trade or business) has $100x adjusted basis in its assets. S purchases
100 percent of T's stock from X for $100x, and S and T do not file a
consolidated tax return. As a result, S's stock in T is treated as an
asset (under proposed Sec. 1.163(j)-10(c)(5)(ii)(B)) with a basis of
$100x. In contrast, if S and T were to file a consolidated return, S's
stock in T would not be treated as an asset under proposed Sec.
1.163(j)-10(a)(4). Moreover, it is unclear how much adjusted basis the
group could take into account for purposes of the allocation rules.
Would the group's adjusted basis in T's assets equal T's basis in its
assets immediately before the acquisition (here, $0)? Or would all or
some portion of the amount paid by S to acquire T's stock be taken into
account? The commenter argued that S should have the same amount of
adjusted basis in T's assets regardless of whether S and T file a
consolidated return, and that there is no legislative history revealing
congressional intent to treat members of a consolidated group and non-
consolidated corporations differently in this regard. Thus, according
to the commenter, S should be able to take into account the amount paid
for its T stock for purposes of the allocation rules in proposed Sec.
1.163(j)-10.
Although Congress did not expressly address this issue, Congress
did make clear that the section 163(j) limitation applies at the
consolidated group level (see H. Rept. 115-466, at 386 (2017)).
Moreover, section 1502 provides broad authority for the Secretary of
the Treasury to prescribe regulations to determine the tax liability of
a consolidated group in a manner that clearly reflects the income tax
liability of the group and that prevents the avoidance of tax
liability. Consistent with legislative intent regarding section 163(j)
and with the broad grant of authority under section 1502, the proposed
regulations treat a consolidated group as a single corporation for
purposes of the allocation rules of Sec. 1.163(j)-10, and they
disregard the stock of members for purposes of this section.
Additionally, the Treasury Department and the IRS have questions
and concerns about treating the acquisition of stock of a member (or of
an entity that becomes a member) as an asset sale. How would the
purchase price be added to the group's basis in the member's assets,
and how would the additional basis added to these assets be
depreciated? Would this approach deem the transaction to be an asset
acquisition for all Federal income tax purposes or just for purposes of
section 163(j), and what complications would arise from treating the
transaction as an asset purchase for purposes of section 163(j) but as
a stock purchase for other purposes?
Due to concerns about these and other issues, the final regulations
do not adopt the commenter's recommendation. However, the Treasury
Department and the IRS continue to study the issue raised by the
commenter and may address the issue in future guidance.
5. Inclusion of Income From Excepted Trades or Businesses in
Consolidated ATI
A commenter noted that, because every member of a consolidated
group is treated as engaged in every trade or business of the group for
purposes of proposed Sec. 1.163(j)-10, a member engaged solely in an
excepted regulated utility trade or business that incurs interest
expense related to its business activities will be subject to the
section 163(j) limitation if other group members are engaged in non-
excepted trades or businesses. The commenter suggested that this
outcome is contrary to the policy rationale for the exception for
regulated utility trades or businesses. The commenter further noted
that the gross income of the excepted trade or business is not included
in the group's ATI calculation, and that this outcome could produce
anomalous results. The commenter thus recommended that a proportionate
share of the gross income of the excepted trade or business be included
as an adjustment to consolidated ATI.
The Treasury Department and the IRS do not agree that the results
under proposed Sec. 1.163(j)-10(a)(4) are inconsistent with
congressional intent or lead to anomalous results. As noted in part
XI(C)(4) of this Summary of Comments and Explanation of Revisions
section, Congress expressly stated that the section 163(j) limitation
applies at the consolidated group level. Thus, the treatment of a
consolidated group as a single corporation, and the treatment of every
member as engaged in every trade or business of the group, is
consistent with congressional intent. Moreover, if the section 163(j)
limitation were inapplicable to group members engaged in excepted
trades or businesses, consolidated groups could readily avoid the
section 163(j) limitation by concentrating their external borrowing in
such members. Furthermore, although a portion of the interest expense
of a member engaged solely in an excepted trade or business will be
subject to the section 163(j) limitation if the group is otherwise
engaged in non-excepted trades or businesses, a portion of the interest
expense of a member engaged solely in a non-excepted trade or business
will not be subject to the section 163(j) limitation if the group is
otherwise engaged in excepted trades or businesses--and all of that
member's income will factor into the group's ATI calculation. Finally,
as the commenter acknowledged, section 163(j)(8)(A)(i) specifically
excludes from the determination of ATI any item of income, gain,
deduction, or loss that is allocable to an excepted trade or business.
For the foregoing reasons, the Treasury Department and the IRS have
determined that no changes to the final regulations are needed with
respect to this comment.
6. Engaging in Excepted or Non-Excepted Trades or Businesses as a
``Special Status''
One commenter suggested that the Treasury Department and the IRS
consider whether engaging in an excepted trade or business should be
treated as a ``special status'' under Sec. 1.1502-13(c)(5) for
purposes of applying the intercompany transaction rules of Sec.
1.1502-13.
[[Page 56734]]
The intercompany transaction rules apply for purposes of
redetermining and allocating attributes under Sec. 1.1502-13(c)(1)(i)
in order to reach a ``single entity'' answer under the matching rule of
Sec. 1.1502-13(c). For example, one member of a consolidated group is
a dealer in securities under section 475 (dealer) and sells a security
to a second member that is not a dealer; that second member then sells
the security to a nonmember in a later year. The matching rule can
apply to ensure that the taxable items of the two members harmonize
with regard to timing and character in order to reach the same overall
tax treatment that would be given to a single corporation whose two
operating divisions engaged in those transactions. See Sec. 1.1502-
13(c)(7)(i), Example 11.
However, if one member has ``special status'' under Sec. 1.1502-
13(c)(5) but the other does not, then attributes of the item would not
be redetermined under the matching rule. For example, if S (a bank to
which section 582(c) applies) and B (a nonbank) are members of a
consolidated group, and if S sells debt securities at a gain to B, the
character of S's intercompany gain is ordinary (as required under
section 582(c)), but the character of B's corresponding item is
determined under Sec. 1.1502-13(c)(1)(i) without the application of
section 582(c). See Sec. 1.1502-13(c)(5).
The ``special status'' rules of Sec. 1.1502-13(c)(5) are
applicable to entities, such as banks or insurance companies, that are
subject to a separate set of Federal income tax rules. Although there
are special tax rules for farming, real estate, and utilities, an
entity engaged in such trades or businesses also may be engaged in
other trades or businesses to which such special tax rules would not
apply. Further, the entity's farming, real estate, or utility trade or
business need not be its primary trade or business. Moreover, the
treatment of excepted trades or businesses as a special status
effectively would result in additional tracing of specific items for
purposes of Sec. 1.1502-13. As noted in the preamble to the proposed
regulations, the Treasury Department and the IRS have decided not to
apply a tracing regime to allocate interest expense and income between
excepted and non-excepted trades or businesses. Thus, the final
regulations do not treat engaging in an excepted trade or business as a
special status.
D. Quarterly Asset Testing
Under proposed Sec. 1.163(j)-10(c)(6), a taxpayer must determine
the adjusted basis in its assets on a quarterly basis and average those
amounts to determine the relative amounts of asset basis for its
excepted and non-excepted trades or businesses for a taxable year. In
the preamble to the proposed regulations, the Treasury Department and
the IRS requested comments on the frequency of asset basis
determinations required under proposed Sec. 1.163(j)-10(c).
In response, commenters stated that this quarterly determination
requirement is administratively burdensome, and that such a burden is
unwarranted because, in many circumstances, measuring asset basis less
frequently would produce similar results. Thus, commenters recommended
that taxpayers be permitted to allocate asset basis for a taxable year
based on the average of adjusted asset basis at the beginning and end
of the year. As a result, the ``determination date'' would be the last
day of the taxpayer's taxable year, and the ``determination period''
would begin on the first day of the taxpayer's taxable year and end on
the last day of the year.
Several commenters recommended that this approach be modeled on the
interest valuation provisions in Sec. 1.861-9T(g)(2)(i). Under these
rules, taxpayers generally must compute the value of assets based on an
average of asset values at the beginning and end of the year. However,
if a ``substantial distortion'' of asset values would result from this
approach (for example, if there is a major acquisition or disposition),
the taxpayer must use a different method of asset valuation that more
clearly reflects the average value of assets.
Other commenters suggested that their proposed approach could be
limited to cases in which there is no more than a de minimis change in
asset basis between the beginning and end of the taxable year. For
example, this approach could be available for a taxable year only if
the taxpayer demonstrates that its total adjusted basis (as measured in
accordance with the rules in proposed Sec. 1.163(j)-10(c)(5)) at the
end of the year in its assets used in its excepted trades or
businesses, as a percentage of the taxpayer's total adjusted basis at
the end of such year in all of its assets used in a trade or business,
does not differ by more than 10 percent from such percentage at the
beginning of the year.
The Treasury Department and the IRS acknowledge that determining
asset basis on a quarterly basis would impose an administrative burden.
The Treasury Department and the IRS also agree with commenters that a
safeguard is needed to account for episodic events, such as
acquisitions, dispositions, or changes in business, that could affect
average values. Thus, the final regulations permit a taxpayer to
compute asset basis in its excepted and non-excepted trades or
businesses by averaging asset basis at the beginning and end of the
year, so long as the taxpayer falls under a 20 percent de minimis
threshold.
E. De Minimis Rules
1. Overview
The proposed regulations provide a number of de minimis rules to
simplify the application of Sec. 1.163(j)-10. For example, proposed
Sec. 1.163(j)-10(c)(3)(iii)(C)(3) provides that a utility trade or
business is treated entirely as an excepted regulated utility trade or
business if more than 90 percent of the items described in proposed
Sec. 1.163(j)-1(b)(15) are furnished or sold at rates qualifying for
the excepted regulated utility trade or business exception. Proposed
Sec. 1.163(j)-10(c)(3)(iii)(B)(2) provides that, if 90 percent or more
of the basis in an asset would be allocated under proposed Sec.
1.163(j)-10(c)(3) to either excepted or non-excepted trades or
businesses, then the entire basis in the asset is allocated to either
excepted or non-excepted trades or businesses, respectively. In turn,
proposed Sec. 1.163(j)-10(c)(1)(ii) provides that, if 90 percent or
more of a taxpayer's basis in its assets is allocated under proposed
Sec. 1.163(j)-10(c) to either excepted or non-excepted trades or
businesses, then all of the taxpayer's interest expense and interest
income are allocated to either excepted or non-excepted trades or
businesses, respectively.
2. Order in Which the De Minimis Rules Apply
A commenter recommended that these de minimis rules be applied in
the order in which they are listed in the foregoing paragraph. In other
words, a taxpayer first should determine the extent to which its
utility businesses are excepted regulated utility trades or businesses.
The taxpayer then should determine the extent to which the basis of any
assets used in both excepted and non-excepted trades or businesses
should be wholly allocated to either excepted or non-excepted trades or
businesses. Only then should the taxpayer determine whether all of its
interest expense and interest income should be wholly allocated to
either excepted or non-excepted trades or businesses. The Treasury
Department and the IRS agree that the order recommended by the
commenter is the most reasonable application of these de minimis rules,
and the final regulations adopt language confirming this ordering.
[[Page 56735]]
3. Mandatory Application of De Minimis Rules
Commenters also requested that the final regulations continue to
mandate the application of the foregoing de minimis rules rather than
make such de minimis rules elective. The commenters expressed concern
that creating an election to use the de minimis rules in Sec.
1.163(j)-10(c)(1) and (3) would create uncertainty for taxpayers, and
they argued that mandatory application of the de minimis rules would
simplify the rules for taxpayers. The Treasury Department and the IRS
agree that mandatory application of the de minimis rules simplifies the
application of Sec. 1.163(j)-10 and eases the burdens of compliance
and administration. Therefore, the final regulations continue to
mandate the application of the de minimis rules in Sec. 1.163(j)-
10(c)(1) and (3).
4. De Minimis Threshold for Electric Cooperatives
A commenter requested that the de minimis threshold for utilities
in proposed Sec. 1.163(j)-10(c)(3)(iii)(C)(3) be lowered from 90
percent to 85 percent for electric cooperatives. The commenter argued
that a different threshold is appropriate for electric cooperatives
because, under section 501(c)(12), 85 percent or more of an electric
cooperative's income (with adjustments) must consist of amounts
collected from members for the sole purpose of meeting losses and
expenses in order for the cooperative to be exempt from Federal income
tax.
The Treasury Department and the IRS have determined that the final
regulations should provide the same de minimis threshold for electric
cooperatives as for other utility trades or businesses. The 85 percent
threshold under section 501(c)(12) measures a cooperative's income,
with adjustments that are specific to section 501. Moreover, an
electric cooperative is not required to qualify for tax exemption under
section 501(c)(12) to be engaged in an excepted regulated utility trade
or business. Therefore, the Treasury Department and the IRS have
determined that the nexus between section 501(c)(12) and proposed Sec.
1.163(j)-10 is insufficient to justify lowering the utility de minimis
threshold to 85 percent for electric cooperatives, and the final
regulations do not incorporate the commenter's suggestion.
5. Standardization of 90 Percent De Minimis Tests
The terminology used in the 90 percent de minimis tests in proposed
Sec. 1.163(j)-10 is not consistent. For example, proposed Sec.
1.163(j)-10(c)(3)(iii)(C)(3) uses a ``more than 90 percent'' standard,
whereas proposed Sec. 1.163(j)-10(c)(3)(iii)(B)(2) uses a ``90 percent
or more'' standard. For the sake of consistency, and in order to
minimize confusion, the final regulations standardize the language used
in these tests.
6. Overlapping De Minimis Tests
In addition to the de minimis tests previously described in this
part XI(E) of the Summary of Comments and Explanation of Revisions
section, proposed Sec. 1.163(j)-10(c)(3)(iii)(B)(1) also contains
another de minimis rule. Under this rule, if at least 90 percent of
gross income generated by an asset during a determination period is
with respect to either excepted or non-excepted trades or businesses,
then the entire basis in the asset is allocated to either excepted or
non-excepted trades or businesses, respectively.
The Treasury Department and the IRS have determined that this rule
not only overlaps with, but also may yield results inconsistent with,
the de minimis rule in Sec. 1.163(j)-10(c)(3)(iii)(B)(2). Thus, the
final regulations eliminate the de minimis rule in proposed Sec.
1.163(j)-10(c)(3)(iii)(B)(1).
F. Assets Used in More Than One Trade or Business
1. Overview
Proposed Sec. 1.163(j)-10(c)(3) contains special rules for
allocating basis in assets used in more than one trade or business. In
general, if an asset is used in more than one trade or business during
a determination period, the taxpayer's adjusted basis in the asset must
be allocated to each trade or business using one of three permissible
methodologies, depending on which methodology most reasonably reflects
the use of the asset in each trade or business during that
determination period. These three methodologies are: (i) The relative
amounts of gross income that an asset generates, has generated, or may
reasonably be expected to generate, within the meaning of Sec. 1.861-
9T(g)(3), with respect to the trades or businesses; (ii) if the asset
is land or an inherently permanent structure, the relative amounts of
physical space used by the trades or businesses; and (iii) if the
trades or businesses generate the same unit of output, the relative
amounts of output of those trades or businesses. However, taxpayers
must use the relative output methodology to allocate the basis of
assets used in both excepted and non-excepted utility trades or
businesses.
As described in part XI(E)(1) of this Summary of Comments and
Explanation of Revisions section, a taxpayer's allocation of basis in
assets used in more than one trade or business is subject to several de
minimis rules (see proposed Sec. 1.163(j)-10(c)(3)(iii)).
2. Consistency Requirement
A commenter requested clarification that the consistency
requirement in proposed Sec. 1.163(j)-10(c)(3)(iii)(A) does not
require a taxpayer to use a single methodology for different categories
of assets, because a methodology that is reasonable for one type of
asset (for example, office buildings) may not be reasonable for another
(for example, intangibles). The Treasury Department and the IRS agree
with this comment, and the final regulations have been clarified
accordingly.
3. Changing a Taxpayer's Allocation Methodology
The Treasury Department and the IRS have determined that requiring
taxpayers to obtain consent from the Commissioner to change their
allocation methodology would impose an undue burden. Thus, the final
regulations permit a taxpayer to change its allocation methodology
after a period of five taxable years without obtaining consent from the
Commissioner. A taxpayer that seeks to change its allocation
methodology more frequently must obtain consent from the Commissioner.
The Treasury Department and the IRS also have determined that an
allocation methodology is not a method of accounting because there is
no guarantee that a taxpayer will be able to deduct a disallowed
business interest expense carryforward in future taxable years (as a
result, there could be a permanent disallowance). See the discussion in
part III(A) of this Summary of Comments and Explanation of Revisions
section.
4. Mandatory Use of Relative Output for Utility Trades or Businesses
A commenter requested that the final regulations allow electric
cooperatives to use methodologies other than relative output to
allocate the basis of assets used in both excepted and non-excepted
utility trades or businesses. The commenter noted that alternative
methods, such as allocations based on dollars of sales (or sales less
the cost of sales), have been allowed by the IRS in
[[Page 56736]]
the context of allocating expenses between patronage and non-patronage
sales. The commenter also stated that economic realities facing
electric cooperatives operating on a not-for-profit basis would not be
accurately reflected by a relative output methodology.
The Treasury Department and the IRS have concluded that relative
output most reasonably reflects the use of assets in excepted and non-
excepted utility trades or businesses because Sec. 1.163(j)-
1(b)(15)(i)(A) divides utility businesses into excepted regulated
utility trades or businesses and non-excepted utility businesses on the
same basis. To the extent that items described in Sec. 1.163(j)-
1(b)(15)(i)(A) are sold at rates described in Sec. 1.163(j)-
1(b)(15)(i)(B), and to the extent that the trade or business is an
electing regulated utility trade or business under Sec. 1.163(j)-
1(b)(15)(iii), a utility trade or business is an excepted trade or
business. The Treasury Department and the IRS do not agree that the
final regulations should apply one methodology for differentiating
excepted and non-excepted utility trades or businesses under Sec.
1.163(j)-1 and a different methodology to determine the allocation of
an asset's basis between such businesses. Therefore, the final
regulations do not incorporate the commenter's suggestion.
Another commenter recommended that the rule mandating the use of
relative output for the allocation of asset basis under proposed Sec.
1.163(j)-10(c)(3)(iii)(C)(2) not be used either to allocate assets used
exclusively in excepted or non-excepted utility trades or businesses or
to apply the de minimis test of proposed Sec. 1.163(j)-10(c)(1)(ii).
The special rule in proposed Sec. 1.163(j)-10(c)(3)(iii)(C)(2)
mandates the use of relative output only for the purpose of allocating
the basis of assets used in both excepted and non-excepted utility
trades or businesses. Therefore, the rule does not mandate the use of
relative output to allocate the basis of an asset that is used solely
in either an excepted regulated utility trade or business or a non-
excepted utility trade or business, except to the extent the de minimis
rule in proposed Sec. 1.163(j)-10(c)(3)(iii)(C)(3) treats a taxpayer's
entire trade or business as either an excepted trade or business or a
non-excepted trade or business. The language proposed by the commenter
still subjects assets to the de minimis rule in proposed Sec.
1.163(j)-10(c)(3)(iii)(C)(3). Because the proposed regulations achieve
the result requested by the commenter, the final regulations do not
adopt the recommended change.
The de minimis rule in proposed Sec. 1.163(j)-10(c)(1)(ii) applies
only after the basis of assets has been allocated between excepted and
non-excepted trades or businesses. This de minimis rule treats all of a
taxpayer's trades or businesses as either excepted or non-excepted
trades or businesses based on such allocation. Because the rule of
proposed Sec. 1.163(j)-10(c)(1)(ii) does not apply the methodologies
listed in proposed Sec. 1.163(j)-10(c)(3), including the relative
output methodology, no change to the proposed regulations is necessary
to achieve the result requested by the commenter with respect to
proposed Sec. 1.163(j)-10(c)(1)(ii).
G. Exclusions From Basis Calculations
For purposes of allocating interest expense and interest income
under the asset-basis allocation method in proposed Sec. 1.163(j)-
10(c), a taxpayer's basis in certain types of assets generally is not
taken into account. These assets include cash and cash equivalents (see
proposed Sec. 1.163(j)-10(c)(5)(iii)). As noted in the preamble to the
proposed regulations, this rule is intended to discourage taxpayers
from moving cash to excepted trades or businesses to increase the
amount of asset basis therein. In the preamble to the proposed
regulations, the Treasury Department and the IRS requested comments on
this special rule, including whether any exceptions should apply (such
as for working capital).
In response, commenters recommended that working capital be
included in the basis allocation determination, along with collateral
that secures derivatives that hedge business assets and liabilities
within the meaning of Sec. 1.1221-2.
The Treasury Department and the IRS have concluded that the
inclusion of working capital in the basis allocation determination
could lead to frequent disputes between taxpayers and the IRS over the
amount of cash that comprises ``working capital'' and the allocation of
such amount between and among a taxpayer's excepted and non-excepted
trades or businesses. Thus, the final regulations do not adopt this
recommendation.
The Treasury Department and the IRS also have concluded that the
inclusion of collateral that secures derivatives that hedge business
assets and liabilities within the meaning of Sec. 1.1221-2 could lead
to frequent disputes between taxpayers and the IRS for reasons similar
to those for working capital. For example, it is not always clear which
business asset or liability is being hedged, especially in the case of
an aggregate hedging transaction. In addition, taxpayers could use this
rule as a planning opportunity for purposes of allocating the
collateral to excepted trades or businesses. Thus, the final
regulations also do not adopt this recommendation.
H. Look-Through Rules
1. Ownership Thresholds; Direct and Indirect Ownership Interests
Proposed Sec. 1.163(j)-10(c)(5)(ii) provides, in part, that if a
taxpayer owns an interest in a partnership or stock in a corporation
that is not a member of the taxpayer's consolidated group, the
partnership interest or stock is treated as an asset of the taxpayer
for purposes of the allocation rules of proposed Sec. 1.163(j)-10.
For purposes of allocating a partner's basis in its partnership
interest between excepted and non-excepted trades or businesses under
proposed Sec. 1.163(j)-10, the partner generally may look through to
its share of the partnership's basis in the partnership's assets (with
certain modifications and limitations) regardless of the extent of the
partner's ownership interest in the partnership. However, the partner
must apply this look-through rule if its direct and indirect interest
in the partnership is greater than or equal to 80 percent. Similar
rules apply to shareholders of S corporations. See proposed Sec.
1.163(j)-10(c)(5)(ii)(A)(2)(i) and (c)(5)(ii)(B)(3)(ii).
For purposes of allocating a shareholder's stock basis between
excepted and non-excepted trades or businesses, a shareholder of a
domestic non-consolidated C corporation or a CFC also must look through
to the assets of the corporation if the shareholder's direct and
indirect interest therein satisfies the ownership requirements of
section 1504(a)(2). Shareholders of domestic non-consolidated C
corporations and CFCs may not look through their stock in such
corporations if they do not satisfy this ownership threshold. See
proposed Sec. 1.163(j)-10(c)(5)(ii)(B)(2)(i) and (c)(7)(i)(A).
If a shareholder receives a dividend that is not investment income,
and if the shareholder looks through to the assets of the payor
corporation under proposed Sec. 1.163(j)-10(c)(5)(ii) for the taxable
year, the shareholder also must look through to the activities of the
payor corporation to allocate the dividend between the shareholder's
excepted and non-excepted trades or businesses. See proposed Sec.
1.163(j)-10(b)(3) and (c)(7)(i)(B).
Commenters recommended that taxpayers be afforded greater
flexibility to look through their stock in domestic
[[Page 56737]]
non-consolidated C corporations and CFCs. For example, one commenter
suggested that the look-through threshold for CFCs be lowered to 50
percent (analogous to the look-through threshold for related CFCs in
section 954(c)(6)). Another commenter recommended that a taxpayer be
allowed to look through its stock in a domestic non-consolidated C
corporation if the taxpayer owns at least 80 percent of such stock by
value, regardless of whether the taxpayer also owns 80 percent of such
stock by vote. Yet another commenter recommended that a taxpayer be
allowed to look through its stock in a domestic non-consolidated C
corporation (or be allowed to allocate its entire basis in such stock
to an excepted trade or business) if (i) the taxpayer and the C
corporation are engaged in the same excepted trade or business, and
(ii) the taxpayer either (A) owns at least 50 percent of the stock of
the C corporation, or (B) owns at least 20 percent of the stock of the
C corporation and exercises a significant degree of control over the
corporation's trade or business. Another commenter recommended that the
ownership threshold for looking through domestic non-consolidated C
corporations and CFCs be eliminated entirely so that interest expense
paid or accrued on debt incurred to finance the acquisition of a real
estate business is exempt from the section 163(j) limitation (if the
business qualifies for and makes an election under proposed Sec.
1.163(j)-9), regardless of whether that business is held directly or
through a subsidiary.
The Treasury Department and the IRS have determined that a de
minimis ownership threshold is appropriate for domestic non-
consolidated C corporations and CFCs because, unlike a partnership, a
corporation generally is respected as an entity separate from its
owner(s) for tax purposes. See, for example, Moline Properties v.
Commissioner, 319 U.S. 436 (1943). The look-through rule for non-
consolidated C corporations provides a limited exception to this
general rule. Moreover, unlike S corporations, domestic C corporations
are not taxed as flow-through entities. Thus, the final regulations
retain an 80 percent ownership threshold for looking through a domestic
non-consolidated C corporation or a CFC.
However, the final regulations permit a taxpayer to look through
its stock in a domestic non-consolidated C corporation or a CFC if the
taxpayer owns at least 80 percent of such stock by value, regardless of
whether the taxpayer also owns at least 80 percent of such stock by
vote. Corresponding changes have been made to the look-through rule for
dividends.
Additionally, the final regulations permit a shareholder that meets
the ownership requirements for looking through the stock of a domestic
non-consolidated C corporation (determined without applying the
constructive ownership rules of section 318(a)) to look through to such
shareholder's pro rata share of the C corporation's basis in its assets
for purposes of Sec. 1.163(j)-10(c) (asset basis look-through
approach). If a shareholder applies the asset basis look-through
approach, it must do so for all domestic non-consolidated C
corporations for which the shareholder is eligible to use this
approach, and it must continue to use the asset basis look-through
approach in all future taxable years in which the shareholder is
eligible to use this approach.
Commenters also asked for clarification as to the meaning of an
``indirect'' interest for purposes of these look-through rules. For
example, commenters asked what the term ``indirect'' means in the
context of the look-through rule for dividends. Commenters further
noted that, because section 1504(a)(2) does not contain constructive
ownership rules, there is uncertainty as to when a shareholder's
indirect ownership in a corporation is counted for purposes of the
ownership requirement in the look-through rule. Commenters also
requested specific constructive ownership rules, as well as examples to
illustrate the application of the ``direct or indirect'' ownership
threshold.
The Treasury Department and the IRS have determined that, for
purposes of applying the ownership thresholds in Sec. 1.163(j)-
10(c)(5)(ii)(B)(2)(i), (c)(5)(ii)(B)(3)(ii), and (c)(7)(i)(A) to
shareholders of domestic non-consolidated C corporations, CFCs, and S
corporations, as applicable, the constructive ownership rules of
section 318(a) should apply. For example, assume A, B, and C are all
non-consolidated C corporations; A wholly and directly owns B; A and B
each directly own 50 percent of C; A and B both conduct a non-excepted
trade or business; and C conducts an excepted trade or business. Under
section 318(a)(2)(C), A is considered to own the stock owned by B. As a
result, A is considered to own 100 percent of the stock of C, and the
look-through rule of proposed Sec. 1.163(j)-10(c)(5)(ii)(B)(2)(i) and
(c)(7)(i)(A) applies to A's stock in C. Thus, although the Treasury
Department and the IRS have determined that the ownership threshold for
non-consolidated C corporations should remain at 80 percent, the
constructive ownership rules of section 318 will broaden the
availability of the look-through rules to shareholders of such
corporations.
In contrast, the Treasury Department and the IRS have determined
that the constructive ownership rules of section 318(a) should not
apply for purposes of applying the ownership threshold in proposed
Sec. 1.163(j)-10(b)(3) and (c)(7)(i)(B) to the receipt of dividends
from domestic C corporations and CFCs because dividends are not paid to
indirect shareholders. To avoid confusion in this regard, the final
regulations remove the word ``indirect'' from the ownership threshold
for the dividend look-through rule.
2. Application of Look-Through Rules to Partnerships
i. In General
For purposes of proposed Sec. 1.163(j)-10(c), a partnership
interest is treated as an asset of the partner. Pursuant to proposed
Sec. 1.163(j)-10(c)(5)(ii)(A)(1), the partner's adjusted basis in its
partnership interest is reduced, but not below zero, by the partner's
share of partnership liabilities as determined under section 752
(section 752 basis reduction rule). Pursuant to proposed Sec.
1.163(j)-10(c)(5)(ii)(A)(2)(iii), a partner other than a C corporation
or tax-exempt corporation must further reduce its adjusted basis in its
partnership interest by its share of the tax basis of partnership
assets that is not properly allocable to a trade or business
(investment asset basis reduction rule).
As noted in part XI(H)(1) of this Summary of Comments and
Explanation of Revisions section, a partner may determine what portion
of its adjusted tax basis in a partnership interest is attributable to
an excepted or non-excepted trade or business by reference to its share
of the partnership's basis in the partnership's assets (look-through
rule). Under proposed Sec. 1.163(j)-10(c)(5)(ii)(A)(2)(i), a partner
generally may choose whether to apply the look-through rule without
regard to its ownership percentage, with two exceptions. First, if a
partner's direct or indirect interest in a partnership is greater than
or equal to 80 percent of the partnership's capital or profits, the
partner must apply the look-through rule. Second, if the partnership is
eligible for the small business exemption under section 163(j)(3) and
proposed Sec. 1.163(j)-2(d)(1), a partner may not apply the look-
through rule.
Proposed Sec. 1.163(j)-10(c)(5)(ii)(A)(2)(ii) provides that if,
after applying the investment asset basis
[[Page 56738]]
reduction rule, at least 90 percent of a partner's share of a
partnership's basis in its assets (including adjustments under sections
734(b) and 743(b)) is allocable to either excepted or non-excepted
trades or businesses, the partner's entire basis in its partnership
interest is treated as allocable to such excepted or non-excepted
trades or businesses.
Pursuant to proposed Sec. 1.163(j)-10(c)(5)(ii)(A)(2)(iv), if a
partner, other than a C corporation or a tax-exempt corporation, does
not apply the look-through rule, the partner generally will treat its
basis in the partnership interest as either an asset held for
investment or a non-excepted trade or business asset as determined
under section 163(d).
ii. Coordination of Look-Through Rule and Basis Determination Rules
Outside of the partnership context, proposed Sec. 1.163(j)-
10(c)(5)(i) provides rules regarding the computation of adjusted basis
for purposes of allocating business interest expense between excepted
and non-excepted trades or businesses (collectively, the ``basis
determination rules''). For example, proposed Sec. 1.163(j)-
10(c)(5)(i)(A) generally provides that the adjusted basis of non-
depreciable property other than land is the adjusted basis of the asset
used for determining gain or loss from the sale or other disposition of
that asset as provided in Sec. 1.1011-1, and proposed Sec. 1.163(j)-
10(c)(5)(i)(C) generally provides that the adjusted basis of land and
inherently permanent structures is its unadjusted basis. For purposes
of applying the look-through rule, the Treasury Department and the IRS
intended the basis determination rules to require adjustments to the
partnership's basis in its assets and the partner's basis in its
partnership interest to the extent of the partner's share of any
adjustments to the basis of the partnership's assets. Accordingly, the
final regulations explicitly provide that such is the case.
Multiple commenters noted that the proposed regulations do not
specify whether a partner that does not apply the look-through rule
should use the adjusted tax basis in its partnership interest or should
adjust its tax basis to reflect what its basis would be if the
partnership applied the basis determination rules to its assets.
Because all partnerships are not subject to section 163(j) and cannot
provide all partners with the information necessary to adjust the tax
basis of their partnership interests consistent with the basis
determination rules, the Treasury Department and the IRS have
determined that the basis determination rules should not apply to the
basis of a partnership interest if a partner does not apply the look-
through rule.
iii. Applying the Look-Through Rule and Determining Share of
Partnership Basis
Proposed Sec. 1.163(j)-10(c)(5)(ii)(A)(2)(i) provides that, for
purposes of the look-through rule, a partner's share of a partnership's
assets is determined using a reasonable method, taking into account
special allocations under section 704(b), adjustments under sections
734(b) and 743(b), and direct adjustments relating to assets subject to
qualified nonrecourse indebtedness under proposed Sec. 1.163(j)-
10(d)(4). Commenters argued that this language does not provide
adequate guidance regarding how a partner should determine its share of
the tax basis of a specific partnership asset when applying the look-
through rule. The commenters stated that, by indicating that sections
743(b) and 704(b) should be taken into account, the proposed
regulations imply that a partner's share of the partnership's basis in
an asset is determined by reference to the future depreciation
deductions that a partner would be allocated with regard to such asset
or the amount of basis to be taken into account by that partner in
determining its allocable share of gain or loss on the partnership's
disposition of the asset. The commenters also requested that final
regulations address whether and how allocations under section 704(c)
affect a partner's share of the partnership's basis in its assets.
After further consideration, the Treasury Department and the IRS have
decided to retain the rule in proposed Sec. 1.163(j)-
10(c)(5)(ii)(A)(2)(i).
iv. Investment Asset Basis Reduction Rule
Under proposed Sec. 1.163(j)-10(c)(5)(ii)(A)(2)(iii), for purposes
of applying the investment asset basis reduction rule, a partner's
share of a partnership's assets is determined under a reasonable
method, taking into account special allocations under section 704(b). A
commenter recommended clarifying whether the investment asset basis
reduction should be made in accordance with a partner's share of the
partnership's actual adjusted basis in an asset or in accordance with
the partner's share of the partnership's basis in an asset as
determined pursuant to the basis determination rules. The commenter
further recommended that the approach adopted on this issue should be
consistent with the approach adopted for purposes of determining a
partner's adjusted basis in its partnership interest.
The Treasury Department and the IRS agree that these two rules
should be applied consistently. After further consideration, the
Treasury Department and the IRS have decided to retain the rule that
allows a partner's share of a partnership's investment assets to be
determined using a reasonable method, taking into account special
allocations under section 704(b). However, if a partner elects to apply
the look-through rule, then the partner also must apply the basis
determination rules. If a partner elects not to apply, or is precluded
from applying, the look-through rule, then the approach the partner
uses for purposes of the investment asset basis reduction rule must be
consistent with the approach the partner uses to determine the
partner's adjusted basis in its partnership interest.
v. Coordination of Section 752 Basis Reduction Rule and Investment
Asset Basis Reduction Rule
Multiple commenters noted that the combined effect of the section
752 basis reduction rule and the investment asset basis reduction rule
could require a partner, other than a C corporation or a tax-exempt
corporation, in a partnership that holds investment assets funded by
partnership liabilities to reduce the adjusted tax basis of its
partnership interest twice--once for the partnership's basis in its
investment assets, and a second time for the liabilities that funded
their purchase. The Treasury Department and the IRS have determined
that this result would be inappropriate. Accordingly, the final
regulations amend the investment asset basis reduction rule by
providing that, with respect to a partner other than a C corporation or
tax-exempt corporation, the partner's adjusted basis in its partnership
interest is decreased by the partner's share of the excess of (a) the
partnership's asset basis with respect to those assets over (b) the
partnership's debt that is traced to such assets in accordance with
Sec. 1.163-8T. In order to neutralize the effect of any cost recovery
deductions associated with a partnership's investment assets funded by
partnership liabilities (for example, non-trade or business property
held for the production of income), the final regulations also amend
the investment asset basis reduction rule by providing that, with
respect to a partner other than a C corporation or tax-exempt
corporation, the partner's adjusted basis in its partnership interest
is increased by the partner's share of the excess of (a) the
partnership's debt that is traced to
[[Page 56739]]
such assets in accordance with Sec. 1.163-8T over (b) the
partnership's asset basis with respect to those assets.
vi. Allocating Basis in a Partnership Interest Between Excepted and
Non-Excepted Trades or Businesses
A commenter requested explicit confirmation that, under the look-
through rule, a partner allocates the basis of its partnership interest
between excepted and non-excepted trades or businesses in the same
proportion as the partner's share of the partnership's adjusted tax
basis in its trade or business assets is allocated between excepted and
non-excepted trades or businesses. The final regulations explicitly
state that this is the rule.
Commenters also stated that the proposed regulations do not address
how a partner should allocate business interest expense and business
interest income under proposed Sec. 1.163(j)-10(c) to the extent the
partner (i) has zero basis in all partnership interests for purposes of
section 163(j), and (ii) owns no other trade or business assets. The
Treasury Department and the IRS have determined that these facts would
be rare, particularly given the adjustments to partnership basis
provided for in Sec. 1.163(j)-10. Therefore, the final regulations do
not include a rule addressing this fact pattern. However, the Treasury
Department and the IRS request comments on how frequently this fact
pattern would occur and how best to address such a situation.
3. Additional Limitation on Application of Look-Through Rules to C
Corporations
A commenter noted that the look-through rules may be distortive if
an individual (A) that is directly engaged in a trade or business also
owns stock in a C corporation (with its own trade or business) that
satisfies the section 1504(a)(2) ownership requirements. A's interest
expense that is attributable to A's investment in the C corporation
under Sec. 1.163-8T retains its character as investment interest
expense. Moreover, if A also has business interest expense, the
allocation of that expense between excepted and non-excepted trades or
businesses would appear to take into account A's investment in the C
corporation on a look-through basis as well. Thus, A's shares in the C
corporation may be double-counted insofar as they affect the character
of both the directly attributable investment interest expense and the
unrelated business interest expense.
To address the possible distortive effects of the look-through
rules when applied to stock of a non-consolidated C corporation that is
held as an investment, the final regulations provide that the look-
through rule in Sec. 1.163(j)-10(c)(5)(ii)(B)(2)(i) is available only
if dividends paid on the stock would not be included in the taxpayer's
investment income under section 163(d)(4)(B). Because corporations
cannot have investment income under section 163(d)(4)(B), this
additional requirement does not otherwise affect their ability to look-
through the stock of a non-consolidated C corporation.
4. Dispositions of Stock in Non-Consolidated C Corporations
Under proposed Sec. 1.163(j)-10(b)(4)(i), if a shareholder
recognizes gain or loss upon the disposition of its stock in a non-
consolidated C corporation, if such stock is not property held for
investment, and if the taxpayer looks through to the assets of the C
corporation under proposed Sec. 1.163(j)-10(c)(5)(ii)(B), then the
taxpayer must allocate gain or loss from the stock disposition to
excepted or non-excepted trades or businesses based upon the relative
amounts of the corporation's adjusted basis in the assets used in its
trades or businesses. This rule is analogous to the look-through rule
for dividends in proposed Sec. 1.163(j)-10(b)(3).
However, the dividend look-through rule also provides that, if at
least 90 percent of the payor corporation's adjusted basis in its
assets during the taxable year is allocable to either excepted or non-
excepted trades or businesses, then all of the taxpayer's dividend
income from the payor corporation for the taxable year is treated as
allocable to excepted or non-excepted trades or businesses,
respectively. Commenters asked why the rule regarding the disposition
of non-consolidated C corporation stock is not subject to a 90 percent
de minimis rule analogous to the rule for dividends.
The Treasury Department and the IRS have determined that the rule
regarding the disposition of stock in a non-consolidated C corporation
(including a CFC) should be subject to a 90 percent de minimis rule.
The final regulations have modified proposed Sec. 1.163(j)-10(b)(4)(i)
accordingly.
5. Application of Look-Through Rules to Small Businesses
Under proposed Sec. 1.163(j)-10(c)(5)(ii)(D), a taxpayer may not
apply the look-through rules in proposed Sec. 1.163(j)-10(b)(3) and
(c)(5)(ii)(A), (B), and (C) to an entity that is eligible for the small
business exemption. As described in the preamble to the proposed
regulations, the Treasury Department and the IRS determined that these
look-through rules should not be available in these cases because of
the administrative burden that would be imposed on small businesses
from collecting and providing information to their shareholders or
partners regarding inside asset basis when those small businesses are
themselves exempt from the application of section 163(j). The preamble
to the proposed regulations also provides that a taxpayer that is
eligible for the small business exemption may not make an election
under proposed Sec. 1.163(j)-9.
Commenters requested that entities that qualify for the small
business exemption be allowed to make an election under proposed Sec.
1.163(j)-9, and that such an electing entity's shareholders or partners
be permitted to apply the look-through rules. Absent such a rule,
shareholders and partners of a small business entity that conducts an
excepted trade or business could be worse off than shareholders and
partners of a larger entity (ineligible for the small business
exemption) that conducts an excepted trade or business.
As noted in part X(A) of this Summary of Comments and Explanation
of Revisions section, the Treasury Department and the IRS have
determined that entities eligible for the small business exemption
should be permitted to make a protective election under proposed Sec.
1.163(j)-9. Accordingly, the final regulations also allow taxpayers to
apply the look-through rules to entities that qualify for the small
business exemption and that make a protective election under proposed
Sec. 1.163(j)-9.
6. Application of the Look-Through Rules to Foreign Utilities
Section 163(j)(7)(A)(iv) does not treat utilities that are
exclusively regulated by foreign regulators (and not by a State
government, a political subdivision of a State government, an agency or
instrumentality of the United States, or the governing or ratemaking
body of a domestic electric cooperative) (foreign-regulated utility) as
excepted trades or businesses. As a result, under the interest
allocation rules of proposed Sec. 1.163(j)-10(c), a U.S. corporation
that looks through to the assets of a CFC that operates a foreign-
regulated utility must allocate its entire basis in its CFC stock to a
non-excepted trade or business, even if all of the CFC's operating
assets are used in a foreign-regulated utility business. Moreover, if
the U.S. corporation has significant basis in its CFC stock, a
significant portion of the U.S. corporation's business interest expense
will be subject to the section
[[Page 56740]]
163(j) limitation, even if the U.S. corporation is solely or primarily
engaged in an excepted utility trade or business.
A commenter noted that, if the U.S. corporation does not have
sufficient income from non-excepted trades or businesses, the
corporation might never be able to deduct its disallowed business
interest expense. The commenter thus recommended that stock in a CFC
engaged in a foreign-regulated utility trade or business be treated as
having zero basis for purposes of the interest allocation rules in
proposed Sec. 1.163(j)-10(c).
The final regulations do not adopt the commenter's recommendation.
However, the Treasury Department and the IRS have determined that, if a
taxpayer applies the look-through rule to a CFC, the taxpayer may
allocate its basis in its CFC stock to an excepted trade or business to
the extent the CFC is engaged in either (i) an excepted trade or
business, or (ii) a foreign-regulated utility trade or business that
would be treated as an excepted trade or business if the utility meets
certain requirements related to regulation by a foreign government. The
final regulations have been modified accordingly. See Sec. 1.163(j)-
10(c)(5)(ii)(C)(2).
I. Deemed Asset Sale
Proposed Sec. 1.163(j)-10(c)(5)(iv) provides that, solely for
purposes of determining the amount of basis allocable to excepted and
non-excepted trades or businesses under proposed Sec. 1.163(j)-10(c),
an election under section 336, 338, or 754, as applicable, is deemed to
have been made for any acquisition of corporate stock or partnership
interests with respect to which the taxpayer demonstrates to the
satisfaction of the Commissioner that the taxpayer was eligible to make
an election but was actually or effectively precluded from doing so by
a regulatory agency with respect to an excepted regulated utility trade
or business. As explained in the preamble to the proposed regulations,
this deemed asset sale rule is intended to place taxpayers that are
actually or effectively precluded from making an election under section
336, section 338, or section 754 on the same footing for purposes of
the basis allocation rules in proposed Sec. 1.163(j)-10(c) as
taxpayers that are not subject to such limitations.
Commenters pointed out that, as a practical matter, a basis step-up
election generally cannot be made if the acquired entity has a
regulatory liability for deferred taxes on its books because, in that
case, the election may cause customer bills to increase. In other
words, deferred tax liabilities typically lower a utility's rate base
(which is used to compute the rates charged to customers). An election
under section 336, section 338, or section 754 would eliminate this
deferred tax liability, thereby increasing the rate base and
potentially increasing the rates charged to customers. As a result,
regulatory agencies frequently do not approve a basis step-up election
made in connection with the sale or purchase of a regulated utility.
Commenters argued that even broaching the possibility of such a basis
step-up could create concerns for the regulatory agency regarding a
proposed acquisition. Commenters also queried how taxpayers that do not
raise this issue with the regulatory agency can ``demonstrate'' that
they were ``effectively precluded'' by the agency from making the
election. In short, commenters claimed that the ``demonstration''
requirement in proposed Sec. 1.163(j)-10(c)(5)(iv) would be
impractical, result in unnecessary requests to regulatory agencies,
lead to controversy, create uncertainty, and limit the effectiveness of
this provision.
To address the foregoing concerns, the final regulations provide
that a taxpayer that acquired or acquires an interest in a regulated
entity should be deemed to have made an election to step up the tax
basis of the assets of the acquired entity if the taxpayer can
demonstrate that (a) the acquisition qualified for an election under
section 336, 338, or 754, and (b) immediately before the acquisition,
the acquired entity had a regulatory liability for deferred taxes on
its books with respect to property predominantly used in an excepted
regulated utility trade or business.
J. Carryforwards of Disallowed Disqualified Interest
Proposed Sec. 1.163(j)-1(b)(10) defines the term ``disallowed
disqualified interest'' to mean interest expense, including
carryforwards, for which a deduction was disallowed under old section
163(j) in the taxpayer's last taxable year beginning before January 1,
2018, and that was carried forward under old section 163(j). Under the
proposed regulations, disallowed disqualified interest that is properly
allocable to a non-excepted trade or business is subject to the section
163(j) limitation as a disallowed business interest expense
carryforward. See proposed Sec. Sec. 1.163(j)-2(c)(1) and 1.163(j)-
11(b)(1). In the preamble to the proposed regulations, the Treasury
Department and the IRS requested comments as to how the allocation
rules in proposed Sec. 1.163(j)-10 should apply to disallowed
disqualified interest.
Commenters recommended several possible approaches to allocating
disallowed disqualified interest between excepted and non-excepted
trades or businesses. Under one approach (historical approach), a
taxpayer would apply the allocation rules of proposed Sec. 1.163(j)-10
to disallowed disqualified interest in the taxable year in which such
interest expense was incurred. Although this approach would be
consistent with the allocation rules for other business interest
expense, it likely would be administratively burdensome for many
taxpayers because such interest expense may have been incurred years
(if not decades) ago.
Under another approach (effective date approach), a taxpayer would
apply the allocation rules of proposed Sec. 1.163(j)-10 to disallowed
disqualified interest in the taxpayer's first taxable year beginning
after December 31, 2017, as if the disallowed disqualified interest
expense were incurred in that year. Although this approach would be
less administratively burdensome than the historical approach, it might
not accurately represent the taxpayer's circumstances in the year(s) in
which the disallowed disqualified interest actually was incurred.
Under a third approach, taxpayers would be permitted to use any
reasonable method to allocate disallowed disqualified interest between
excepted and non-excepted trades or businesses, provided the method is
applied consistently to disallowed disqualified interest that arose in
the same taxable year. This approach also might include the effective
date approach as a safe harbor. However, this approach could prove to
be administratively burdensome for the IRS.
To reduce the administrative burden for both taxpayers and the IRS,
the final regulations permit taxpayers to use either the historical
approach or the effective date approach.
A commenter also pointed out that proposed Sec. 1.163(j)-11(b)(1)
could be construed as permitting only disallowed disqualified interest
that is properly allocable to a non-excepted trade or business to be
carried forward to the taxpayer's first taxable year beginning after
December 31, 2017. The commenter requested confirmation that disallowed
disqualified interest that is properly allocable to an excepted trade
or business also is carried forward. The final regulations confirm this
point. See Sec. 1.163(j)-11(c)(1).
K. Anti-Abuse Rule
Proposed Sec. 1.163(j)-10(c)(8) provides an anti-abuse rule to
discourage
[[Page 56741]]
taxpayers from manipulating the allocation of business interest expense
and business interest income between non-excepted and excepted trades
or businesses. Pursuant to this provision, if a principal purpose for
the acquisition, disposition, or change in use of an asset was to
artificially shift the amount of basis allocable to excepted or non-
excepted trades or businesses on a determination date, the additional
basis or change in use is not taken into account for purposes of Sec.
1.163(j)-10.
A commenter expressed support for this rule but suggested that the
final regulations eliminate the ``principal purpose'' standard and rely
instead on a rule based on asset acquisitions, dispositions, or changes
in use that do not have ``a substantial business purpose.''
The Treasury Department and the IRS have determined that using ``a
substantial business purpose'' as the threshold for applying the anti-
abuse rule would limit the effectiveness of this rule because taxpayers
generally would be able to provide an ostensible business purpose for
the acquisition, disposition, or transfer of an asset. Thus, the anti-
abuse rule in the final regulations retains the ``principal purpose''
standard.
L. Direct Allocation
1. Overview
As previously noted, proposed Sec. 1.163(j)-10(c) generally
requires interest expense and interest income to be allocated between
excepted and non-excepted trades or businesses according to the
relative amounts of basis in the assets used in such trades or
businesses. However, proposed Sec. 1.163(j)-10(d) contains several
exceptions to this general rule.
First, a taxpayer with qualified nonrecourse indebtedness is
required to directly allocate interest expense from such indebtedness
to the taxpayer's assets in the manner and to the extent provided in
Sec. 1.861-10T(b) (see proposed Sec. 1.163(j)-10(d)(1)). Section
1.861-10T(b) defines the term ``qualified nonrecourse indebtedness'' to
mean any borrowing (other than borrowings excluded by Sec. 1.861-
10T(b)(4)) that satisfies certain requirements, including the
requirements that (i) the creditor can look only to the identified
property (or any lease or other interest therein) as security for
payment of the principal and interest on the loan, and (ii) the cash
flow from the property is reasonably expected to be sufficient to
fulfill the terms and conditions of the loan agreement. For these
purposes, the term ``cash flow from the property'' does not include
revenue if a significant portion thereof is derived from activities
such as sales or the use of other property. Thus, revenue derived from
the sale or lease of inventory or similar property, including plant or
equipment used in the manufacture and sale or lease, or purchase and
sale or lease, of such inventory or similar property, does not
constitute cash flow from the property. See Sec. 1.861-10T(b)(3)(i).
Second, a taxpayer that is engaged in the trade or business of
banking, insurance, financing, or a similar business is required to
directly allocate interest expense and interest income from such
business to the taxpayer's assets used in that business (see proposed
Sec. 1.163(j)-10(d)(2)).
Additionally, for purposes of the general allocation rule in
proposed Sec. 1.163(j)-10(c), taxpayers are required to reduce their
asset basis by the entire amount of the basis in the assets to which
interest expense is directly allocated pursuant to proposed Sec.
1.163(j)-10(d)(1) or (2). See proposed Sec. 1.163(j)-10(d)(4).
2. Expansion of the Direct Allocation Rule
Some commenters recommended that the direct allocation rule in
proposed Sec. 1.163(j)-10(d) be applied in circumstances other than
those set forth in proposed Sec. 1.163(j)-10(d)(1) and (2). For
example, a commenter queried whether a borrowing could be considered
qualified nonrecourse indebtedness for purposes of proposed Sec.
1.163(j)-10(d) even if the loan document doesn't require the creditor
to look exclusively to an asset as security for payment of principal
and interest on a loan (as required by Sec. 1.861-10T(b)(2)(iii)).
Other commenters asked that direct allocation be applied to debt
directly incurred by an excepted regulated utility trade or business.
These commenters argued that, because such debt must be approved by a
regulatory agency and relates directly to the underlying needs of that
trade or business, such debt should be viewed as ``properly allocable''
to that trade or business. Moreover, they claimed that the definition
of ``qualified nonrecourse indebtedness'' in Sec. 1.861-10T(b) is too
narrow to include either debt directly incurred by an excepted
regulated utility trade or business or debt incurred to purchase stock
of a corporation or interests in a partnership primarily engaged in an
excepted regulated utility trade or business.
In contrast, other commenters supported the decision to limit the
availability of tracing to the limited circumstances in proposed Sec.
1.163(j)-10(d).
As noted in part XI(L)(1) of this Summary of Comments and
Explanation of Revisions section, a borrowing is not considered
qualified nonrecourse indebtedness under Sec. 1.861-10T(b) unless the
creditor can look only to the identified property (or any interest
therein) as security for the loan. By definition, the creditor on a
non-recourse loan may not seek to recover the borrower's other assets;
in other words, the creditor has no further recourse. The Treasury
Department and the IRS decline to expand the exception in proposed
Sec. 1.163(j)-10(d)(1) to include unsecured debt because, by
definition, such debt is supported by all of the assets of the
borrower.
The Treasury Department and the IRS also have determined that the
definition of qualified nonrecourse indebtedness should not be expanded
to encompass indebtedness incurred to acquire stock or partnership
interests in an entity primarily engaged in an excepted trade or
business because such an approach is akin to tracing. As noted in the
preamble to the proposed regulations, money is fungible, and the
Treasury Department and the IRS have determined that a tracing regime
would be inappropriate, with limited exceptions. The Treasury
Department and the IRS have determined that the definition of qualified
nonrecourse indebtedness should not be expanded to encompass all
indebtedness directly incurred by regulated utility trades or
businesses, for similar reasons.
However, the Treasury Department and the IRS appreciate that it is
difficult for utility trades or businesses to avail themselves of the
direct allocation rule in proposed Sec. 1.163(j)-10(d)(1) given the
definition of qualified nonrecourse debt in Sec. 1.861-10T(b). In
particular, the Treasury Department and the IRS understand that the
exclusion of inventory revenue from the calculation of ``cash flow from
the property'' effectively precludes many utilities from using direct
allocation under proposed Sec. 1.163(j)-10(d)(1). Thus, solely for
purposes of the allocation rules in proposed Sec. 1.163(j)-10, the
final regulations create an exception to the definition of qualified
nonrecourse indebtedness in Sec. 1.861-10T(b) to allow for the
inclusion of revenue from the sale or lease of inventory for utility
trades or businesses.
Another commenter recommended that, for taxpayers engaged in
excepted regulated utility trades or businesses, the basis in certain
grants and contributions in aid of construction should be directly
allocated to non-
[[Page 56742]]
excepted trades or businesses if the costs have not been taken into
account by a regulatory body in determining the cost of the utility's
service for ratemaking purposes. As discussed in part II of this
Summary of Comments and Explanation of Revisions section, the final
regulations do not require the rates for the sale or furnishing of
utility items to be established or approved on a cost of service and
rate of return basis in order for a utility trade or business to
qualify as an excepted regulated utility trade or business. Without
such a requirement, the Treasury Department and the IRS do not find a
significant nexus between a regulatory body's determination of a
utility trade or business's cost of service and the allocation of the
basis in grants and contributions in aid of construction. Therefore,
the final regulations do not adopt the commenter's recommendation.
3. Basis Reduction Requirement for Qualified Nonrecourse Indebtedness
Commenters noted that, as drafted, the basis reduction requirement
in proposed Sec. 1.163(j)-10(d)(4) would lead to inappropriate results
for assets that are acquired using both equity financing and qualified
nonrecourse indebtedness (or using both recourse and nonrecourse
indebtedness) because this requirement would remove asset basis that
was not financed by qualified nonrecourse indebtedness.
Commenters also observed that this requirement could lead to
significant distortions because a small amount of qualified nonrecourse
indebtedness would cause an entire property to be removed from a
taxpayer's basis allocation computation. For example, assume a taxpayer
has (i) $500,000 of unsecured debt, (ii) property used in an excepted
trade or business with a basis of $10 million and $100,000 of qualified
nonrecourse indebtedness (Asset A), and (iii) a non-excepted trade or
business whose assets have a basis of $1 million. Under proposed Sec.
1.163(j)-10(d)(4), Asset A would be entirely excluded from the basis
allocation computation in proposed Sec. 1.163(j)-10(c). As a result,
all interest expense on the $500,000 of unsecured debt would be subject
to the section 163(j) limitation.
Commenters further noted that taxpayers could take advantage of
this basis adjustment rule to minimize the application of section
163(j). In other words, taxpayers could incur a relatively small amount
of nonrecourse debt to acquire assets used in non-excepted trades or
businesses, thereby reducing the amount of asset basis allocated to
such trades or businesses for purposes of the general allocation rule
in proposed Sec. 1.163(j)-10(c).
To eliminate these distortions and inappropriate results,
commenters recommended that basis in the assets securing qualified
nonrecourse indebtedness be reduced (but not below zero) for purposes
of the general allocation rule solely by the amount of such qualified
nonrecourse indebtedness. The Treasury Department and the IRS agree
with this recommendation, and the final regulations have been modified
accordingly.
4. Direct Allocation Rule for Financial Services Businesses
Commenters asked for clarification of the direct allocation rule
for financial services entities in proposed Sec. 1.163(j)-10(d)(2).
For example, commenters noted that, because the definition in Sec.
1.904-4(e)(2) includes income from certain services (including
investment advisory services), this rule may apply to taxpayers that
are not doing much actual financing, and commenters queried whether the
direct allocation rule should apply to such taxpayers. Commenters also
asked whether proposed Sec. 1.163(j)-10(d)(2) is intended to cover all
of a bank's activities or only part of them and, if the answer is the
latter, whether a bank must bifurcate its activities for purposes of
proposed Sec. 1.163(j)-10.
Commenters also questioned the basis reduction rule in proposed
Sec. 1.163(j)-10(d)(4) for financial services businesses. Commenters
noted that, unlike the case of qualified nonrecourse indebtedness, it
may not be possible to trace all interest expense related to a
financial services business to specific assets. Moreover, requiring a
taxpayer to fully eliminate its basis in the assets of a financial
services business under proposed Sec. 1.163(j)-10(d)(4) could be
distortive because the taxpayer's general debt obligations likely
support at least some portion of the taxpayer's financial services
business assets.
Given the uncertainty surrounding the proper scope of the direct
allocation rule for financial services businesses in proposed Sec.
1.163(j)-10(d)(2) and the proper application of the basis reduction
rule to such businesses in proposed Sec. 1.163(j)-10(d)(4), the
Treasury Department and the IRS have decided to remove proposed Sec.
1.163(j)-10(d)(2). To ensure that financial services entities are not
unduly affected by the rule (in proposed Sec. 1.163(j)-10(c)(5)(iii))
that excludes cash and cash equivalents from the general asset basis
allocation rule in proposed Sec. 1.163(j)-10(c), the final regulations
have retained the exception in proposed Sec. 1.163(j)-10(c)(5)(iii)
for financial services entities.
XII. Comments on Proposed Changes to Sec. 1.382-2: General Rules for
Ownership Change
As described in the preamble to the proposed regulations, section
382(k)(1) provides that, for purposes of section 382, the term ``loss
corporation'' includes a corporation entitled to use a carryforward of
disallowed interest described in section 381(c)(20), which refers to
carryovers of disallowed business interest described in section
163(j)(2). Section 163(j)(2) permits business interest expense for
which a deduction is disallowed under section 163(j)(1) to be carried
forward to the succeeding taxable year.
In turn, section 382(d)(3) provides that the term ``pre-change
loss'' includes disallowed business interest expense carryforwards
``under rules similar to the rules'' in section 382(d)(1). Section
382(d)(1) treats as a ``pre-change loss'' both (i) net operating loss
carryforwards to the taxable year in which the change date occurs
(change year), and (ii) the net operating loss carryforward for the
change year to the extent such loss is allocable to the pre-change
period.
Proposed changes to Sec. 1.382-2 clarified that a ``pre-change
loss'' includes the portion of any disallowed business interest expense
of the old loss corporation paid or accrued in the taxable year of the
testing date that is attributable to the pre-change period, and that a
``loss corporation'' includes a corporation that is entitled to use a
carryforward of such a disallowed business interest expense.
Commenters noted that, viewed in isolation, section 382(k)(1) would
not appear to apply to a corporation that has only a current-year
disallowed business interest expense. Some commenters also claimed that
the inclusion of current-year disallowed business interest expense in
the definition of a ``loss corporation'' is inconsistent with the
statutory language of section 382(k)(1).
The Treasury Department and the IRS have determined that section
382 should apply to current-year disallowed business interest expense
(to the extent such expense is allocable to the pre-change period)
because this approach is consistent with the statutory treatment of
NOLs. See section 382(k)(1) (providing, in part, that the term ``loss
corporation'' means a corporation ``having a net operating loss for the
taxable year in which the ownership change occurs''). Moreover, as a
policy matter, current-year attributes that relate
[[Page 56743]]
to the period before an ownership change should be subject to section
382. The exclusion of these items would permit trafficking in losses,
which is contrary to the stated policy underlying section 382 of
preventing ``exploit[ation] by persons other than those who incurred
the loss.'' H. Rept. 83-1337, at 42 (1954). Thus, no changes to the
final regulations have been made in response to these comments.
However, the final regulations revise the definition of a ``section 382
disallowed business interest carryforward'' (which includes both
disallowed business interest expense carryforwards and current-year
disallowed business interest expense allocable to the pre-change
period) in Sec. 1.382-2(a)(7) to reflect changes to the allocation
rules discussed in part XIII of this Summary of Comments and
Explanation of Revisions section.
XIII. Comments on Proposed Changes to Sec. 1.382-6: Allocation of
Income and Loss to Periods Before and After the Change Date for
Purposes of Section 382
Section 1.382-6 provides rules for the allocation of income and
loss to periods before and after the change date for purposes of
section 382. Section 1.382-6(a) generally provides that a loss
corporation must allocate its net operating loss or taxable income, and
its net capital loss or modified capital gain net income, for the
change year between the pre-change and post-change periods by ratably
allocating an equal portion to each day in the year. Section 1.382-
6(b), which contains an exception to this general rule, permits a loss
corporation to elect to allocate the foregoing items for the change
year between the pre-change and post-change periods as if the loss
corporation's books were closed on the change date. Such an election
does not terminate the loss corporation's taxable year as of the change
date (in other words, the change year is still treated as a single tax
year for Federal income tax purposes).
The proposed regulations revise Sec. 1.382-6 to address the
treatment of business interest expense. More specifically, the proposed
regulations provide that, regardless of whether a loss corporation has
made a closing-of-the-books election under Sec. 1.382-6(b), the amount
of the corporation's deduction for current-year business interest
expense is calculated based on ratable allocation for purposes of
calculating the corporation's taxable income attributable to the pre-
change period.
Commenters objected to the mandatory use of ratable allocation for
business interest expense in Sec. 1.382-6. For example, commenters
argued that this approach is distortive (and taxpayer-unfavorable) in
situations in which the loss corporation incurs minimal interest
expense in the pre-change period but makes highly leveraged
acquisitions in the post-change period. Another commenter noted that
this approach is distortive (and taxpayer-favorable) in situations in
which the loss corporation incurs significant business interest expense
in the pre-change period and allocates a portion of that expense to the
post-change period. To avoid these distortions and complications,
commenters recommended that a closing-of-the-books election also be
allowed for business interest expense.
The Treasury Department and the IRS acknowledge that a ratable
allocation approach may lead to distortions and administrative burdens
in certain situations. Thus, the final regulations permit a loss
corporation to allocate current-year business interest expense between
the pre-change and post-change periods using the closing-of-the-books
method set forth in Sec. 1.382-6(b)(4) if the loss corporation makes a
closing-of-the-books election under Sec. 1.382-6(b). Section 1.382-
6(b)(4) also provides correlative rules for the allocation of
disallowed business interest expense carryforwards to the pre-change
and post-change periods when a closing-of-the-books election is made.
In turn, section 1.382-6(a)(2) clarifies the amount of business
interest expense, disallowed business interest expense, and disallowed
business interest expense carryforwards that are allocable to the pre-
change and post-change periods if no closing-of-the-books election is
made.
XIV. Comments on and Changes to Proposed Sec. 1.383-1: Special
Limitations on Certain Capital Losses and Excess Credits
Section 1.383-1(d) provides ordering rules for the utilization of
pre-change losses and pre-change credits and for the absorption of the
section 382 limitation and the section 383 credit limitation. Under
proposed changes to Sec. 1.383-1(d), a taxpayer's section 382
limitation would be absorbed by disallowed business interest expense
carryforwards before being absorbed by NOLs. As described in the
preamble to the proposed regulations, the Treasury Department and the
IRS prioritized the use of disallowed business interest expense
carryforwards over NOLs because ``taxpayers must calculate their
current-year income or loss in order to determine whether and to what
extent they can use an NOL in that year, and deductions for business
interest expense, including carryforwards from prior taxable years,
factor into the calculation of current-year income or loss.''
Although commenters described the foregoing ordering rule as
understandable and fairly simple to administer, they noted that pre-
2018 NOLs (unlike disallowed business interest expense carryforwards)
have a limited carryforward period, and that such NOLs may expire
without use as a result of this ordering rule. Commenters thus
recommended allowing taxpayers to elect an alternative ordering rule
with respect to pre-2018 NOLs.
The Treasury Department and the IRS have decided not to adopt this
recommended approach, for several reasons. First, as commenters also
noted, such an approach would add complexity. Second, as stated in the
preamble to the proposed regulations, deductions for business interest
expense (including disallowed business interest expense carryforwards)
factor into the determination whether and to what extent a taxpayer can
use an NOL in a taxable year. Thus, no changes have been made to
proposed Sec. 1.383-1(d) in the final regulations.
XV. Other Comments About Section 382
A. Application of Section 382(l)(5)
Section 382(l)(5) provides an exception to the general loss
limitation rule under section 382(a) for an old loss corporation in
Title 11 proceedings or in similar cases if the historic shareholders
and creditors of such corporation own at least 50 percent of the stock
of the new loss corporation as a result of being shareholders or
creditors immediately before the ownership change. If this exception
applies, the corporation's pre-change losses and excess credits that
may be carried over to a post-change year must be ``computed as if no
deduction was allowable under this chapter for the interest paid or
accrued'' on debt converted into stock under Title 11 (or in a similar
case) during the 3-year period preceding the year of the ownership
change (change year) or during the pre-change period in the change
year. Section 382(l)(5)(B). In other words, because the old loss
corporation gets the benefit of treating certain creditors as
shareholders for purposes of determining whether the corporation has
undergone an ownership change within the meaning of section 382(g), the
corporation must treat the debt held by such creditors as equity for
Federal income tax purposes. As a result, the corporation must treat
[[Page 56744]]
the interest payments as non-deductible distributions on equity.
As provided in proposed Sec. 1.382-2, section 382 disallowed
business interest carryforwards are pre-change losses. Because a
deduction for such carryforwards is ``allowable'' in a future year,
commenters asked whether such carryforwards must be recomputed under
section 382(l)(5)(B).
The Treasury Department and the IRS have determined that no
clarification of the rule is necessary. Because section 382 disallowed
business interest carryforwards are pre-change losses, if a corporation
has such a carryforward from any taxable year ending during the 3-year
period preceding the change year (or during the pre-change period in
the change year), and if section 382(l)(5) applies to an ownership
change, the corporation must recompute the amount of such carryforwards
as if the business interest expense that generated such carryforwards
were not interest.
B. Application of Section 382(e)(3)
A commenter also recommended that the final regulations address the
application of section 382(e)(3) to foreign corporations with section
382 disallowed business interest carryforwards. Section 382(e)(3)
provides that, except as otherwise provided in regulations, only items
treated as connected with the conduct of a U.S. trade or business are
taken into account in determining the value of an old loss corporation
that is a foreign corporation if an ownership change occurs. Thus, if a
foreign corporation is not engaged in a U.S. trade or business, that
corporation's section 382 limitation is zero. As a result, if a foreign
corporation with no U.S. trade or business undergoes a section 382
ownership change, section 382(e)(3) appears to limit the corporation's
section 382 disallowed business interest carryforwards to $0. The
commenter described this result as onerous and unintended and
recommended that, for purposes of applying section 382 to such
carryforwards, a foreign corporation's value be treated as the total
value of its stock.
The Treasury Department and the IRS are aware of this issue and
other issues relating to the application of section 382 to CFCs. The
Treasury Department and the IRS continue to study the application of
section 382 to CFCs and may address this issue in future guidance. The
Treasury Department and the IRS welcome further comments on the
application of section 382 to CFCs.
C. Application of Section 382(h)(6)
As noted in the Background section, the September 2019 section 382
proposed regulations included a rule expressly providing that section
382 disallowed business interest carryforwards are not treated as
RBILs, thus precluding a double detriment under section 382 with
respect to such carryforwards. This conclusion might have been reached
by application of the general anti-duplication principles reflected in
the current regulations under section 382. See, for example, Sec.
1.382-8(d) (regarding duplicative reductions in value of loss
corporations). However, because of the complexity of this area, the
Treasury Department and the IRS included the clarification to prevent
possible confusion and to provide certainty to taxpayers that there is
no double detriment with respect to section 382 disallowed business
interest carryforwards. Although no formal comments were received on
this rule during the comment period for the September 2019 section 382
proposed regulations, informal comments from practitioners active in
the field have been uniformly positive and have confirmed that this
rule is a welcome, taxpayer-beneficial addition to the regulations
under section 382.
Due to the uncontroversial nature of this rule, the Treasury
Department and the IRS have determined that finalization of this
portion of the September 2019 section 382 proposed regulations is
warranted at this time. The Treasury Department and the IRS continue to
actively study the remainder of the rules in the September 2019 section
382 proposed regulations.
XVI. Definition of Real Property Trade or Business
Commenters suggested that the definition of a ``real property trade
or business'' should be clarified to include all rental real estate,
even if the rental real estate does not rise to the level of a section
162 trade or business. The Treasury Department and the IRS have
determined that modifications to the rules in the proposed regulations
are not necessary to make this point clear. Section 1.469-9(b)(1)
provides that the definition of a ``trade or business'' (for purposes
of section 469(c)(7)(C)) includes interests in rental real estate even
if the rental real estate gives rise to deductions under section 212.
The definition of real property trade or business in Sec. 1.469-
9(b)(2) (for purposes of section 469(c)(7)(C)) necessarily would
encompass or include the definition of a trade or business as provided
in Sec. 1.469-9(b)(1). Accordingly, taxpayers engaged in rental real
estate activities that do not necessarily rise to the level of a
section 162 trade or business nevertheless will be treated as engaged
in real property trades or businesses for purposes of section
469(c)(7)(C) (and section 163(j) by reference), and such taxpayers will
be permitted to make the election for a trade or business to be an
electing real property trade or business for purposes of section
163(j).
Commenters also requested clarification that a trade or business
should not be required to have a direct nexus or relationship to rental
real estate in order to qualify as a real property trade or business
under section 469(c)(7)(C). The Treasury Department and the IRS agree
that businesses involving real property construction, reconstruction,
development, redevelopment, conversion, acquisition, or brokerage
should not necessarily be required to have a direct nexus or
relationship to rental real estate to be treated as a real property
trade or business under section 469(c)(7)(C). The proposed regulations
provide definitions for the terms ``real property management'' and
``real property operations'' while reserving the remaining nine terms
in section 469(c)(7)(C) as undefined. The statement in the preamble to
the proposed regulations regarding a nexus or relationship to rental
real estate was intended as the rationale for the decision to limit the
definition of the two terms to the management and operation of rental
real estate. Without these limiting definitions, the Treasury
Department and the IRS were concerned that these two terms could be
read so broadly as to allow virtually any type of business to qualify
as a real property trade or business. The other nine terms in section
469(c)(7)(C) currently remain undefined, although the Treasury
Department and the IRS intend to issue additional guidance in the
future to provide definitions for these terms.
The Treasury Department and the IRS generally agree with the
observation that real property construction, reconstruction,
development, redevelopment, conversion, acquisition, or brokerage
businesses should not necessarily be required to have a direct nexus or
relationship to rental real estate in order to be treated as real
property trades or businesses. However, the expectation nevertheless
remains that the end products or final objectives of such businesses
should at least have the potential to be used as rental real estate or
as integral components in rental real estate activities.
[[Page 56745]]
Several commenters requested clarification regarding whether
timberlands will qualify as real property trades or businesses. The
Treasury Department and the IRS have concluded that unharvested or
unsevered timber clearly fall within the definition of ``real
property'' as provided in the proposed regulations. The question is
whether the activity of holding of timberlands falls within the
definition of a ``real property trade or business.'' The Treasury
Department and the IRS have concluded that the maintenance and
management of timberlands generally does not meet the intended meaning
of any of the eleven terms in section 469(c)(7)(C), and that the owners
of timberlands were not intended recipients for relief from the per se
passive rule for rental real estate when section 469(c)(7) originally
was enacted. However, as set forth in the Concurrent NPRM, such
activities might constitute the development of real estate within the
meaning of section 469(c)(7)(C). See proposed Sec. 1.469-
9(b)(2)(ii)(A) and (B) contained in the Concurrent NPRM.
One commenter requested an example illustrating that the management
or operation of a pipeline or transmission line will meet the
definition of a real property trade or business. In addition, another
commenter requested an example illustrating that the operation of a
bridge, tunnel, toll road, or airport qualifies as a real property
trade or business.
Although the Treasury Department and the IRS generally agree that
the operation of a pipeline, bridge, tunnel, toll road, or airport may
meet the definition of a real property trade or business under certain
and specific facts and circumstances, the answers to these questions
will remain dependent on the facts and circumstances of each case. The
Treasury Department and the IRS expect that such examples generally
will provide very limited guidance to most taxpayers because any such
examples likely will be viewed as inapplicable for taxpayers with any
differing facts and circumstances.
Additionally, one commenter recommended removing the reference to
the term ``customers'' from the definitions of the terms ``real
property management'' and ``real property operation'' because, in
certain situations, the party paying for the use of the property or for
other services may be a governmental agency providing services to the
general public or for the public good. The Treasury Department and the
IRS have determined that this modification is unnecessary because the
term ``customer'' for this purpose is broad enough to include
governmental entities.
One commenter also requested that the definition of a real property
trade or business be revised to include broadband, street lighting,
telephone poles, parking meters, and rolling stock. The Treasury
Department and the IRS decline to revise the definition of real
property trade or business in section 469(c)(7)(C) in this manner
because the maintenance and management of these types of assets
generally do not meet the intended meaning of any of the eleven terms
in section 469(c)(7)(C), and the owners of such assets were not
intended recipients for relief from the per se passive rule for rental
real estate when section 469(c)(7) originally was enacted.
One commenter requested that the final regulations remove the last
sentence in the definition of each of the terms ``real property
management'' and ``real property operation.'' The commenter stated that
these sentences create confusion regarding whether incidental services
provided along with rental real estate will cause the business to fail
to qualify as a real property trade or business. In response to this
comment, the Treasury Department and the IRS have revised these
sentences to clarify that incidental services, even if significant, do
not disqualify a business as a real property trade or business.
Statement of Availability of IRS Documents
The IRS Notices, Revenue Rulings, and Revenue Procedures cited in
this document are published in the Internal Revenue Bulletin (or
Cumulative Bulletin) and are available from the Superintendent of
Documents, U.S. Government Publishing Office, Washington, DC 20402, or
by visiting the IRS website at https://www.irs.gov.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 13771, 13563 and 12866 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health and safety effects, distributive impacts, and equity). Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, of reducing costs, of harmonizing rules, and of promoting
flexibility.
The final regulations have been designated as subject to review
under Executive Order 12866 pursuant to the Memorandum of Agreement
(April 11, 2018) between the Treasury Department and the Office of
Management and Budget (OMB) regarding review of tax regulations. OMB
has designated this final regulation as economically significant under
section 1(c) of the Memorandum of Agreement. Accordingly, the final
regulations have been reviewed by OMB's Office of Information and
Regulatory Affairs. For purposes of E.O. 13771 this rule is regulatory.
A. Need for the Final Regulations
The Tax Cuts and Jobs Act (TCJA) substantially modified the
statutory rules of section 163(j) to limit the amount of net business
interest expense that can be deducted in the current taxable year. As a
result of those changes, a number of the relevant terms and necessary
calculations that taxpayers are required to apply under the statute can
benefit from greater specificity. The Treasury Department and the IRS
issued proposed regulations related to section 163(j) on December 28,
2018 (proposed regulations). The comments to the proposed regulations
demonstrate a variety of opinions on how to define terms and on how
section 163(j) interacts with other sections of the Code and
corresponding regulations.
Based on these considerations, the final regulations are needed to
bring clarity to instances where the meaning of the statute was unclear
and to respond to comments received on the proposed regulations. Among
other benefits, the clarity provided by the final regulations generally
helps ensure that all taxpayers calculate the business interest expense
limitation in a similar manner.
B. Background and Overview
The TCJA substantially modified the statutory rules of section
163(j) to limit the amount of net business interest expense that can be
deducted in the current taxable year of any taxpayer, with limited
exceptions. As described in the preamble to the proposed regulations
(83 FR 67490), section 163(j) prior to TCJA generally applied to
domestic corporations with interest paid or accrued to related persons
that were not subject to Federal income tax. With the enactment of
TCJA, the amount allowed under section 163(j)(1) as a deduction for
business interest expense is limited to the sum of (1) the taxpayer's
business interest income for the taxable year; (2) 30 percent of the
taxpayer's adjusted taxable income (ATI) for the taxable year; and (3)
the taxpayer's floor plan financing interest expense for the taxable
year. As
[[Page 56746]]
described in the Background section earlier, the Coronavirus Aid,
Relief, and Economic Security Act (CARES Act) amended section 163(j) to
provide special rules relating to the ATI limitation for taxable years
beginning in 2019 or 2020. The section 163(j) limitation applies to all
taxpayers, except for certain small businesses with average annual
gross receipts of $25 million or less (adjusted for inflation) and
certain trades or businesses. The excepted trades or businesses are the
trade or business of providing services as an employee, electing real
property businesses, electing farming businesses, and certain regulated
utility businesses. Any amount of business interest not allowed as a
deduction for any taxable year as a result of the limitation under
section 163(j)(1) is carried forward and treated as business interest
paid or accrued in the next taxable year under section 163(j)(2).
Congress modified section 163(j) under the TCJA, in part, out of
concern that prior law treated debt-financed investment more favorably
than equity-financed investment. According to Congress, this debt bias
generally encouraged taxpayers to utilize more leverage than they would
in the absence of the Code. Limiting the deduction of business interest
is meant to reduce the relative favorability of debt and hence
encourage a more efficient capital structure for firms. Congress also
believed it necessary to apply the limit broadly across different types
of taxpayers so as not to distort the choice of entity (see H.R. Rep.
No. 115-409, at 247 (2017)).
C. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the economic
effects of the final regulations relative to a no-action baseline
reflecting anticipated Federal income tax-related behavior in the
absence of these final regulations.
2. Summary of Economic Effects
The final regulations provide certainty and clarity to taxpayers
regarding terms and calculations that are contained in section 163(j),
which was substantially modified by TCJA. In the absence of this
clarity, the likelihood that different taxpayers would interpret the
rules regarding the deductibility of business interest expense
differently would be exacerbated. In general, overall economic
performance is enhanced when businesses face more uniform signals about
tax treatment. Certainty and clarity over tax treatment also reduce
compliance costs for taxpayers. For those situations where taxpayers
would generally adopt similar interpretations of the statute even in
the absence of guidance, the final regulations provide value by helping
to ensure that those interpretations are consistent with the intent and
purpose of the statute. For example, the final regulations may specify
a tax treatment that few or no taxpayers would adopt in the absence of
specific guidance but that nonetheless advances Congressional intent.
The Treasury Department and the IRS project that the final
regulations will have an annual economic effect greater than $100
million ($2020). This determination is based on the substantial volume
of business interest payments in the economy \2\ and the general
responsiveness of business investment to effective tax rates,\3\ one
component of which is the deductibility of interest expense. Based on
these two magnitudes, even modest changes in the deductibility of
interest payments (and in the certainty of that deductibility) provided
by the final regulations, relative to the no-action baseline, can be
expected to have annual effects greater than $100 million. This claim
is particularly likely to hold for the first set of general 163(j)
guidance that is promulgated following major legislation, such as TCJA.
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\2\ Interest deductions in tax year 2013 for corporations,
partnerships, and sole proprietorships were approximately $800
billion.
\3\ See E. Zwick and J. Mahon, ``Tax Policy and Heterogeneous
Investment Behavior,'' at American Economic Review 2017, 107(1):
217-48 and articles cited therein.
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The Treasury Department and the IRS have not undertaken more
precise estimates of the economic effects of changes in business
activity stemming from these final regulations. The Treasury Department
and the IRS do not have readily available data or models that predict
with reasonable precision the decisions that taxpayers would make under
the final regulations versus alternative regulatory approaches,
including the no-action baseline. Nor do they have readily available
data or models that would measure with reasonable precision the loss or
gain in economic surplus resulting from those business decisions
relative to the decisions that would be made under an alternative
regulatory approach. Such estimates would be necessary to quantify the
economic effects of the final regulations versus alternative
approaches.
In the absence of such quantitative estimates, the Treasury
Department and the IRS have undertaken a qualitative analysis of the
economic effects of the final regulations relative to the no-action
baseline and relative to alternative regulatory approaches. This
analysis is presented in the next two sections of this Special
Analyses.
3. Economic Effects of Provisions Substantially Revised From the
Proposed Regulations
a. Calculation of ATI
Similar to the proposed regulations, the final regulations
prescribe various adjustments to the calculation of ATI to prevent
double counting of deductions and to provide relief for particular
types of taxpayers or taxpayers in particular circumstances to ensure
that all taxpayers are treated equitably when calculating ATI. One of
these adjustments prevents the double counting of depreciation
deductions when a depreciable asset is sold (only relevant for
depreciation deductions in taxable years beginning after December 31,
2017, and before January 1, 2022). Other adjustments apply to
particular types of taxpayers, such as regulated investment companies
(RICs), real estate investment trusts (REITs), or consolidated groups.
As an alternative, the Treasury Department and the IRS considered
not providing such adjustments. Without such adjustments, however,
certain taxpayers may be disadvantaged relative to otherwise similar
taxpayers. For example, if RICs and REITs included the dividends paid
deduction when calculating ATI, then these entities would almost always
have ATI of zero or close to zero. This outcome would limit the ability
of such taxpayers to ever deduct business interest expense for Federal
income tax purposes even when their financing profile was similar to
other entities that could deduct similar net business interest expense.
Based on calculations using the IRS's Statistics of Income (SOI)
sample of corporate taxpayers for 2017, the Treasury Department and the
IRS estimate that approximately $13.5 billion of net business interest
expense is potentially affected by the dividends paid deduction
adjustment to ATI provided to RICs and REITs in the final regulations.
This net business interest expense is the amount of interest expense
that is greater than interest income for RICs and REITs with gross
receipts greater than $25 million.
The final regulations make one notable change compared to the
proposed regulations regarding the ATI calculation for taxpayers that
manufacture or produce inventory. Under the proposed regulations, the
[[Page 56747]]
amount of any depreciation, amortization, or depletion that is
capitalized into inventory under section 263A during a taxable year
beginning before January 1, 2022 was not added back to taxable income
when calculating ATI for that taxable year. Under the final
regulations, such amounts are added back to tentative taxable income,
regardless of the period in which the capitalized amount is recovered
through cost of goods sold.
Without the final regulations, a taxpayer with depreciation,
amortization, or depletion expense that is subject to capitalization
would have lower ATI (and potentially a higher tax liability due to
smaller net interest deductions) than a similarly situated taxpayer
with depreciation, amortization, or depletion expense that is not
subject to capitalization. Thus, the effect of the final regulations
for the calculation of ATI is to prevent economic distortions by having
the net interest limitation apply more stringently for certain types of
taxpayers than others. The final regulations achieve this outcome more
effectively that alternative regulatory approaches, including the
proposed regulations and the no-action baseline.
Number of Affected Taxpayers. The Treasury Department and the IRS
estimate that roughly 61,000 entities are both (i) subject to
calculating their section 163(j) net interest limitation and (ii)
required by the Code to capitalize any expenses, including
depreciation, amortization, or depletion expenses. This estimate is an
upper bound estimate of the number of taxpayers potentially affected by
the definition of ATI prescribed under the regulations because
capitalized depreciation, amortization, or depletion expenses are not
separately reported and this tax return item includes other types of
capitalized expenses.
b. Definition of Interest
The statute limits the amount of deductible interest expense for a
taxpayer but, as described in the Explanation of Provisions section of
the proposed regulations, there are no generally applicable statutory
provisions or regulations addressing when financial instruments are
treated as debt for Federal income tax purposes or when a payment is
counted as interest. While there are several places in the Code and
regulations where interest expense or interest income is defined, such
as in the regulations that allocate and apportion interest expense
(Sec. 1.861-9T) and in the Subpart F regulations (Sec. 1.954-2),
these rules only apply to particular taxpayers in particular
situations.
The proposed regulations defined interest for the purpose of the
section 163(j) limitation as (1) amounts associated with conventional
debt instruments and amounts already treated as interest for all
purposes under existing statutory provisions or regulations; (2)
additional amounts that are functionally similar to interest but not
currently labeled as interest under the Code, or amounts treated as
interest for certain purposes, such as amounts described in Sec. Sec.
1.861-9T and 1.954-2; and (3) any deductible expense or loss
predominantly incurred in consideration of the time value of money as
part of an anti-avoidance rule. Thus, the proposed regulations applied
to interest associated with conventional debt instruments as well as
generally to transactions that are indebtedness in substance even if
not in form.
The Treasury Department and the IRS proposed this definition of
interest, rather than leaving the term interest undefined for purposes
of section 163(j). In the absence of this clarity, the likelihood that
different taxpayers would reach different conclusions over whether a
particular business expense was deductible business interest expense
would be exacerbated. In general, overall economic performance is
enhanced when businesses face more uniform signals about tax treatment.
Another concern about not defining the term at all is that taxpayer
uncertainty over whether certain transactions are considered interest
could increase burdens to the IRS and taxpayers including with respect
to disputes and litigation about whether particular payments are
interest for section 163(j) purposes.
A further concern, over providing a narrower definition of
interest, is that it could encourage taxpayers to engage in
transactions that provide financing while generating deductions
economically similar to interest but that were not defined as interest
for the purposes of section 163(j). There are several reasons why
curbing such taxpayer behavior would be beneficial. First, the ability
of taxpayers to engage in such transactions is correlated with the size
of the trade or business, with large businesses more likely to benefit
from such avoidance strategies than small businesses. Second, when the
deciding factor for using such transactions is the tax benefit of
avoiding a section 163(j) limitation, then such transactions would
impose more cost or risk on the taxpayer than using a traditional debt
instrument. Engaging in such transactions is an inefficient use of
resources. Third, such avoidance strategies may discourage taxpayers
from shifting to a less leveraged capital structure, and thus would
counteract the intention of the statute to reduce the prevalence of
highly-leveraged firms and the probability of systemic financial
distress. Fourth, greater use of financing outside of conventional debt
instruments may make it more difficult for financial institutions to
determine the overall level of leverage and credit risk of firms
seeking financing, which may distort the allocation of capital across
businesses away from firms and investments with less credit risk.
The final regulations prescribe a definition of interest that is
similar to the definition of interest in the proposed regulations
although with changes made in response to comments.\4\ There are three
general types of changes: (1) Changes are made to the proposed
regulations that modify, and generally limit, to what extent certain
amounts are included under the definition of interest for the purposes
of section 163(j). (2) Several items deemed to be interest for the
purpose of section 163(j) under proposed Sec. 1.163(j)-1(b)(20)(iii)
are not included in the final regulations. (3) The anti-avoidance rule
in proposed Sec. 1.163-1(b)(20)(iv) is modified to include a principal
purpose test and now also applies to situations where a taxpayer seeks
to artificially increase the amount of interest income.
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\4\ The proposed regulations represent the regulatory
alternative to which the final regulations are compared in the
following analysis.
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To the extent that these changes narrow the definition of interest
that is subject to the section 163(j) limitation relative to the
proposed regulations, they are expected to (i) reduce the cost of
financing for taxpayers, an effect that is expected to increase
investment by these taxpayers, and (ii) increase the proportion of that
financing that might generally be considered debt-financed. The first
effect occurs because taxpayers can deduct without limitation costs
from a larger set of financial instruments under the final regulations,
relative to the proposed regulations. They will choose these
instruments only if the cost of obtaining funds through those
instruments is lower than what would have been available under the
proposed regulations. By extension, this change lowers the overall cost
of financing for taxpayers. A lower cost of financing is associated
with greater investment by taxpayers, all other things equal. The
second effect occurs because the larger set of financial instruments
for which taxpayers can deduct expense without limitation (under the
final regulations,
[[Page 56748]]
relative to the proposed regulations) generally consists of instruments
that have a greater share of debt characteristics, rather than equity
characteristics. To the extent that taxpayers use these instruments to
a greater degree under the final regulations relative to the proposed
regulations, the share of debt-financing will increase. Congress has
generally expressed the view that excessive debt-financing may be a
less efficient capital structure for firms. See Senate Budget
Explanation of the Bill at 165.
Because the final regulations define interest based on the intent
and purpose of the statute and generally treat similar taxpayers
similarly and similar economic activity similarly, the Treasury
Department and the IRS have determined that the net result under these
final regulations is a more efficient allocation of capital across
taxpayers relative to regulatory alternatives, within the context of
the intent and purpose of the statute.
The Treasury Department and the IRS have not undertaken
quantitative estimates of the change in the level or nature of economic
activity arising from the final regulations relative to the proposed
regulations due to limitations on available data, but to the extent
possible has provided further below an estimate of the quantity of
potentially affected taxpayers and volume of transactions. Consider,
for example, the treatment of guaranteed payments for the use of
capital provided by a partner to a partnership, a financial arrangement
that has both equity and debt characteristics. The proposed regulations
included guaranteed payments to capital in the definition of interest
while the final regulations do not, except to the extent that they are
covered by other provisions of the final regulations. The Treasury
Department and the IRS have not undertaken quantitative estimates of
this regulatory decision because we do not have readily available data
or models to measure with sufficient precision: (i) The volume and
nature of guaranteed payments to capital and other financial
instruments that taxpayers might use if the final regulations were in
effect; (ii) the volume and nature of guaranteed payments and other
financial instruments that taxpayers might have used if the proposed
regulations were in effect; and (iii) the types of economic activities
that partnerships might undertake under these two financial portfolios.
Regarding item (iii), the Treasury Department and the IRS do not have
readily available data or models to predict how economic activity might
differ under debt-financed versus equity-financed investment for the
sets of instruments affected by these final regulations.
Compliance costs are also expected to be lower for those
transactions that are not subject to the section 163(j) limitation
under the final regulations and that would be subject to the limitation
under the proposed regulations. Generally, this is because taxpayers
would be less likely to need to calculate the section 163(j) limitation
and less likely to need to track unused interest deductions that are
carried forward to future tax years. For most taxpayers, this impact on
compliance costs is expected to be relatively small. However, for
certain taxpayers using hedging transactions, calculating the amount of
interest associated with the transactions would be burdensome and not
including such transactions in the definition of interest lowers
compliance costs to a greater degree. The Treasury Department and the
IRS have not estimated the reduction in compliance costs for these
taxpayers (under the final regulations, relative to the proposed
regulations) because we do not have data or models that are suitable
for this estimation.
The specific changes made with regard to items (1), (2), and (3)
are discussed in further detail here.
(1) The final regulations change (relative to the proposed
regulations) how amounts from certain transactions will be considered
interest for the purposes of section 163(j). There are two main forms
of transactions that are affected:
Treatment of swaps. The proposed regulations treated a non-cleared
swap with significant non-periodic payments as two separate
transactions consisting of an on-market, level payment swap and a loan
(the embedded loan rule).\5\ The time value component associated with
the embedded loan is recognized as interest expense to the payor and
interest income to the recipient. The treatment of cleared swaps was
not specified in the proposed regulations. The final regulations add
two exceptions to the embedded loan rule. Specifically, the final
regulations add exceptions for cleared swaps and for those non-cleared
swaps that require the parties to meet the margin or collateral
requirements of a federal regulator (or requirements that are
substantially similar to a federal regulator). Relative to the proposed
regulations this treatment will discourage taxpayers from using swaps
that are unregulated and dissimilar to regulated swaps, because under
the final regulations only such swaps will require the time value
component associated with the embedded loan to be treated as interest.
One reason for excepting both regulated and non-regulated
collateralized swaps from the definition of interest is that the
repayment risk of using such transactions is small, while the non-
collateralized swaps are more risky as individual transactions and
would be likely to contribute to the overall riskiness of the financial
system.
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\5\ A cleared swap is a collateralized swap that was cleared by
a derivatives clearing organization or by a clearing agency. A non-
cleared swap is a swap that has not been so cleared.
---------------------------------------------------------------------------
Substitute interest payments. The proposed regulations provided
that certain substitute interest payments will be treated as interest
for the purposes of section 163(j).\6\ The final regulations modify the
treatment of substitute interest payments by only including such
transactions as interest when the transaction is not part of the
ordinary course of business of the taxpayer. The Treasury Department
and the IRS have determined that the ordinary course rule in the final
regulations provides an appropriate and effective limit on the
treatment of substitute interest as interest for section 163(j)
purposes. This change has the effect of reducing the amount of
substitute interest payments that will be deemed interest for the
purpose of section 163(j) relative to the proposed regulations.
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\6\ A substitute interest payment is a payment, made to the
transferor of a security in a securities lending transaction or a
sale-repurchase transaction, of an amount equivalent to an interest
payment which the owner of the transferred security is entitled to
receive during the term of the transaction. This provision applies
to substitute interest payments as described in Sec. 1.861-2(a)(7).
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For taxpayers that use substitute interest payments in the ordinary
course of business, the final regulations may lower the after-tax cost
of such transactions and such taxpayers are more likely to use
transactions with substitute interest payments relative to the proposed
regulations. The Treasury Department and the IRS do not have readily
available data or models to estimate either (i) the change in financing
arrangements, including both substitute interest payments and other
financial instruments, that will be used by taxpayers under this
provision of the final regulations relative to the proposed
regulations, or (ii) the change in the volume or nature of economic
activity by these taxpayers given these financing arrangements.
(2) The items removed by the final regulations from the definition
of interest in the proposed regulations include debt issuance costs,
guaranteed payments for the use of capital provided
[[Page 56749]]
by a partner to a partnership, and hedging transactions.\7\ Under the
final regulations, these items can still be considered interest under
the anti-avoidance rule. These items share some characteristics with
interest, but comments received on the proposed regulations indicate
there is not a consensus that such items should always be defined as
interest. Removing these items from the definition of interest lowers
compliance costs for taxpayers in some cases relative to the proposed
regulations. However, not including these items in the definition of
interest increases uncertainty regarding whether amounts from certain
transactions will be treated as interest under the anti-avoidance rule,
and more disputes are likely to arise between taxpayers and the IRS.
---------------------------------------------------------------------------
\7\ Commitment fees are also not included in the definition of
interest in the final regulations, but may be addressed as part of
another guidance project on the treatment of fees relating to debt
instruments and other securities in the future.
---------------------------------------------------------------------------
The final regulations do not include debt issuance costs, such as
legal fees for document preparation, in the definition of interest.
Debt issuance costs are usually small relative to total interest
payments in a lending transaction and often the payments are made to a
third-party who is not the lender. Hence, there is limited ability for
taxpayers to be able to disguise interest payments as debt issuance
costs. The primary effect of not including debt issuance costs in the
definition of interest is to decrease the after-tax cost of debt
financing.
The final regulations do not include hedging transactions in the
definition of interest. Taxpayers could have multiple reasons for
engaging in hedging transactions other than just to lower the amount of
interest expense, such as a reduction in risk. Not including hedging
transactions in the definition of interest should decrease
administration and compliance costs compared to the treatment in the
proposed regulations since it can be difficult to separate the time
value component from the insurance aspects of a hedging transaction.
Under the final regulations, taxpayers are more likely to use hedging
relative to the proposed regulations due to the decline in compliance
costs and due to the reduced after-tax cost of using hedges.
The final regulations do not include guaranteed payments in the
definition of interest. Guaranteed payments for the use of capital
provided by a partner to a partnership have both equity and debt
characteristics. The partner who provided the capital is an owner of
the business, but also receives payments that are similar to interest.
Removing guaranteed payments from the definition of interest lowers the
after-tax cost of such financing for some taxpayers and may lead these
taxpayers to increase the fraction of financing through capital with
guaranteed payments relative to other financial instruments. The
Treasury Department and the IRS do not have readily available data or
models to project the change in the volume or nature of businesses'
economic activities that would arise as a consequence of this change in
the tax treatment of guaranteed payments to capital, relative to the
proposed regulations.
(3) The final regulations also modify the anti-avoidance rule found
in proposed Sec. 1.163-1(b)(20)(iv) relative to the proposed rule. One
change is that the anti-avoidance rule not only applies to financing
transactions used to avoid the classification of financing expense as
interest expense, but also excludes transactions that artificially
increase the taxpayer's interest income from being included as interest
income. The final regulations also add a principal purpose condition to
the anti-avoidance rule. That is, the anti-avoidance rule in the final
regulations only applies to amounts where a principal purpose of the
taxpayer for engaging in a transaction is to artificially reduce the
amount of net business interest expense, whether this stems from a
decrease in the amounts reported as interest expense or an increase in
the amounts reported as interest income. This symmetric anti-avoidance
rule adopted under the final regulations, applying to both interest
income and interest expense, increases the number of transactions to
which the rule could potentially apply compared to the proposed
regulations. However, including a principal purpose test in the anti-
avoidance rule will decrease how often the rule would potentially apply
to transactions relative to the proposed rule.
The anti-avoidance rule is an important component of the definition
of interest because it is difficult for the Treasury Department and the
IRS to specifically categorize every type of transaction already in
practice or to anticipate future innovations in financial transactions.
Relative to regulatory alternatives, the anti-avoidance rule will help
limit the ability of taxpayers to structure transactions in such a way
that would allow deductible expenses that are economically similar to
interest and frustrate the application of the statute. In summary, the
definition of interest in the final regulations provides clarity to
taxpayers and the IRS regarding which specific transactions and types
of transactions generate interest subject to the section 163(j)
limitation, which should lower compliance and administrative costs
relative to providing no definition or a narrower definition of
interest. The Treasury Department and the IRS further have determined
that the definition of interest specified under the final regulations
will encourage a more efficient allocation of capital and use of
financing across taxpayers relative to the no-action baseline, within
the context of the intent and purpose of the statute.
Number of Affected Taxpayers. The Treasury Department and the IRS
estimate that the number of partnerships potentially affected by the
change in treatment to guaranteed payments for the use of capital
provided by a partner to a partnership is 6,000. This is the number of
partnerships in tax year 2017 with more than $25 million in gross
receipts that also report paying deductible guaranteed payments. The
amount of total guaranteed payments reported by these partnerships is
approximately $30 billion. However, it is not known to what extent
these guaranteed payments are made to capital or labor, as the tax form
for that tax year did not distinguish between the two types of
guaranteed payments. Beginning in 2019, Form 1065 will separately
report those two types of guaranteed payments.
It is not possible to provide a meaningful estimate of the number
of taxpayers potentially affected by the final regulations that have
deductible debt issuance costs, substitute interest payments, or
amounts from swaps or hedging transactions, because those amounts are
not reported separately on a tax return.
4. Economic Effects of Provisions Not Substantially Revised From the
Proposed Regulations
a. Calculation of Excess Business Interest Expense, Excess Business
Interest Income, and Excess Taxable Income for Partnerships and S
Corporations
The statute applies broadly to different types of entities,
including passthrough entities, such as partnerships and S
corporations. The statute specifies that the section 163(j) limitation
applies at the entity level for a partnership but that items such as
excess business interest expense and excess taxable income must be
allocated to partners for a variety of reasons including to compute
their own 163(j) limitation. The statute further specifies
[[Page 56750]]
that the items should be allocated in the same manner as
``nonseparately stated taxable income or loss of the partnership'';
however, this concept had not previously been defined by statute or
regulations prior to the proposed regulations. In the absence of
guidance, partnerships would have significant uncertainty in
determining which partners receive excess items. This uncertainty could
lead one partnership to undertake an activity that another partnership
might decline to take based solely on different expectations about tax
treatment of interest income rather than underlying productivity
differences or economic signals.
The final regulations provide guidance on how to allocate
partnership excess business interest expense, excess business interest
income, and excess taxable income to partners. The allocation method
detailed in the final regulations follows a number of principles.
First, it ensures that the sum of the excess items at the partner level
is equal to the total at the partnership level. Second, it ensures that
the partnership does not allocate excess business interest expense to a
partner that was allocated items that include ATI and business interest
income that supported the partnership's deductible business interest
expense (unless the partner was allocated more interest expense than
its share of deductible business interest expense). Finally, it ensures
that the partnership allocates any excess taxable income or excess
business interest income to partners that are allocated more items
comprising ATI or business interest income than necessary to support
their allocation of business interest expense.
The final regulations thus provide a method to ensure that all
partnerships allocate these items consistently and in a way that
matches income and interest expense, thus promoting economically
efficient investment decisions across taxpayers and across financing
options, relative to the no-action baseline.
b. Interest Income Inclusion for Owners of Partnerships and S
Corporations
The final regulations ensure that, for owners of partnerships and S
corporations, business interest income is used only once, at the entity
level, in offsetting business interest expenses. It thereby avoids
exacerbating the incentive to seek out interest income relative to
other forms of less economically productive income in order to avoid
the section 163(j) limitation, relative to the no-action baseline.
c. Rules Related to Excepted Businesses
For purposes of section 163(j), the statute states in section
163(j)(7) that the term ``trade or business'' does not include certain
regulated utilities, or an electing real property trade or business or
an electing farming business. The final regulations clarify whether a
trade or business could elect as a farming business or a real property
trade or business and thus be excepted from section 163(j).
Specifically, Sec. 1.163(j)-9 provides guidance in applying the rules
for farming and real property trade or business elections. For an
electing real property trade or business and electing farming business,
the statue specifies that ``any such election shall be made at such
time and in such manner as the Secretary shall prescribe, and once
made, shall be irrevocable.'' Therefore Sec. 1.163(j)-9 provides
taxpayers with the time and manner for electing real property trades or
businesses and electing farming businesses. In addition, the final
regulations define the conditions under which an election terminates.
In the absence of specific guidance, taxpayers may engage in
behavior that counteracts the intent and purpose of the statute and
would not otherwise be taken except to avoid the irrevocable nature of
the election the statute specified. The final regulations increase the
likelihood that taxpayers interpret the `irrevocable' designation
similarly and do not engage in tax-motivated behavior by appearing to
cease operations in an effort to change an irrevocable designation.
In addition, Sec. 1.163(j)-9(h) provides a safe harbor for certain
REITs to elect to be electing real property trades or businesses. A
special rule applies to REITs for which 10 percent or less of the value
of the REIT's assets are real property financing assets. Under this
rule, all of the assets of the REIT are treated as real property trade
or business assets. The benefit of the safe harbor is to provide REITs
the same tax treatment and apply the same general rules as apply to
other taxpayers, an economically efficient approach. The special rule
threshold of 10 percent for real property financing assets has the
benefit of maintaining consistency with section 856(c)(4), which uses
the same values for the REIT asset test at the close of the REIT's
taxable year. Taxpayers will benefit in reduced compliance time and
cost in applying new rules if the rules are consistent with other rules
that they must comply with under the Code. An estimate of the
compliance cost savings that would be due to this cross-code
consistency, relative to regulatory alternatives, is beyond the
capabilities of the IRS's compliance model.
In addition, the final regulations provide a rule that stipulates
that if at least 80 percent of a trade or business's real property (by
fair market value) is leased to a trade or business under common
control with the real property trade or business, the trade or business
cannot make an election to be an electing real trade or business. In
the absence of such a rule, taxpayers could restructure their business
such that real estate components of non-real estate businesses are
separated from the rest of their business to artificially reduce the
application of section 163(j) by leasing the real property to the
taxpayer and electing this ``business'' to be an excepted real property
trade or business. Therefore, the prime benefit of this rule is to
preserve the intent of the statute of allowing elections in the real
property sector without incentivizing other sectors of the economy to
restructure their business for the sole intent of avoiding the section
163(j) limitation.
The Treasury Department and the IRS received no comments requesting
that the percentage amounts be changed.
Number of Affected Taxpayers. The Treasury Department and the IRS
project that nearly 3,500 REITs are potentially affected by the
provision in the final regulations that allows REITs for which 10
percent or less of the value of the REIT's assets are real property
financing assets to elect to treat all of its assets as allocable to an
excepted real property trade or business. This estimate is based the
number of REITs in the SOI sample of corporate taxpayers for 2017 that
identify as an Equity REIT. An Equity REIT is identified by a check-box
on form 1120-REIT where the choice is Equity REIT or Mortgage REIT. The
Mortgage REIT category should be chosen by the taxpayer if the primary
source of gross receipts is derived from mortgage interest and fees.
These Equity REITs reported $1.7 trillion in total assets.
The Treasury Department and the IRS project that roughly 2.8
million filers are potentially affected by provisions of the final
regulations that affect electing real property trades or businesses or
electing farm businesses. This estimate is based on a count of all
filers with NAICS codes starting with 111 or 112 (farming), and 531
(real property) with at least $10 million in gross receipts in taxable
year 2017.
d. Allocation Rules Between Excepted and Non-Excepted Trades or
Businesses
The statute is silent over how ATI, interest income, and expense
should be allocated between excepted and non-
[[Page 56751]]
excepted trades or businesses. Thus, the Treasury Department and the
IRS decided to provide taxpayers with an allocation method. Because
allocation, by whatever method, is costly for taxpayers, the final
regulations further provide that allocation is only required when the
share of the asset tax basis in both the excepted and the non-excepted
trades or businesses exceeds 10 percent. In other words, if the share
for either excepted or non-excepted trades or businesses is 10 percent
or less, allocation is not required. The Treasury Department and the
IRS received no comments that addressed the 10 percent threshold
provided in this provision.
In terms of the allocation method, the Treasury Department and the
IRS decided in the final regulations to require taxpayers to allocate
interest expense and interest income between related excepted and non-
excepted trades or businesses based on the relative amounts of the
taxpayer's adjusted tax basis in the assets used in its excepted and
non-excepted trades or businesses. As discussed in the Explanation of
Provisions section of the proposed regulations, this general method of
allocation reflects the fact that money is fungible and the view that
interest expense is attributable to all activities and property,
regardless of any specific purpose for incurring an obligation on which
interest is paid. This asset basis approach is consistent with the
regulations under section 861. Because this approach is familiar to
taxpayers and consistent with other parts of the Code, taxpayers
benefit in reduced time and cost spent learning and applying the rules,
relative to alternative regulatory approaches. An estimate of the
compliance cost savings that would be due to this familiarity and
cross-code consistency, relative to regulatory alternatives, is beyond
the capabilities of the IRS's compliance model.
The Treasury Department and the IRS considered several alternatives
to this asset basis approach for allocating interest income and
expense. First, a tracing approach was considered whereby taxpayers
would be required to trace disbursements of debt proceeds to specific
expenditures. However, tracing would impose a significant compliance
burden on taxpayers due to the complexity of matching interest income
and expense among related companies. Further, it is not clear how
taxpayers would retroactively apply a tracing regime to existing debt.
In particular, because C corporations would have had no reason to trace
the proceeds of any existing indebtedness, imposing a tracing regime on
existing indebtedness would require corporations to reconstruct the use
of funds within their treasury operations at the time such indebtedness
was issued, even if the issuance occurred many years ago, and even if
the funds were used for a myriad of purposes across a large number of
entities. Such an approach would impose substantial compliance costs
and may be impractical or even impossible for indebtedness issued years
ago.
Moreover, because money is fungible, a tracing regime would be
distortive and subject to manipulation. Although taxpayers are impacted
from both a commercial and tax perspective by the amount of capital
raised through the issuance of equity and indebtedness, any trade or
business conducted by a taxpayer is generally indifferent to the source
of funds. As a result, if taxpayers were allowed to use a tracing
regime to allocate indebtedness to excepted trades or businesses, there
would be an incentive to treat excepted trades or businesses as funded
largely from indebtedness, and to treat non-excepted trades or
businesses as funded largely from other types of funding, such as
equity funding, despite the fact that, as an economic matter, all of a
taxpayer's trades or businesses are funded based on the taxpayer's
overall capital structure.
The Treasury Department and the IRS rejected a tracing approach
because the complexity of such an approach could be more difficult for
taxpayers and the IRS to administer and would create too great an
incentive to structure financing with the sole purpose of avoiding the
application of the statute, relative to the final regulations. The
assumption that a trade or business is indifferent to its source of
funds may not be appropriate in cases in which certain indebtedness is
secured by the assets of the trade or business and cash flow from those
assets is expected to support the payments required on the
indebtedness. The final regulations provide for a limited tracing rule
in those cases.
The Treasury Department and the IRS also considered allocating
interest expense based on the relative fair market value of the assets
used in excepted and non-excepted trades or businesses. However,
determinations of fair market value frequently are burdensome for
taxpayers, which may have numerous assets without a readily established
market price. For this reason, disputes between taxpayers and the IRS
over the fair market value of an asset are a common and costly
occurrence. In the TCJA, Congress repealed the use of fair market value
in the apportionment of interest expense under section 864 of the Code
(see section 14502(a) of the TCJA) and claimed that the ability to
elect to allocate interest expense under section 864 on the basis of
fair market value of assets has led to inappropriate results and
needless complexity. See Senate Budget Explanation of the Bill at 400.
Thus, the Treasury Department and the IRS have determined that
allocating interest expense based on relative amounts of asset basis is
more appropriate than a regime based on the relative fair market value
of assets.
The Treasury Department and the IRS also considered allocating
interest expense to excepted and non-excepted trades or businesses
based on the relative amounts of gross income generated by such trades
or businesses. However, gross income is more variable and volatile than
asset basis, in part because it is based on an annual measurement.
Methods could be developed to look at multiple years of gross income
through an averaging or other smoothing methodology, but any such
approach would necessarily create a number of difficult technical
questions because the income of different trades or businesses may be
subject to differing business cycles and the taxpayers may exert
control over the timing of income items, which may lead taxpayers to
make tax-driven business decisions with no accompanying general
economic benefit. In the TCJA, Congress also repealed the use of gross
income in the apportionment of interest expense under section 864 of
the Code (see section 14502(a) of the TCJA). Thus, the Treasury
Department and the IRS have determined that allocating interest expense
based on relative amounts of asset basis is more appropriate than a
regime based on the relative amounts of gross income.
Number of Affected Taxpayers. The Treasury Department and the IRS
estimate that roughly 83,000 firms had allocated interest income and
expenses among multiple trades or businesses in tax year 2015 and thus
are potentially affected by provisions of the final regulations that
affect the annual allocation statement. This estimate is based on a
count of all Forms 1120, 1120S, and 1065 in tax year 2015 in real
estate, farming, and public utilities industries that had over $25
million in gross receipts.
II. Paperwork Reduction Act
The collections of information contained in the final regulations
have been submitted to the Office of Management and Budget for review
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
[[Page 56752]]
3507(d)). An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a valid control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
return information are confidential, as required by section 6103.
A. Collections of Information Imposed by the Regulations
The collections of information imposed directly by these
regulations are contained in Sec. Sec. 1.163(j)-1(b)(15)(iii),
1.163(j)-2(b)(2)(ii), 1.163(j)-2(b)(3), 1.163(j)-9 and 1.163(j)-10.
The collection of information in Sec. Sec. 1.163(j)-1(b)(15)(iii)
and 1.163(j)-9, the election statement, is required for taxpayers to
make a one-time election to treat their regulated utility trade or
business, real property trade or business or farming trade or business
as an electing excepted regulated utility trade or business, electing
real property trade or business under section 163(j)(7)(B) or an
electing farming business under section 163(j)(7)(C). The election to
be an excepted regulated utility trade or business was not in the
proposed regulations. The scope of taxpayers eligible to make an
election to be an excepted real property or farming trade or business
has changed from the proposed regulations. As discussed in part X of
the Summary of Comments and Explanation of Revisions section, under the
proposed regulations, taxpayers that met the small business exemption
test under section 448(c) were not able to make an election for their
trade or business to be an electing real property trade or business or
an electing farming business because they were already not subject to
the limitation. Under the final regulations, those taxpayers are
eligible to make a protective election. Additionally, under the
proposed regulations, it was unclear whether taxpayers that were unsure
of whether their activity constitutes a trade or business under section
162 could make an election. The final regulations clarify that a
taxpayer that is unsure whether its activity constitutes a trade or
business under section 162 is eligible to make an election.
The collections of information in Sec. Sec. 1.163(j)-2(b)(2)(ii)
and 1.163(j)-2(b)(3) are required to make two elections relating to
changes made to section 163(j)(10) by the CARES Act. The election under
Sec. 1.163(j)-2(b)(2)(ii) is for a taxpayer to use the 30 percent ATI
limitation instead of the 50 percent ATI limitation when calculating
the taxpayer's section 163(j) limitation for a 2019 or 2020 taxable
year, as provided in section 163(j)(10)(A)(i) and (iii). The election
under Sec. 1.163(j)-2(b)(2) is for a taxpayer to use the taxpayer's
ATI for the last taxable beginning in 2019 as its ATI for any taxable
year beginning in 2020, as provided in section 163(j)(10)(B). Revenue
Procedure 2020-22 describes the time and manner for making these
elections. See also Sec. 1.163(j)-2(b)(4).
Taxpayers make the elections by timely filing a Federal income tax
return or Form 1065, including extensions, an amended Federal income
tax return, amended Form 1065, or administrative adjustment request, as
applicable. More specifically, taxpayers complete the Form 8990,
Limitation on Business Interest Expense under Section 163(j), using the
30 percent ATI limitation and/or using the taxpayer's 2019 ATI, as
applicable. No formal statements are required to make these elections.
Accordingly, for Paperwork Reduction Act purposes, the reporting burden
associated with the collections of information in Sec. Sec. 1.163(j)-
2(b)(2)(ii) and 1.163(j)-2(b)(3) will be reflected in the IRS Form 8990
Paperwork Reduction Act Submissions (OMB control number 1545-0123).
The collection of information in Sec. 1.163(j)-10, the allocation
statement, is required for taxpayers to demonstrate how they allocated
their interest expense, interest income, and other items of income and
deduction between excepted and non-excepted trades or businesses. The
mechanics of the allocation statement, and the scope of taxpayers
required to file the allocation statement, have not changed from the
proposed regulations.
Section 1.163(j)-10 in the final regulations contains another
collection of information, an allocation methodology change request,
requiring taxpayers to request the Commissioner's permission to change
a methodology for allocating the basis in an asset that is used in
multiple trades or businesses if the request is being made within five
years of any prior change. This requirement does not create a new
burden because the allocation methodology change request is made by
following the procedures for requesting a letter ruling in section 7.01
of Revenue Procedure 2020-1, 2020-1 IRB 1. Revenue Procedure 2020-1 was
approved by the Office of Management and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-
0123.
In 2018, the Treasury Department and the IRS considered developing
a form election and allocation statement under Sec. Sec. 1.163(j)-9
and 1.163(j)-10 for taxpayers to make the one-time election and to
demonstrate their interest allocation. To minimize taxpayer burden, the
Treasury Department and the IRS decided that, for now, taxpayers should
be allowed to use their own election form and allocation statement. In
the future, if the Treasury Department and the IRS develop election or
allocation form, the draft versions of the forms will be posted for
comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.html.
Certain forms have been modified with simple questions to signal
whether the taxpayer is subject to section 163(j). The Treasury
Department and the IRS are considering modifying certain forms with a
checkbox to note that a taxpayer has made an election for a trade or
business to be an electing real property trade or business or electing
farming business.
For the allocation methodology change request in Sec. 1.163(j)-10,
the Treasury Department and the IRS initially determined that taxpayers
should file a change request any time there is a change in methodology.
However, a change in allocation methodology presents a burden for
taxpayers. The disadvantages of changing an allocation methodology
regularly, including the administrative and accounting costs associated
with any such change, outweigh the advantages of changing an allocation
methodology regularly. Accordingly, the Treasury Department and the IRS
do not anticipate taxpayers using the allocation methodology change
request regularly. The final regulations require the request to be made
only if a change has not been made in the past 5 years. To minimize any
compliance burden, the procedures in Revenue Procedure 2020-1, which
are familiar to taxpayers, apply for the allocation methodology change
request.
B. Burden Estimates
The following burden estimates are based on the information that is
available to the IRS, and have been updated from the proposed
regulations to take into account the new election for certain regulated
utility trades or businesses, the increased scope of potential filers
for the election statement and to use 2017 Statistics of Income (SOI)
tax data where available.
The most recently available 2017 SOI tax data indicates that
approximately 8,208 filers are possible for the one-time election to
opt out of the section 163(j) limitation as an electing excepted
[[Page 56753]]
regulated utility trade or business. This estimate was based on a count
of Form 1065, 1065B, 1120 and 1120-S filers with NAICS codes starting
with 2211 (electric power generation, transmission and distribution),
2212 (natural gas distribution), and 2213 (water, sewage and other
systems).
The 2017 SOI tax data indicates that approximately 2,838,981 filers
are possible for the one-time election to opt out of the section 163(j)
limitation as an electing real property trade or business or as an
electing farming business were the statute then in effect. This
estimate is based on a count of all filers with NAICS codes starting
with 111 or 112 (farming), and 531 (real property) with at least $10
million in gross receipts in taxable year 2017. The increase in
potential filers from the number provided in the proposed regulations
is due exclusively to the fact that the final regulations provide that
taxpayers that satisfy the small business exemption are eligible to
file an election.
For the election to use the 30 percent ATI limitation for a 2019 or
2020 taxable year under Sec. 1.163(j)-2(b)(ii), while any taxpayer
subject to the section 163(j) limitation is eligible to make the
election, the Treasury Department and the IRS estimate that only
taxpayers that actively want to reduce their deductions will make this
election. The application of the base erosion minimum tax under section
59A depends, in part, on the amount of a taxpayer's deductions.
Accordingly, the Treasury Department and the IRS estimate that
taxpayers that are subject to both the base erosion minimum tax under
section 59A and section 163(j) are the potential filers of this
election. Using the 2017 SOI tax data, the Treasury Department estimate
that 3,376 firms will make the election. This estimate was determined
by examining the number of C corporations with at least $500,000,000 in
gross receipts, that do not have an NAICS code associated with a trade
or business that is generally not subject to the section 163(j)
limitation (2211 (electric power generation, transmission and
distribution), 2212 (natural gas distribution), 2213 (water, sewage and
other systems), 111 or 112 (farming), 531 (real property)).
For the election to use the taxpayer's 2019 ATI in 2020 under Sec.
1.163(j)-2(b)(3), the Treasury Department and the IRS estimate that
72,608 firms will make the election. This figure was determined, using
2017 SOI tax data, by examining Form 1040, Form 1120, Form 1120S, and
Form 1065 filers with more than $26M in gross receipts, that have
reported interest expense, and do not have an NAICS code associated
with any trade or business that is generally not subject to the section
163(j) limitation.
The Treasury Department and the IRS continue to estimate the same
number of filers, 82,755, for the annual allocation statement as was
projected in the proposed regulations. Using the 2015 SOI tax data, the
Treasury Department and the IRS estimate that 82,755 firms will have
allocated interest income and expenses among multiple trades or
businesses, some of which are excepted from the section 163(j)
limitation and some that are not. This estimate is a count of all tax
Forms 1120, 1120S, and 1065 in real estate, farming, and public
utilities industries that had over $25 million in gross receipts. While
the number of affected taxpayers will increase with growth in the
economy, the Treasury Department and the IRS expect that the portion of
affected taxpayers will remain approximately the same over the
foreseeable future.
The time and dollar compliance burden are derived from the Business
Taxpayers Burden model provided by the IRS's Office of Research,
Applied Analytics, and Statistics (RAAS). This model relates the time
and out-of-pocket costs of business tax preparation, derived from
survey data, to assets and receipts of affected taxpayers along with
other relevant variables. See ``Tax Compliance Burden'' (John Guyton et
al, July 2018) at https://www.irs.gov/pub/irs-soi/d13315.pdf. A
respondent may require more or less time than the estimated burden,
depending on the circumstances.
The burden estimates listed in the below table attempt to capture
only those discretionary changes made in these proposed regulations,
and may not include burden estimates for forms associated with the
statute. Changes made by the Act or through new information collections
are captured separately in forthcoming published ``Supporting
Statements'' for each of these forms and will be aggregated with the
estimates provided below to summarize the total burden estimates for
each information collection listed below. Those total burden estimates
will be available for review and public comment at https://www.reginfo.gov/public/Forward?SearchTarget=PRA&textfield. The Treasury
Department and the IRS request comment on these estimates.
--------------------------------------------------------------------------------------------------------------------------------------------------------
Estimated average Estimated
Estimated number annual burden Estimated total monetized burden Estimated
Likely respondents of respondents hours per annual reporting @$95/hour frequency of
respondent burden (hours) ($millions) responses
--------------------------------------------------------------------------------------------------------------------------------------------------------
Section 1.163(j)-1(b)(15)(iii) Corporations and 8,028 business 0 to 30 minutes 2,007............ $190,665......... One-time.
(one-time election statement partnerships with respondents (estimated
(2017 Levels). regulated utility (including Forms average: 15
trades or businesses. 1120, 1120-S, and minutes).
1065 filers).
Section 1.163(j)-2(b)(ii) C corporations with 3,376 business See Form 8990.... See Form 8990.... See Form 8990.... See Form 8990.
(election to apply the 30 more than $500 M in respondents (Form
percent ATI percentage). gross receipts. 1120 filers).
Section 1.163(j)-2(b)(3) Individuals, 72,608 business See Form 8990.... See Form 8990.... See Form 8990.... See Form 8990.
(election to use 2019 ATI as corporations, and respondents
2020 ATI). partnerships with more (including Form
than $26 M in gross 1120, Form 1120-
receipts and not part S, and Form 1065
of an excepted trade filers).
or business.
[[Page 56754]]
Section 1.163(j)-9 (one-time Individuals, 2,838,981 business 0 to 30 minutes 70,746........... 67.4............. One-time.
election statement) (2017 corporations, and respondents (all (estimated
Levels). partnerships with real filers). average:15
property or farming minutes).
trades or businesses
with gross receipts
exceeding $10 million.
Section 1.163(j)-10 (annual Individuals, 82,755 business 15 minutes to 2 82,755........... 7.9.............. Annually.
allocation statement) (2015 corporations, and respondents hours (estimated
Levels). partnerships (1) with (including Forms average: 1 hour).
more than one trade or 1120, 1120-S, and
business (at least one 1065 filers).
of which is a real
property or farming
trade or business),
and (2) public
utilities, with gross
receipts exceeding the
statutory threshold of
$25 million.
Section 1.163(j)-10 (change in Individuals, See Rev. Proc. See Rev. Proc. See Rev. Proc. See Rev. Proc. On occasion.
allocation methodology corporations, and 2020-1. 2020-1. 2020-1. 2020-1.
request). partnerships that want
to change their
methodology for
allocating basis among
two or more trades or
businesses, and (1)
with more than one
trade or business (at
least one of which is
a real property or
farming trade or
business), and (2)
public utilities, with
gross receipts
exceeding the
statutory threshold of
$25 million.
Section 1.163(j)-10 (one-time Same as above.......... 82,755............ 4 hours (start-up 331,020.......... 31.4............. One-time.
start-up cost to develop burden).
procedures for filing an
annual allocation statement)
(2017 Levels).
Three year monetized burden ....................... .................. ................. ................. 40.8............. Three year annual
estimate. average.
--------------------------------------------------------------------------------------------------------------------------------------------------------
The three-year annual average of the monetized burden for the
information collection and resulting from discretionary requirements
contained in this rulemaking is estimated to be 40.9 million ($2017)
([($190, 665) + ($67.4 million + $31.4 million) + ($7.9 million x 3)]/
3). To ensure more accuracy and consistency across its information
collections, the IRS is currently in the process of revising the
methodology it uses to estimate burden and costs. Once this methodology
is complete, the IRS will provide this information to reflect a more
precise estimate of burdens and costs.
C. Forms
The IRS has developed Form 8990, ``Limitation on Business Interest
Expense Under Section 163(j),'' to facilitate reporting of the
limitation. The form is posted at https://www.irs.gov/pub/irs-access/f8990_accessible.pdf. The Form 8990 instructions are posted at https://www.irs.gov/pub/irs-pdf/i8990.pdf. The Form 1120 series and the Form
1065 have been revised to include a question to alert taxpayers of the
need to file a Form 8990. The instructions to those and other forms
have been revised to include information about the Form 8990.
As described previously, the reporting burdens associated with the
information collections in the proposed regulations are included in the
aggregated burden estimates for OMB control number 1545-0123 (in the
case of filers of Form 1120, Form 1065 and Form 8990), 1545-0074 (in
the case of individual filers), and 1545-0123 (in the case of filers
under Revenue Procedure 2020-1).
The Treasury Department and the IRS request comment on all aspects
of information collection burdens related to these regulations,
including estimates for how much time it would take to comply with the
paperwork burdens described previously for each relevant form and ways
for the IRS to minimize the paperwork burden. In addition, when
available, drafts of IRS forms are posted for comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.htm.
----------------------------------------------------------------------------------------------------------------
Form/revenue procedure Type of filer OMB No(s). Status
----------------------------------------------------------------------------------------------------------------
Business (NEW Model).. 1545-0123............. Published in the Federal
Register on 10/8/18.
Public comment period
closed on 12/10/18.
----------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
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[[Page 56755]]
Individual (NEW Model) 1545-0074............. Limited scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission for all forms
in 2019.
----------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031.
----------------------------------------------------------------------------------------------------------------
Revenue Procedure 20201............ IRS Research estimates 1545-0123............. Published in the Internal
Revenue Bulletin on
January 2, 2020.
----------------------------------------------------------------------------
Link: https://www.irs.gov/irb/2020-01_IRB.
----------------------------------------------------------------------------------------------------------------
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it
is hereby certified that the final regulations will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act
(small entities). This certification can be made because the Treasury
Department and the IRS have determined that the regulations may affect
a substantial number of small entities but have also concluded that the
economic effect on small entities as a result of these regulations is
not expected to be significant.
When enacted, the section 163(j) limitation generally applied to
taxpayers with average annual gross receipts exceeding $25 million. The
gross receipts threshold for general applicability of the section
163(j) limitation increased to $26 million in 2020. The threshold will
be adjusted annually for inflation. However, under the final
regulations, small taxpayers operating regulated utility trades or
businesses, real property trades or businesses and farming trades or
businesses are now eligible to protectively elect out of the election.
Accordingly, the regulations in Sec. Sec. 1.163(j)-1 and -9 may apply
to small business filers that operate regulated utility trades or
businesses, real property trades or businesses or farming trades or
businesses. Those taxpayers may choose to make a protective election,
such that they are not subject to the limitation if their average
annual gross receipts for the three prior tax years eventually exceeds
$26 million (for 2020). Although the exact number of small entities
that will make an election is unknown, an upper bound on the number of
potentially affected entities is 10.5 million. This number was
determined by looking at, for the 2017 taxable year, the number of Form
1120, 1120-S, 1120-REIT, 1065, and individual business filers with more
than $10M in gross receipts that have NAICS codes commonly associated
with real property trades or businesses or farming businesses.
If a taxpayer chooses to make the election for its trades or
businesses, the taxpayer must attach to its tax return a statement
identifying and describing the trade or business for which the election
is being made, and must provide other information as the Commissioner
may require in forms, instructions, or other published guidance. The
election is not required. The election is potentially beneficial to
businesses with business interest, but is detrimental to businesses
that have assets for which bonus depreciation is desired.
The reporting burden is estimated at 0-30 minutes, depending on
individual circumstances, with an estimated average of 0.25 hours for
all affected entities, regardless of size. The burden on small entities
is expected to be the same as other entities because the requirements
to make the election apply equally to all taxpayers. Using the IRS's
taxpayer compliance cost estimates, the monetization rate is $95 per
hour. Thus, the average annual burden is $23.75 per business.
For the section 163(j)(10) elections under Sec. Sec. 1.163(j)-
2(b)(ii) or 1.163(j)-2(b)(3), most small business taxpayers do not need
the elections because, as discussed earlier, they are not subject to
the section 163(j) limitation. For small taxpayers that are subject to
the limitation, the cost to implement the elections is low. Pursuant to
Revenue Procedure 2020-22, these taxpayers simply complete the Form
8990 as if the election has been made. Accordingly, the burden of
complying with the elections, if needed, is no different than for
taxpayers that do not make the elections.
Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding this regulation was submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on its
effect on small business, and no comments were received.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
section, of $100 million in 1995 dollars, update annually for
inflation. This rule does not include any Federal mandate that may
result in expenditures by state, local, or tribal governments, or by
the private section in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. This final rule does not have
federalism implications and does not impose substantial direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive Order.
VI. Congressional Review Act
The Administrator of the Office of Information and Regulatory
Affairs of the Office of Management and Budget has determined that this
is a major rule for purposes of the Congressional Review Act (5 U.S.C.
801 et seq.) (CRA). Under section 801(3) of the CRA, a major rule takes
effect 60 days after the rule is published in the Federal Register.
Notwithstanding this requirement, section 808(2) of the CRA allows
agencies to dispense with the requirements of 801 when the agency for
good cause finds that such procedure would be impracticable,
unnecessary, or contrary to the public interest and the rule shall take
effect at such time as the agency promulgating the rule determines.
The Treasury Department and the IRS have determined that the rules
in this Treasury decision shall take effect for
[[Page 56756]]
taxable years beginning on or after November 13, 2020. Pursuant to
section 808(2) of the CRA, however, the Treasury Department and the IRS
find, for good cause, that a 60-day delay in the effective and the
applicability date for the anti-avoidance rules in Sec. 1.163(j)-
1(b)(22)(iv) is unnecessary and contrary to the public interest.
Section 1.163(j)-1(b)(22)(iv) serves an anti-abuse function and,
because Sec. 1.163(j)-1(b)(22)(iv) provides a clear scope of abusive
transactions that could otherwise be executed prior to the effective
date of the section, immediate application of Sec. 1.163(j)-
1(b)(22)(iv) is necessary as of the publication of this final
regulation.
Drafting Information
The principal authors of these regulations are Susie Bird, Charles
Gorham, Justin Grill, Zachary King, Jaime Park, Kathy Reed, Joanna
Trebat and Sophia Wang, Office of the Associate Chief Counsel (Income
Tax and Accounting); Kevin M. Jacobs, Russell Jones, John Lovelace,
Marie Milnes-Vasquez, Aglaia Ovtchinnikova, and Julie Wang, Office of
the Associate Chief Counsel (Corporate); William Kostak, Anthony
McQuillen, and Adrienne Mikolashek, Office of the Associate Chief
Counsel (Passthroughs and Special Industries); Azeka Abramoff, Angela
Holland, and Steve Jensen, Office of the Associate Chief Counsel
(International); William E. Blanchard, Michael Chin, Steven Harrison,
Andrea Hoffenson, and Diana Imholtz, Office of the Associate Chief
Counsel (Financial Institutions and Products). Other personnel from the
Treasury Department and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by:
0
1. Adding entries in numerical order for Sec. Sec. 1.163(j)-1 through
1.163(j)-11;
0
2. Revising the entries for Sec. Sec. 1.263A-8 through 1.263A-15;
0
3. Adding entries in numerical order for Sec. Sec. 1.382-1 and 1.383-
0;
0
4. Revising the entry for Sec. 1.383-1; and
0
5. Adding entries in numerical order for Sec. Sec. 1.860C-2 and
1.1502-90.
The additions and revisions read as follows:
Authority: 26 U.S.C. 7805, unless otherwise noted.
* * * * *
Section 1.163(j)-1 also issued under 26 U.S.C. 163(j)(8)(B) and
26 U.S.C. 1502.
Section 1.163(j)-2 also issued under 26 U.S.C. 1502.
Section 1.163(j)-3 also issued under 26 U.S.C. 1502.
Section 1.163(j)-4 also issued under 26 U.S.C. 163(j)(8)(B) and
26 U.S.C. 1502.
Section 1.163(j)-5 also issued under 26 U.S.C. 1502.
Section 1.163(j)-6 also issued under 26 U.S.C. 163(j)(8)(B) and
26 U.S.C. 1502.
Section 1.163(j)-7 also issued under 26 U.S.C. 163(j)(8)(B) and
26 U.S.C. 1502.
Section 1.163(j)-8 also issued under 26 U.S.C. 163(j)(8)(B).
Section 1.163(j)-9 also issued under 26 U.S.C. 163(j)(7)(B) and
(C) and 26 U.S.C. 1502.
Section 1.163(j)-10 also issued under 26 U.S.C. 163(j)(8)(B) and
26 U.S.C. 1502.
Section 1.163(j)-11 also issued under 26 U.S.C. 1502.
* * * * *
Sections 1.263A-8 through 1.263A-15 also issued under 26 U.S.C.
263A(j).
* * * * *
Section 1.382-1 also issued under 26 U.S.C. 382(m).
* * * * *
Section 1.383-0 also issued under 26 U.S.C. 382(m) and 26 U.S.C.
383.
Section 1.383-1 also issued under 26 U.S.C. 382(m) and 26 U.S.C.
383.
* * * * *
Section 1.860C-2 also issued under 26 U.S.C. 860C(b)(1) and
860G(e).
* * * * *
Section 1.1502-90 also issued under 26 U.S.C. 382(m) and 26
U.S.C. 1502.
* * * * *
0
Par. 2. Section 1.163(j)-0 is added to read as follows:
Sec. 1.163(j)-0 Table of contents.
This section lists the table of contents for Sec. Sec. 1.163(j)-1
through 1.163(j)-11.
Sec. 1.163(j)-1 Definitions.
(a) In general.
(b) Definitions.
(1) Adjusted taxable income.
(i) Additions.
(ii) Subtractions.
(iii) Depreciation, amortization, or depletion capitalized under
section 263A.
(iv) Application of Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and (E).
(A) Sale or other disposition.
(1) In general.
(2) Intercompany transactions.
(3) Deconsolidations.
(B) Deductions by members of a consolidated group.
(C) Successor assets.
(D) Anti-duplication rule.
(1) In general.
(2) Adjustments following deconsolidation.
(v) Other adjustments.
(vi) Additional rules relating to adjusted taxable income in other
sections.
(vii) ATI cannot be less than zero.
(viii) Examples.
(2) Applicable CFC.
(3) Business interest expense.
(i) In general.
(ii) Special rules.
(4) Business interest income.
(i) In general.
(ii) Special rules.
(5) C corporation.
(6) Cleared swap.
(7) Consolidated group.
(8) Consolidated return year.
(9) Current-year business interest expense.
(10) Disallowed business interest expense.
(11) Disallowed business interest expense carryforward.
(12) Disallowed disqualified interest.
(13) Electing farming business.
(14) Electing real property trade or business.
(15) Excepted regulated utility trade or business.
(i) In general.
(A) Automatically excepted regulated utility trades or businesses.
(B) Electing regulated utility trades or businesses.
(C) Designated excepted regulated utility trades or businesses.
(ii) Depreciation and excepted and non-excepted utility trades or
businesses.
(A) Depreciation.
(B) Allocation of items.
(iii) Election to be an excepted regulated utility trade or
business.
(A) In general.
(B) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(C) Time and manner of making election.
(1) In general.
(2) Election statement contents.
(3) Consolidated group's or partnership's trade or business.
(4) Termination of election.
(5) Additional guidance.
(16) Excess business interest expense.
(17) Excess taxable income.
(18) Floor plan financing indebtedness.
(19) Floor plan financing interest expense.
(20) Group.
(21) Intercompany transaction.
(22) Interest.
(i) In general.
(ii) Swaps with significant nonperiodic payments.
(A) In general.
(B) Exception for cleared swaps.
[[Page 56757]]
(C) Exception for non-cleared swaps subject to margin or collateral
requirements.
(iii) Other amounts treated as interest.
(A) Treatment of premium.
(1) Issuer.
(2) Holder.
(B) Treatment of ordinary income or loss on certain debt
instruments.
(C) Substitute interest payments.
(D) Section 1258 gain.
(E) Factoring income.
(F) [Reserved]
(iv) Anti-avoidance rules.
(A) Principal purpose to reduce interest expense.
(1) Treatment as interest expense.
(2) Corresponding treatment of amounts as interest income.
(B) Interest income artificially increased.
(C) Principal purpose.
(D) Coordination with anti-avoidance rule in Sec. 1.163(j)-2(j).
(v) Examples.
(23) Interest expense.
(24) Interest income.
(25) Member.
(26) Motor vehicle.
(27) Old section 163(j).
(28) Ownership change.
(29) Ownership date.
(30) Real estate investment trust.
(31) Real property.
(32) Regulated investment company.
(33) Relevant foreign corporation.
(34) S corporation.
(35) [Reserved]
(36) Section 163(j) limitation.
(37) Section 163(j) regulations.
(38) Separate return limitation year.
(39) Separate return year.
(40) Separate tentative taxable income.
(41) Tax-exempt corporation.
(42) Tax-exempt organization.
(43) Tentative taxable income.
(i) In general.
(ii) [Reserved]
(iii) Special rules for defining tentative taxable income.
(44) Trade or business.
(i) In general.
(ii) Excepted trade or business.
(iii) Non-excepted trade or business.
(45) Unadjusted basis.
(46) United States shareholder.
(c) Applicability date.
(1) In general.
(2) Anti-avoidance rules.
(3) Swaps with significant nonperiodic payments.
(i) In general.
(ii) Anti-avoidance rule.
Sec. 1.163(j)-2 Deduction for business interest expense limited.
(a) Overview.
(b) General rule.
(1) In general.
(2) 50 percent ATI limitation for taxable years beginning in 2019
or 2020.
(3) Election to use 2019 ATI in 2020.
(4) Time and manner of making or revoking the elections.
(c) Disallowed business interest expense carryforward.
(1) In general.
(2) Coordination with small business exemption.
(3) Cross-references.
(d) Small business exemption.
(1) Exemption.
(2) Application of the gross receipts test.
(i) In general.
(ii) Gross receipts of individuals.
(iii) Partners and S corporation shareholders.
(iv) Tax-exempt organizations.
(e) REMICs.
(f) Trusts.
(i) Calculation of ATI with respect to certain trusts and estates.
(ii) Calculation of ATI with respect to certain beneficiaries.
(g) Tax-exempt organizations.
(h) Examples.
(i) [Reserved]
(j) Anti-avoidance rule.
(1) In general.
(2) Examples.
(k) Applicability date.
Sec. 1.163(j)-3 Relationship of the section 163(j) limitation to
other provisions affecting interest.
(a) Overview.
(b) Coordination of section 163(j) with certain other provisions.
(1) In general.
(2) Disallowed interest provisions.
(3) Deferred interest provisions.
(4) At risk rules, passive activity loss provisions, and limitation
on excess business losses of noncorporate taxpayers.
(5) Capitalized interest expenses.
(6) Reductions under section 246A.
(7) Section 381.
(8) Section 382.
(c) Examples.
(d) Applicability date.
Sec. 1.163(j)-4 General rules applicable to C corporations
(including REITs, RICs, and members of consolidated groups) and tax-
exempt corporations.
(a) Scope.
(b) Characterization of items of income, gain, deduction, or loss.
(1) Interest expense and interest income.
(2) Adjusted taxable income.
(3) Investment interest, investment income, investment expenses,
and certain other tax items of a partnership with a C corporation
partner.
(i) Characterization as expense or income properly allocable to a
trade or business.
(ii) Effect of characterization on partnership.
(iii) Separately stated interest expense and interest income of a
partnership not treated as excess business interest expense or excess
taxable income of a C corporation partner.
(iv) Treatment of deemed inclusions of a domestic partnership that
are not allocable to any trade or business.
(4) Application to RICs and REITs.
(i) In general.
(ii) Tentative taxable income of RICs and REITs.
(iii) Other adjustments to adjusted taxable income for RICs and
REITs.
(5) Application to tax-exempt corporations.
(6) Adjusted taxable income of cooperatives.
(7) Examples.
(c) Effect on earnings and profits.
(1) In general.
(2) Special rule for RICs and REITs.
(3) Special rule for partners that are C corporations.
(4) Examples.
(d) Special rules for consolidated groups.
(1) Scope.
(2) Calculation of the section 163(j) limitation for members of a
consolidated group.
(i) In general.
(ii) Interest.
(iii) Calculation of business interest expense and business
interest income for a consolidated group.
(iv) Calculation of adjusted taxable income.
(v) Treatment of intercompany obligations.
(A) In general.
(B) Repurchase premium.
(3) Investment adjustments.
(4) Examples.
(e) Ownership of partnership interests by members of a consolidated
group.
(1) [Reserved]
(2) Change in status of a member.
(3) Basis adjustments under Sec. 1.1502-32.
(4) Excess business interest expense and Sec. 1.1502-36.
(f) Cross-references.
(g) Applicability date.
(1) In general.
(2) [Reserved]
Sec. 1.163(j)-5 General rules governing disallowed business
interest expense carryforwards for C corporations.
(a) Scope and definitions.
(1) Scope.
(2) Definitions.
(i) Allocable share of the consolidated group's remaining section
163(j) limitation.
(ii) Consolidated group's remaining section 163(j) limitation.
[[Page 56758]]
(iii) Remaining current-year interest ratio.
(b) Treatment of disallowed business interest expense
carryforwards.
(1) In general.
(2) Deduction of business interest expense.
(3) Consolidated groups.
(i) In general.
(ii) Deduction of business interest expense.
(A) General rule.
(B) Section 163(j) limitation equals or exceeds the current-year
business interest expense and disallowed business interest expense
carryforwards from prior taxable years.
(C) Current-year business interest expense and disallowed business
interest expense carryforwards exceed section 163(j) limitation.
(iii) Departure from group.
(iv) Example: Deduction of interest expense.
(c) Disallowed business interest expense carryforwards in
transactions to which section 381(a) applies.
(d) Limitations on disallowed business interest expense
carryforwards from separate return limitation years.
(1) General rule.
(A) Cumulative section 163(j) SRLY limitation.
(B) Subgrouping.
(2) Deduction of disallowed business interest expense carryforwards
arising in a SRLY.
(3) Examples.
(e) Application of section 382.
(1) Pre-change loss.
(2) Loss corporation.
(3) Ordering rules for utilization of pre-change losses and for
absorption of the section 382 limitation.
(4) Disallowed business interest expense from the pre-change period
in the year of a testing date.
(5) Recognized built-in loss.
(f) Overlap of SRLY limitation with section 382.
(g) Additional limitations.
(h) Applicability date.
Sec. 1.163(j)-6 Application of the section 163(j) limitation to
partnerships and subchapter S corporations.
(a) Overview.
(b) Definitions.
(1) Section 163(j) items.
(2) Partner basis items.
(3) Remedial items.
(4) Excess business interest income.
(5) Deductible business interest expense.
(6) Section 163(j) excess items.
(7) Non-excepted assets.
(8) Excepted assets.
(c) Business interest income and business interest expense of the
partnership.
(1)-(2) [Reserved]
(3) Character of business interest expense.
(d) Adjusted taxable income of a partnership.
(1) Tentative taxable income of a partnership.
(2) Section 734(b), partner basis items, and remedial items.
(e) Adjusted taxable income and business interest income of
partners.
(1) Modification of adjusted taxable income for partners.
(2) Partner basis items and remedial items.
(3) Disposition of partnership interests.
(4) Double counting of business interest income and floor plan
financing interest expense prohibited.
(f) Allocation and determination of section 163(j) excess items
made in the same manner as nonseparately stated taxable income or loss
of the partnership.
(1) Overview.
(i) In general.
(ii) Relevance solely for purposes of section 163(j).
(2) Steps for allocating deductible business interest expense and
section 163(j) excess items.
(i) Partnership-level calculation required by section 163(j)(4)(A).
(ii) Determination of each partner's relevant section 163(j) items.
(iii) Partner-level comparison of business interest income and
business interest expense.
(iv) Matching partnership and aggregate partner excess business
interest income.
(v) Remaining business interest expense determination.
(vi) Determination of final allocable ATI.
(A) Positive allocable ATI.
(B) Negative allocable ATI.
(C) Final allocable ATI.
(vii) Partner-level comparison of 30 percent of adjusted taxable
income and remaining business interest expense.
(viii) Partner priority right to ATI capacity excess determination.
(ix) Matching partnership and aggregate partner excess taxable
income.
(x) Matching partnership and aggregate partner excess business
interest expense.
(xi) Final section 163(j) excess item and deductible business
interest expense allocation.
(g) Carryforwards.
(1) In general.
(2) Treatment of excess business interest expense allocated to
partners.
(3) Excess taxable income and excess business interest income
ordering rule.
(h) Basis adjustments.
(1) Section 704(d) ordering.
(2) Excess business interest expense basis adjustments.
(3) Partner basis adjustment upon disposition of partnership
interest.
(4)-(5) [Reserved]
(i)-(j) [Reserved]
(k) Investment items and certain other items.
(l) S corporations.
(1) In general.
(i) Corporate level limitation.
(ii) Short taxable periods.
(2) Character of deductible business interest expense.
(3) Adjusted taxable income of an S corporation.
(4) Adjusted taxable income and business interest income of S
corporation shareholders.
(i) Adjusted taxable income of S corporation shareholders.
(ii) Disposition of S corporation stock.
(iii) Double counting of business interest income and floor plan
financing interest expense prohibited.
(5) Carryforwards.
(6) Basis adjustments and disallowed business interest expense
carryforwards.
(7) Accumulated adjustment accounts.
(8) Termination of qualified subchapter S subsidiary election.
(9) Investment items.
(10) Application of section 382.
(m) Partnerships and S corporations not subject to section 163(j).
(1) Exempt partnerships and S corporations.
(2) Partnerships and S corporations engaged in excepted trades or
businesses.
(3) Treatment of excess business interest expense from partnerships
that are exempt entities in a succeeding taxable year.
(4) S corporations with disallowed business interest expense
carryforwards prior to becoming exempt entities.
(n) [Reserved]
(o) Examples.
(p) Applicability date.
Sec. 1.163(j)-7 Application of the section 163(j) limitation to
foreign corporations and United States shareholders.
(a) Overview.
(b) General rule regarding the application of section 163(j) to
relevant foreign corporations.
(c)-(f) [Reserved]
(g) Rules concerning the computation of adjusted taxable income of
a relevant foreign corporation.
(1) Tentative taxable income.
(2) Treatment of certain dividends.
(h)-(l) [Reserved]
(m) Applicability date.
Sec. 1.163(j)-8 [Reserved]
Sec. 1.163(j)-9 Elections for excepted trades or businesses; safe
harbor for certain REITs.
[[Page 56759]]
(a) Overview.
(b) Availability of election.
(1) In general.
(2) Special rules.
(i) Exempt small businesses.
(ii) Section 162 trade or business not required for electing real
property trade or business.
(c) Scope and effect of election.
(1) In general.
(2) Irrevocability.
(3) Depreciation.
(d) Time and manner of making election.
(1) In general.
(2) Election statement contents.
(3) Consolidated group's trade or business.
(4) Partnership's trade or business.
(e) Termination of election.
(1) In general.
(2) Taxable asset transfer defined.
(3) Related party defined.
(4) Anti-abuse rule.
(f) Additional guidance.
(g) Examples.
(h) Safe harbor for REITs.
(1) In general.
(2) REITs that do not significantly invest in real property
financing assets.
(3) REITs that significantly invest in real property financing
assets.
(4) REIT real property assets, interests in partnerships, and
shares in other REITs.
(i) Real property assets.
(ii) Partnership interests.
(iii) Shares in other REITs.
(A) In general.
(B) Information necessary.
(iv) Tiered entities.
(5) Value of shares in other REITs.
(i) In general.
(ii) Information necessary.
(iii) Tiered REITs.
(6) Real property financing assets.
(7) Application of safe harbor for partnerships controlled by
REITS.
(8) REITs or partnerships controlled by REITs that do not apply the
safe harbor.
(i) [Reserved]
(j) Special anti-abuse rule for certain real property trades or
businesses.
(1) In general.
(2) Exceptions.
(i) De minimis exception.
(ii) Look-through exception.
(iii) Inapplicability of exceptions to consolidated groups.
(iv) Exception for certain REITs.
(3) Allocations.
(4) Examples.
(k) Applicability date.
Sec. 1.163(j)-10 Allocation of interest expense, interest income,
and other items of expense and gross income to an excepted trade or
business.
(a) Overview.
(1) In general.
(i) Purposes.
(ii) Application of section.
(2) Coordination with other rules.
(i) In general.
(ii) Treatment of investment interest, investment income,
investment expenses, and certain other tax items of a partnership with
a C corporation or tax-exempt corporation as a partner.
(3) Application of allocation rules to foreign corporations and
foreign partnerships.
(4) Application of allocation rules to members of a consolidated
group.
(i) In general.
(ii) Application of excepted business percentage to members of a
consolidated group.
(iii) Basis in assets transferred in an intercompany transaction.
(5) Tax-exempt organizations.
(6) Application of allocation rules to disallowed disqualified
interest.
(7) Examples.
(b) Allocation of tax items other than interest expense and
interest income.
(1) In general.
(2) Gross income other than dividends and interest income.
(3) Dividends.
(i) Look-through rule.
(ii) Inapplicability of the look-through rule.
(4) Gain or loss from the disposition of non-consolidated C
corporation stock, partnership interests, or S corporation stock.
(i) Non-consolidated C corporations.
(ii) Partnerships and S corporations.
(5) Expenses, losses, and other deductions.
(i) Expenses, losses, and other deductions that are definitely
related to a trade or business.
(ii) Other deductions.
(6) Treatment of investment items and certain other items of a
partnership with a C corporation partner.
(7) Examples: Allocation of income and expense.
(c) Allocating interest expense and interest income that is
properly allocable to a trade or business.
(1) General rule.
(i) In general.
(ii) De minimis exception.
(2) Example.
(3) Asset used in more than one trade or business.
(i) General rule.
(ii) Permissible methodologies for allocating asset basis between
or among two or more trades or businesses.
(iii) Special rules.
(A) Consistent allocation methodologies.
(1) In general.
(2) Consent to change allocation methodology.
(B) De minimis exception.
(C) Allocations of excepted regulated utility trades or businesses.
(1) In general.
(2) Permissible method for allocating asset basis for utility
trades or businesses.
(3) De minimis rule for excepted utility trades or businesses.
(4) Example.
(D) Special allocation rule for real property trades or business
subject to special anti-abuse rule.
(1) In general.
(2) Allocation methodology for real property.
(3) Example.
(4) Disallowed business interest expense carryforwards; floor plan
financing interest expense.
(5) Additional rules relating to basis.
(i) Calculation of adjusted basis.
(A) Non-depreciable property other than land.
(B) Depreciable property other than inherently permanent
structures.
(C) Special rule for land and inherently permanent structures.
(D) Depreciable or amortizable intangible property and depreciable
income forecast method property.
(E) Assets not yet used in a trade or business.
(F) Trusts established to fund specific liabilities.
(G) Inherently permanent structure.
(ii) Partnership interests; stock in non-consolidated C
corporations.
(A) Partnership interests.
(1) Calculation of asset basis.
(2) Allocation of asset basis.
(i) In general.
(ii) De minimis rule.
(iii) Partnership assets not properly allocable to a trade or
business.
(iv) Inapplicability of partnership look-through rule.
(B) Stock in domestic non-consolidated corporations.
(1) In general.
(2) Domestic non-consolidated C corporations.
(i) Allocation of asset basis.
(ii) De minimis rule.
(iii) Inapplicability of corporate look-through rule.
(iv) Use of inside basis for purposes of C corporation look-through
rule.
(3) S corporations.
(i) Calculation of asset basis.
(ii) Allocation of asset basis.
(iii) De minimis rule.
(iv) Inapplicability of S corporation look-through rule.
(C) Stock in relevant foreign corporations.
(1) In general.
(2) Special rule for CFC utilities.
(D) Inapplicability of look-through rule to partnerships or non-
consolidated
[[Page 56760]]
C corporations to which the small business exemption applies.
(E) Tiered entities.
(iii) Cash and cash equivalents and customer receivables.
(iv) Deemed asset sale.
(v) Other adjustments.
(6) Determination dates; determination periods; reporting
requirements.
(i) Determination dates and determination periods.
(A) Quarterly determination periods.
(B) Annual determination periods.
(ii) Application of look-through rules.
(iii) Reporting requirements.
(A) Books and records.
(B) Information statement.
(iv) Failure to file statement.
(7) Ownership threshold for look-through rules.
(i) Corporations.
(A) Asset basis.
(B) Dividends.
(ii) Partnerships.
(iii) Inapplicability of look-through rule.
(8) Anti-abuse rule.
(d) Direct allocations.
(1) In general.
(2) Qualified nonrecourse indebtedness.
(3) Assets used in more than one trade or business.
(4) Adjustments to basis of assets to account for direct
allocations.
(5) Example: Direct allocation of interest expense.
(e) Examples.
(f) Applicability date.
Sec. 1.163(j)-11 Transition rules.
(a) Overview.
(b) Application of section 163(j) limitation if a corporation joins
a consolidated group during a taxable year of the group beginning
before January 1, 2018.
(1) In general.
(2) Example
(c) Treatment of disallowed disqualified interest.
(1) In general.
(2) Earnings and profits.
(3) Disallowed disqualified interest of members of an affiliated
group.
(i) Scope.
(ii) Allocation of disallowed disqualified interest to members of
the affiliated group.
(A) In general.
(B) Definitions.
(1) Allocable share of the affiliated group's disallowed
disqualified interest.
(2) Disallowed disqualified interest ratio.
(3) Exempt related person interest expense.
(iii) Treatment of carryforwards.
(4) Application of section 382.
(i) Ownership change occurring before November 13, 2020.
(A) Pre-change loss.
(B) Loss corporation.
(ii) Ownership change occurring on or after November 13, 2020.
(A) Pre-change loss.
(B) Loss corporation.
(5) Treatment of excess limitation from taxable years beginning
before January 1, 2018.
(6) Example: Members of an affiliated group.
(d) Applicability date.
0
Par. 3. Sections 1.163(j)-1 through 1.163(j)-11 are added to read as
follows:
Sec.
* * * * *
1.163(j)-1 Definitions.
1.163(j)-2 Deduction for business interest expense limited.
1.163(j)-3 Relationship of the section 163(j) limitation to other
provisions affecting interest.
1.163(j)-4 General rules applicable to C corporations (including
REITs, RICs, and members of consolidated groups) and tax-exempt
corporations.
1.163(j)-5 General rules governing disallowed business interest
expense carryforwards for C corporations.
1.163(j)-6 Application of the section 163(j) limitation to
partnerships and subchapter S corporations.
1.163(j)-7 Application of the section 163(j) limitation to foreign
corporations and United States shareholders.
1.163(j)-8 [Reserved]
1.163(j)-9 Elections for excepted trades or businesses; safe harbor
for certain REITs.
1.163(j)-10 Allocation of interest expense, interest income, and
other items of expense and gross income to an excepted trade or
business.
1.163(j)-11 Transition rules.
* * * * *
Sec. 1.163(j)-1 Definitions.
(a) In general. The definitions provided in this section apply for
purposes of the section 163(j) regulations. For purposes of the rules
set forth in Sec. Sec. 1.163(j)-2 through 1.163(j)-11, additional
definitions for certain terms are provided in those sections.
(b) Definitions--(1) Adjusted taxable income. The term adjusted
taxable income (ATI) means the tentative taxable income of the taxpayer
for the taxable year, with the adjustments in this paragraph (b)(1).
(i) Additions. The amounts of the following items that were
included in the computation of the taxpayer's tentative taxable income
(if any) are added to tentative taxable income to determine ATI--
(A) Any business interest expense, other than disallowed business
interest expense carryforwards;
(B) Any net operating loss deduction under section 172;
(C) Any deduction under section 199A;
(D) Subject to paragraph (b)(1)(iii) of this section, for taxable
years beginning before January 1, 2022, any depreciation under section
167, section 168, or section 168 of the Internal Revenue Code (Code) of
1954 (former section 168);
(E) Subject to paragraph (b)(1)(iii) of this section, for taxable
years beginning before January 1, 2022, any amortization of intangibles
(for example, under section 167 or 197) and other amortized
expenditures (for example, under section 174(b), 195(b)(1)(B), 248, or
1245(a)(2)(C));
(F) Subject to paragraph (b)(1)(iii) of this section, for taxable
years beginning before January 1, 2022, any depletion under section
611;
(G) Any deduction for a capital loss carryback or carryover; and
(H) Any deduction or loss that is not properly allocable to a non-
excepted trade or business (for rules governing the allocation of items
to an excepted trade or business, see Sec. Sec. 1.163(j)-1(b)(44) and
1.163(j)-10).
(ii) Subtractions. The amounts of the following items (if any) are
subtracted from the taxpayer's tentative taxable income to determine
ATI --
(A) Any business interest income that was included in the
computation of the taxpayer's tentative taxable income;
(B) Any floor plan financing interest expense for the taxable year
that was included in the computation of the taxpayer's tentative
taxable income;
(C) With respect to the sale or other disposition of property, the
greater of the allowed or allowable depreciation, amortization, or
depletion of the property, as provided under section 1016(a)(2), for
the taxpayer (or, if the taxpayer is a member of a consolidated group,
the consolidated group) for the taxable years beginning after December
31, 2017, and before January 1, 2022, with respect to such property;
(D) With respect to the sale or other disposition of stock of a
member of a consolidated group by another member, the investment
adjustments under Sec. 1.1502-32 with respect to such stock that are
attributable to deductions described in paragraph (b)(1)(ii)(C) of this
section;
(E) With respect to the sale or other disposition of an interest in
a partnership, the taxpayer's distributive share of deductions
described in paragraph (b)(1)(ii)(C) of this section with respect to
property held by the partnership at the time of such sale or other
disposition to the extent such deductions were allowable under section
704(d);
[[Page 56761]]
(F) Any income or gain that is not properly allocable to a non-
excepted trade or business (for rules governing the allocation of items
to an excepted trade or business, see Sec. Sec. 1.163(j)-1(b)(44) and
1.163(j)-10)) and that was included in the computation of the
taxpayer's tentative taxable income; and
(G) An amount equal to the sum of any specified deemed inclusions
that were included in the computation of the taxpayer's tentative
taxable income, reduced by the portion of the deduction allowed under
section 250(a) by reason of the specified deemed inclusions. For this
purpose, a specified deemed inclusion is the inclusion of an amount by
a United States shareholder (as defined in section 951(b)) in gross
income under section 78, 951(a), or 951A(a) with respect to an
applicable CFC (as defined in Sec. 1.163(j)-1(b)(2)) that is properly
allocable to a non-excepted trade or business. Furthermore, a specified
deemed inclusion includes any amounts included in a domestic
partnership's gross income under section 951(a) or 951A(a) with respect
to an applicable CFC to the extent such amounts are attributable to
investment income of the partnership and are allocated to a domestic C
corporation that is a direct (or indirect partner) and treated as
properly allocable to a non-excepted trade or business of the domestic
C corporation under Sec. Sec. 1.163(j)-4(b)(3) and 1.163(j)-10. To
determine the amount of a specified deemed inclusion described in this
paragraph (b)(1)(ii)(G), the portion of a United States shareholder's
inclusion under section 951A(a) treated as being with respect to an
applicable CFC is determined under section 951A(f)(2) and Sec. 1.951A-
6(b)(2).
(iii) Depreciation, amortization, or depletion capitalized under
section 263A. For purposes of paragraph (b)(1)(i) of this section,
amounts of depreciation, amortization, or depletion that are
capitalized under section 263A during the taxable year are deemed to be
included in the computation of the taxpayer's tentative taxable income
for such taxable year, regardless of the period in which the
capitalized amount is recovered. See Example 3 in Sec. 1.163(j)-
2(h)(3).
(iv) Application of Sec. 1.163(j)-1(b)(1)(ii)(C), (D), and (E)--
(A) Sale or other disposition--(1) In general. For purposes of
paragraphs (b)(1)(ii)(C), (D), and (E) of this section, except as
otherwise provided in this paragraph (b)(1)(iv)(A), the term sale or
other disposition does not include a transfer of an asset to an
acquiring corporation in a transaction to which section 381(a) applies.
(2) Intercompany transactions. For purposes of paragraphs
(b)(1)(ii)(C) and (D) of this section, the term sale or other
disposition excludes all intercompany transactions, within the meaning
of Sec. 1.1502-13(b)(1)(i).
(3) Deconsolidations. Notwithstanding any other rule in this
paragraph (b)(1)(iv)(A), any transaction in which a member leaves a
consolidated group is treated as a sale or other disposition for
purposes of paragraphs (b)(1)(ii)(C) and (D) of this section unless the
transaction is described in Sec. 1.1502-13(j)(5)(i)(A).
(B) Deductions by members of a consolidated group. If paragraph
(b)(1)(ii)(C), (D), or (E) of this section applies to adjust the
tentative taxable income of a taxpayer, the amount of the adjustment
under paragraph (b)(1)(ii)(C) of this section equals the greater of the
allowed or allowable depreciation, amortization, or depletion of the
property, as provided under section 1016(a)(2), for any member of the
consolidated group for the taxable years beginning after December 31,
2017, and before January 1, 2022, with respect to such property.
(C) Successor assets. This paragraph (b)(1)(iv)(C) applies if
deductions described in paragraph (b)(1)(ii)(C) of this section are
allowed or allowable to a consolidated group member (S) and either the
depreciable property or S's stock is subsequently transferred to
another member (S1) in an intercompany transaction in which the
transferor receives S1 stock. If this paragraph (b)(1)(iv)(C) applies,
and if the transferor's basis in the S1 stock received in the
intercompany transaction is determined, in whole or in part, by
reference to its basis in the S stock, the S1 stock received in the
intercompany transaction is treated as a successor asset to S's stock
for purposes of paragraph (b)(1)(ii)(D) of this section. Thus, except
as otherwise provided in paragraph (b)(1)(iv)(D) of this section, the
subsequent disposition of either the S1 stock or the S stock gives rise
to an adjustment under paragraph (b)(1)(ii)(D) of this section.
(D) Anti-duplication rule--(1) In general. The aggregate of the
subtractions from tentative taxable income of a consolidated group
under paragraphs (b)(1)(ii)(C) and (D) of this section with respect to
an item of property (including with regard to dispositions of successor
assets described in paragraph (b)(1)(iv)(C) of this section) cannot
exceed the aggregate amount of the consolidated group members'
deductions described in paragraph (b)(1)(ii)(C) of this section with
respect to such item of property. For example, if an adjustment to the
tentative taxable income of a consolidated group is made under
paragraph (b)(1)(ii)(C) of this section with respect to the sale or
other disposition of property by a consolidated group member (S) to an
unrelated person, and if a member of the group subsequently sells or
otherwise disposes of S's stock, no further adjustment to the group's
tentative taxable income is made under paragraph (b)(1)(ii)(D) of this
section in relation to the same property with respect to that stock
disposition.
(2) Adjustments following deconsolidation. Depreciation,
amortization, or depletion deductions allowed or allowable for a
corporation for a consolidated return year of a group are disregarded
in applying this paragraph (b)(1)(iv)(D) to any year that constitutes a
separate return year (as defined in Sec. 1.1502-1(e)) of that
corporation. For example, assume that S deconsolidates from a group
(Group 1) after holding property for which depreciation, amortization,
or depletion deductions were allowed or allowable in Group 1. On the
deconsolidation, S and Group 1 would adjust tentative taxable income
with regard to that property under paragraphs (b)(1)(ii)(D) and
(b)(1)(iv)(A)(3) of this section. If, following the deconsolidation, S
sells the property referred to in the previous sentence, no subtraction
from tentative taxable income is made under paragraph (b)(1)(ii)(C) of
this section during S's separate return year with regard to the amounts
included in Group 1 under paragraphs (b)(1)(ii)(C) and (b)(1)(iv)(A)(3)
of this section.
(v) Other adjustments. ATI is computed with the other adjustments
provided in Sec. Sec. 1.163(j)-2 through 1.163(j)-11.
(vi) Additional rules relating to adjusted taxable income in other
sections. (A) For rules governing the ATI of C corporations, see
Sec. Sec. 1.163(j)-4(b)(2) and (3) and 1.163(j)-10(a)(2)(ii).
(B) For rules governing the ATI of RICs and REITs, see Sec.
1.163(j)-4(b)(4).
(C) For rules governing the ATI of tax-exempt corporations, see
Sec. 1.163(j)-4(b)(5).
(D) For rules governing the ATI of consolidated groups, see Sec.
1.163(j)-4(d)(2)(iv) and (v).
(E) For rules governing the ATI of partnerships, see Sec.
1.163(j)-6(d).
(F) For rules governing the ATI of partners, see Sec. Sec.
1.163(j)-6(e) and 1.163(j)-6(m)(1) and (2).
(G) For rules governing partnership basis adjustments affecting
ATI, see Sec. 1.163(j)-6(h)(2).
[[Page 56762]]
(H) For rules governing the ATI of S corporations, see Sec.
1.163(j)-6(l)(3).
(I) For rules governing the ATI of S corporation shareholders, see
Sec. 1.163(j)-6(l)(4).
(J) For rules governing the ATI of certain beneficiaries of trusts
and estates, see Sec. 1.163(j)-2(f).
(vii) ATI cannot be less than zero. If the ATI of a taxpayer would
be less than zero, the ATI of the taxpayer is zero.
(viii) Examples. The examples in this paragraph (b)(1)(viii)
illustrate the application of paragraphs (b)(1)(ii), (iii), and (iv) of
this section. Unless otherwise indicated, A, B, P, S, and T are
calendar-year domestic C corporations; P is the parent of a
consolidated group of which S and T are members; the exemption for
certain small businesses in Sec. 1.163(j)-2(d) does not apply; no
entity is engaged in an excepted trade or business; no entity has
business interest income or floor plan financing interest expense; and
all amounts of interest expense are deductible except for the potential
application of section 163(j).
(A) Example 1--(1) Facts. In 2021, A purchases a depreciable asset
(Asset X) for $100x and fully depreciates Asset X under section 168(k).
For the 2021 taxable year, A's ATI (after adding back A's depreciation
deductions with respect to Asset X under paragraph (b)(1)(i)(D) of this
section) is $150x. A incurs $45x of business interest expense in 2021.
In 2024, A sells Asset X to an unrelated third party.
(2) Analysis. A's section 163(j) limitation for 2021 is $45x ($150x
x 30 percent). Thus, all $45x of A's business interest expense incurred
in 2021 is deductible in that year. However, under paragraph
(b)(1)(ii)(C) of this section, A must subtract $100x from its tentative
taxable income in computing its ATI for its 2024 taxable year. A would
be required to subtract $100x from its tentative taxable income in
computing its ATI for its 2024 taxable year even if A's ATI in 2021 was
$150x before adding back A's depreciation deductions with respect to
Asset X.
(3) Transfer of assets in a nonrecognition transaction to which
section 381 applies. The facts are the same as in paragraph
(b)(1)(viii)(A)(1) of this section, except that, rather than sell Asset
X to an unrelated third party in 2024, A merges with and into an
unrelated third party in 2024 in a transaction described in section
368(a)(1)(A) in which no gain is recognized. As provided in paragraph
(b)(1)(iv)(A) of this section, the merger transaction is not treated as
a ``sale or other disposition'' for purposes of paragraph (b)(1)(ii)(C)
of this section. Thus, no adjustment to tentative taxable income is
required in 2024 under paragraph (b)(1)(ii)(C) of this section.
(4) Transfer of assets in a nonrecognition transaction to which
section 351 applies. The facts are the same as in paragraph
(b)(1)(viii)(A)(1) of this section, except that, rather than sell Asset
X to an unrelated third party in 2024, A transfers Asset X to B (A's
wholly owned subsidiary) in 2024 in a transaction to which section 351
applies. The section 351 transaction is treated as a ``sale or other
disposition'' for purposes of paragraph (b)(1)(ii)(C) of this section.
Thus, A must subtract $100x from its tentative taxable income in
computing its ATI for its 2024 taxable year.
(B) Example 2--(1) Facts. In 2021, S purchases a depreciable asset
(Asset Y) for $100x and fully depreciates Asset Y under section 168(k).
P reduces its basis in its S stock by $100x under Sec. 1.1502-32 to
reflect S's depreciation deductions. For the 2021 taxable year, the P
group's ATI (after adding back S's depreciation deductions with respect
to Asset Y under paragraph (b)(1)(i)(D) of this section) is $150x. The
P group incurs $45x of business interest expense in 2021. In 2024, P
sells all of its S stock to an unrelated third party.
(2) Analysis. The P group's section 163(j) limitation for 2021 is
$45x ($150x x 30 percent). Thus, all $45x of the P group's business
interest expense incurred in 2021 is deductible in that year. However,
under paragraph (b)(1)(ii)(D) of this section, the P group must
subtract $100x from its tentative taxable income in computing its ATI
for its 2024 taxable year. The answer would be the same if the P
group's ATI in 2021 were $150x before adding back S's depreciation
deductions with respect to Asset Y.
(3) Disposition of less than all member stock. The facts are the
same as in paragraph (b)(1)(viii)(B)(1) of this section, except that,
in 2024, P sells half of its S stock to an unrelated third party.
Pursuant to paragraph (b)(1)(ii)(D) of this section, the P group must
subtract $100x from its tentative taxable income in computing its ATI
for its 2024 taxable year.
(4) Transfer in an intercompany transaction. The facts are the same
as in paragraph (b)(1)(viii)(B)(1) of this section, except that, rather
than sell S's stock to an unrelated third party in 2024, P transfers
S's stock to another member of the P group in an intercompany
transaction (as defined in Sec. 1.1502-13(b)(1)(i)) in 2024. As
provided in paragraph (b)(1)(iv)(A) of this section, the intercompany
transaction is not treated as a ``sale or other disposition'' for
purposes of paragraph (b)(1)(ii)(D) of this section. Thus, no
adjustment to tentative taxable income is required in 2024 under
paragraph (b)(1)(ii)(D) of this section.
(5) Disposition of successor assets. The facts are the same as in
paragraph (b)(1)(viii)(B)(1) of this section, except that, rather than
sell S's stock to an unrelated third party in 2024, P transfers S's
stock to T in 2024 in a transaction to which section 351 applies and,
in 2025, P sells all of its T stock to an unrelated third party.
Pursuant to paragraph (b)(1)(iv)(A) of this section, P's intercompany
transfer of S's stock to T is not a ``sale or other disposition'' for
purposes of paragraph (b)(1)(ii)(D) of this section. However, pursuant
to paragraph (b)(1)(iv)(C) of this section, P's stock in T is treated
as a successor asset for purposes of paragraph (b)(1)(ii)(D) of this
section. Thus, the P group must subtract $100x from its tentative
taxable income in computing its ATI for its 2025 taxable year.
(C) Example 3--(1) Facts. In 2021, S purchases a depreciable asset
(Asset Z) for $100x and fully depreciates Asset Z under section 168(k).
P reduces its basis in its S stock by $100x under Sec. 1.1502-32 to
reflect S's depreciation deductions. For the 2021 taxable year, the P
group's ATI (after adding back S's depreciation deductions with respect
to Asset Z under paragraph (b)(1)(i)(D) of this section) is $150x. The
P group incurs $45x of business interest expense in 2021. In 2024, S
sells Asset Z to an unrelated third party. In 2025, P sells all of its
S stock to a member of another consolidated group.
(2) Analysis. Under paragraph (b)(1)(ii)(C) of this section, the P
group must subtract $100x from its tentative taxable income in
computing its ATI for its 2024 taxable year. The answer would be the
same if the P group's ATI in 2021 were $150x before adding back S's
depreciation deductions with respect to Asset Z. P's sale of all of its
S stock in 2025 is a ``sale or other disposition'' for purposes of
paragraph (b)(1)(ii)(D) of this section. However, pursuant to paragraph
(b)(1)(iv)(D)(1) of this section, no further adjustment to the P
group's tentative taxable income is required in 2025 under paragraph
(b)(1)(ii)(D) of this section.
(3) Disposition of S stock prior to S's asset disposition. The
facts are the same as in paragraph (b)(1)(viii)(C)(1) of this section,
except that, in 2024, P sells all of its S stock to a member of another
consolidated group and, in 2025, S sells Asset Z to an unrelated third
party. Pursuant to paragraph (b)(1)(ii)(D) of this section, the P group
must subtract $100x from its tentative taxable income
[[Page 56763]]
in computing its ATI for its 2024 taxable year. Pursuant to paragraph
(b)(1)(iv)(D)(2) of this section, no adjustment to the acquiring
group's tentative taxable income is required in 2025 under paragraph
(b)(1)(ii)(C) of this section.
(4) Transfer of S stock in nonrecognition transaction. The facts
are the same as in paragraph (b)(1)(vii)(C)(3) of this section, except
that, rather than sell all of S's stock to a member of another
consolidated group, P causes S to merge with and into a member of
another consolidated group in a transaction described in section
368(a)(1)(A). As provided in paragraph (b)(1)(iv)(A) of this section,
the merger transaction is treated as a ``sale or other disposition''
for purposes of paragraph (b)(1)(ii)(D) of this section because S
leaves the P group. Thus, the results are the same as in paragraph
(b)(1)(vii)(C)(3) of this section.
(D) Example 4--(1) Facts. P wholly owns T, which wholly owns S. In
2021, S purchases a depreciable asset (Asset AA) for $100x and fully
depreciates Asset AA under section 168(k). T reduces its basis in its S
stock, and P reduces its basis in its T stock, by $100x under Sec.
1.1502-32 to reflect S's depreciation deductions. For the 2021 taxable
year, the P group's ATI (after adding back S's depreciation deductions
with respect to Asset AA under paragraph (b)(1)(i)(D) of this section)
is $150x. The P group incurs $45x of business interest expense in 2021.
In 2024, T sells all of its S stock to a member of another consolidated
group. In 2025, P sells all of its T stock to a member of another
consolidated group.
(2) Analysis. Pursuant to paragraph (b)(1)(ii)(D) of this section,
the P group must subtract $100x from its tentative taxable income in
computing its ATI for its 2024 taxable year. Pursuant to paragraph
(b)(1)(iv)(D)(1) of this section, no adjustment to the P group's
tentative taxable income is required in 2025 under paragraph
(b)(1)(ii)(D) of this section.
(2) Applicable CFC. The term applicable CFC means a foreign
corporation described in section 957, but only if the foreign
corporation has at least one United States shareholder that owns,
within the meaning of section 958(a), stock of the foreign corporation.
(3) Business interest expense--(i) In general. The term business
interest expense means interest expense that is properly allocable to a
non-excepted trade or business or that is floor plan financing interest
expense. Business interest expense also includes disallowed business
interest expense carryforwards (as defined in paragraph (b)(11) of this
section). However, business interest expense does not include amounts
of interest expense carried forward to the taxable year from a prior
taxable year due to the application of section 465 or section 469,
which apply after the application of section 163(j). For the treatment
of investment interest, see section 163(d); and for the treatment of
personal interest, see section 163(h).
(ii) Special rules. For special rules for defining business
interest expense in certain circumstances, see Sec. Sec. 1.163(j)-
3(b)(2) (regarding disallowed interest expense), 1.163(j)-4(b)
(regarding C corporations) and 1.163(j)-4(d)(2)(iii) (regarding
consolidated groups), 1.163(j)-1(b)(9) (regarding current-year business
interest expense), and 1.163(j)-6(c) (regarding partnerships and S
corporations).
(4) Business interest income--(i) In general. The term business
interest income means interest income includible in the gross income of
a taxpayer for the taxable year which is properly allocable to a non-
excepted trade or business. For the treatment of investment income, see
section 163(d).
(ii) Special rules. For special rules defining business interest
income in certain circumstances, see Sec. Sec. 1.163(j)-4(b)
(regarding C corporations), 1.163(j)-4(d)(2)(iii) (regarding
consolidated groups), and 1.163(j)-6(c) (regarding partnerships and S
corporations).
(5) C corporation. The term C corporation has the meaning provided
in section 1361(a)(2).
(6) Cleared swap. The term cleared swap means a swap that is
cleared by a derivatives clearing organization, as such term is defined
in section 1a of the Commodity Exchange Act (7 U.S.C. 1a), or by a
clearing agency, as such term is defined in section 3 of the Securities
Exchange Act of 1934 (15 U.S.C. 78c), that is registered as a
derivatives clearing organization under the Commodity Exchange Act or
as a clearing agency under the Securities Exchange Act of 1934,
respectively, if the derivatives clearing organization or clearing
agency requires the parties to the swap to post and collect margin or
collateral.
(7) Consolidated group. The term consolidated group has the meaning
provided in Sec. 1.1502-1(h).
(8) Consolidated return year. The term consolidated return year has
the meaning provided in Sec. 1.1502-1(d).
(9) Current-year business interest expense. The term current-year
business interest expense means business interest expense that would be
deductible in the current taxable year without regard to section 163(j)
and that is not a disallowed business interest expense carryforward
from a prior taxable year.
(10) Disallowed business interest expense. The term disallowed
business interest expense means the amount of business interest expense
for a taxable year in excess of the amount allowed as a deduction for
the taxable year under section 163(j)(1) and Sec. 1.163(j)-2(b). For
purposes of section 163(j) and the regulations in this part under
section 163(j) of the Internal Revenue Code (Code) disallowed business
interest expense is treated as ``paid or accrued'' in the taxable year
in which the expense is deductible for Federal income tax purposes
(without regard to section 163(j)) or in the taxable year in which a
deduction for the business interest expense is permitted under section
163(j), as the context may require.
(11) Disallowed business interest expense carryforward. The term
disallowed business interest expense carryforward means any business
interest expense described in Sec. 1.163(j)-2(c).
(12) Disallowed disqualified interest. The term disallowed
disqualified interest means interest expense, including carryforwards,
for which a deduction was disallowed under old section 163(j) (as
defined in paragraph (b)(27) of this section) in the taxpayer's last
taxable year beginning before January 1, 2018, and that was carried
forward pursuant to old section 163(j).
(13) Electing farming business. The term electing farming business
means a trade or business that makes an election as provided in Sec.
1.163(j)-9 or other published guidance and that is--
(i) A farming business, as defined in section 263A(e)(4) or Sec.
1.263A-4(a)(4);
(ii) Any trade or business of a specified agricultural or
horticultural cooperative, as defined in section 199A(g)(4); or
(iii) Specifically designated by the Secretary in guidance
published in the Federal Register or the Internal Revenue Bulletin (see
Sec. 601.601(d) of this chapter) as a farming business for purposes of
section 163(j).
(14) Electing real property trade or business. The term electing
real property trade or business means a trade or business that makes an
election as provided in Sec. 1.163(j)-9 or other published guidance
and that is--
(i) A real property trade or business described in section
469(c)(7)(C) and Sec. 1.469-9(b)(2); or
(ii) A REIT that qualifies for the safe harbor described in Sec.
1.163(j)-9(h); or
(iii) A trade or business specifically designated by the Secretary
in guidance published in the Federal Register or the
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Internal Revenue Bulletin (see Sec. 601.601(d) of this chapter) as a
real property trade or business for purposes of section 163(j).
(15) Excepted regulated utility trade or business--(i) In general.
The term excepted regulated utility trade or business means:
(A) Automatically excepted regulated utility trades or businesses.
A trade or business--
(1) That furnishes or sells--
(i) Electrical energy, water, or sewage disposal services;
(ii) Gas or steam through a local distribution system; or
(iii) Transportation of gas or steam by pipeline; but only
(2) To the extent that the rates for the furnishing or sale of the
items in paragraph (b)(15)(i)(A)(1) of this section--
(i) Have been established or approved by a State or political
subdivision thereof, by any agency or instrumentality of the United
States, or by a public service or public utility commission or other
similar body of any State or political subdivision thereof and are
determined on a cost of service and rate of return basis; or
(ii) Have been established or approved by the governing or
ratemaking body of an electric cooperative; or
(B) Electing regulated utility trades or businesses. A trade or
business that makes a valid election under paragraph (b)(15)(iii) of
this section; or
(C) Designated excepted regulated utility trades or businesses. A
trade or business that is specifically designated by the Secretary in
guidance published in the Federal Register or the Internal Revenue
Bulletin as an excepted regulated utility trade or business (see Sec.
601.601(d) of this chapter) for section 163(j) purposes.
(ii) Depreciation and excepted and non-excepted utility trades or
businesses.
(A) Depreciation. Taxpayers engaged in an excepted trade or
business described in paragraph (b)(15)(i) of this section cannot claim
the additional first-year depreciation deduction under section 168(k)
for any property that is primarily used in the excepted regulated
utility trade or business.
(B) Allocation of items. If a taxpayer is engaged in one or more
excepted trades or businesses, as described in paragraph (b)(15)(i) of
this section, and one or more non-excepted trades or businesses, the
taxpayer must allocate items between the excepted and non-excepted
utility trades or businesses. See Sec. Sec. 1.163(j)-1(b)(44) and
1.163(j)-10(c)(3)(iii)(C). Some trades or businesses with de minimis
furnishing or sales of items described in paragraph (b)(15)(i)(A)(1) of
this section that are not sold pursuant to rates that are determined on
a cost of service and rate of return basis or established or approved
by the governing or ratemaking body of an electric cooperative, and are
not subject to an election in paragraph (b)(15)(iii), are treated as
excepted trades or businesses. See Sec. 1.163(j)-10(c)(3)(iii)(C)(3).
For look-through rules applicable to certain CFCs that furnish or sell
items described in paragraph (b)(15)(i)(A)(1) of this section that are
not sold pursuant to rates that are determined on a cost of service and
rate of return basis or established or approved by the governing or
ratemaking body of an electric cooperative as described in paragraph
(b)(15)(i)(A)(2) of this section, see Sec. 1.163(j)-10(c)(5)(ii)(C).
(iii) Election to be an excepted regulated utility trade or
business. (A) In general. A trade or business that is not an excepted
regulated utility trade or business described in paragraph
(b)(15)(i)(A) or (C) of this section and that furnishes or sells items
described in paragraph (b)(15)(i)(A)(1) of this section is eligible to
make an election to be an excepted regulated utility trade or business
to the extent that the rates for furnishing or selling the items
described in paragraph (b)(15)(i)(A)(1) of this section have been
established or approved by a regulatory body described in paragraph
(b)(15)(i)(A)(2)(i) of this section.
(B) Scope and effect of election--(1) In general. An election under
paragraph (b)(15)(iii) of this section is made with respect to each
eligible trade or business of the taxpayer and applies only to the
trade or business for which the election is made. An election under
paragraph (b)(15)(iii) of this section applies to the taxable year in
which the election is made and to all subsequent taxable years.
(2) Irrevocability. An election under paragraph (b)(15)(iii) of
this section is irrevocable.
(C) Time and manner of making election--(1) In general. Subject to
paragraph (b)(15)(iii)(C)(5) of this section, a taxpayer makes an
election under paragraph (b)(15)(iii) by attaching an election
statement to the taxpayer's timely filed original Federal income tax
return, including extensions. A taxpayer may make elections for
multiple trades or businesses on a single election statement.
(2) Election statement contents. The election statement should be
titled ``Section 1.163(j)-1(b)(15)(iii) Election'' and must contain the
following information for each trade or business:
(i) The taxpayer's name;
(ii) The taxpayer's address;
(iii) The taxpayer's social security number (SSN) or employer
identification number (EIN);
(iv) A description of the taxpayer's electing trade or business
sufficient to demonstrate qualification for an election under this
section, including the principal business activity code; and
(v) A statement that the taxpayer is making an election under
section 1.163(j)-1(b)(15)(iii).
(3) Consolidated group's or partnership's trade or business. The
rules in Sec. 1.163(j)-9(d)(3) and (4) apply with respect to an
election under paragraph (b)(15)(iii) of this section for a
consolidated group's or partnership's trade or business.
(4) Termination of election. The rules in Sec. 1.163(j)-9(e) apply
to determine when an election under paragraph (b)(15)(iii) of this
section terminates.
(5) Additional guidance. The rules and procedures regarding the
time and manner of making an election under paragraph (b)(15)(iii) of
this section and the election statement contents in paragraph
(b)(15)(iii)(C)(2) of this section may be modified through other
guidance (see Sec. Sec. 601.601(d) and 601.602 of this chapter).
Additional situations in which an election may terminate under
paragraph (b)(15)(iii)(C)(4) of this section may be provided through
guidance published in the Federal Register or in the Internal Revenue
Bulletin (see Sec. 601.601(d) of this chapter).
(16) Excess business interest expense. For any partnership, the
term excess business interest expense means the amount of disallowed
business interest expense of the partnership for a taxable year under
section Sec. 1.163(j)-2(b). With respect to a partner, see Sec.
1.163(j)-6(g) and (h).
(17) Excess taxable income. With respect to any partnership or S
corporation, the term excess taxable income means the amount which
bears the same ratio to the partnership's ATI as--
(i) The excess (if any) of--
(A) The amount determined for the partnership or S corporation
under section 163(j)(1)(B); over
(B) The amount (if any) by which the business interest expense of
the partnership, reduced by the floor plan financing interest expense,
exceeds the business interest income of the partnership or S
corporation; bears to
(ii) The amount determined for the partnership or S corporation
under section 163(j)(1)(B).
(18) Floor plan financing indebtedness. The term floor plan
[[Page 56765]]
financing indebtedness means indebtedness--
(i) Used to finance the acquisition of motor vehicles held for sale
or lease; and
(ii) Secured by the motor vehicles so acquired.
(19) Floor plan financing interest expense. The term floor plan
financing interest expense means interest paid or accrued on floor plan
financing indebtedness. For purposes of the section 163(j) regulations,
all floor plan financing interest expense is treated as business
interest expense. See paragraph (b)(3) of this section.
(20) Group. The term group has the meaning provided in Sec.
1.1502-1(a).
(21) Intercompany transaction. The term intercompany transaction
has the meaning provided in Sec. 1.1502-13(b)(1)(i).
(22) Interest. The term interest means any amount described in
paragraph (b)(22)(i), (ii), (iii), or (iv) of this section.
(i) In general. Interest is an amount paid, received, or accrued as
compensation for the use or forbearance of money under the terms of an
instrument or contractual arrangement, including a series of
transactions, that is treated as a debt instrument for purposes of
section 1275(a) and Sec. 1.1275-1(d), and not treated as stock under
Sec. 1.385-3, or an amount that is treated as interest under other
provisions of the Code or the Income Tax Regulations. Thus, interest
includes, but is not limited to, the following:
(A) Original issue discount (OID), as adjusted by the holder for
any acquisition premium or amortizable bond premium;
(B) Qualified stated interest, as adjusted by the holder for any
amortizable bond premium or by the issuer for any bond issuance
premium;
(C) Acquisition discount;
(D) Amounts treated as taxable OID under section 1286 (relating to
stripped bonds and stripped coupons);
(E) Accrued market discount on a market discount bond to the extent
includible in income by the holder under either section 1276(a) or
1278(b);
(F) OID includible in income by a holder that has made an election
under Sec. 1.1272-3 to treat all interest on a debt instrument as OID;
(G) OID on a synthetic debt instrument arising from an integrated
transaction under Sec. 1.1275-6;
(H) Repurchase premium to the extent deductible by the issuer under
Sec. 1.163-7(c) (determined without regard to section 163(j));
(I) Deferred payments treated as interest under section 483;
(J) Amounts treated as interest under a section 467 rental
agreement;
(K) Amounts treated as interest under section 988;
(L) Forgone interest under section 7872;
(M) De minimis OID taken into account by the issuer;
(N) Amounts paid or received in connection with a sale-repurchase
agreement treated as indebtedness under Federal tax principles;
however, in the case of a sale-repurchase agreement relating to tax-
exempt bonds, the amount is not tax-exempt interest;
(O) Redeemable ground rent treated as interest under section
163(c); and
(P) Amounts treated as interest under section 636.
(ii) Swaps with significant nonperiodic payments--(A) In general.
Except as provided in paragraphs (b)(22)(ii)(B) and (C) of this
section, a swap with significant nonperiodic payments is treated as two
separate transactions consisting of an on-market, level payment swap
and a loan. The loan must be accounted for by the parties to the
contract independently of the swap. The time value component associated
with the loan, determined in accordance with Sec. 1.446-
3(f)(2)(iii)(A), is recognized as interest expense to the payor and
interest income to the recipient.
(B) Exception for cleared swaps. Paragraph (b)(22)(ii)(A) of this
section does not apply to a cleared swap (as defined in paragraph
(b)(6) of this section).
(C) Exception for non-cleared swaps subject to margin or collateral
requirements. Paragraph (b)(22)(ii)(A) of this section does not apply
to a non-cleared swap that requires the parties to meet the margin or
collateral requirements of a federal regulator or that provides for
margin or collateral requirements that are substantially similar to a
cleared swap or a non-cleared swap subject to the margin or collateral
requirements of a federal regulator. For purposes of this paragraph
(b)(22)(ii)(C), the term federal regulator means the Securities and
Exchange Commission (SEC), the Commodity Futures Trading Commission
(CFTC), or a prudential regulator, as defined in section 1a(39) of the
Commodity Exchange Act (7 U.S.C. 1a), as amended by section 721 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010,
Public Law 111-203, 124 Stat. 1376, Title VII.
(iii) Other amounts treated as interest--(A) Treatment of premium--
(1) Issuer. If a debt instrument is issued at a premium within the
meaning of Sec. 1.163-13, any ordinary income under Sec. 1.163-
13(d)(4) is treated as interest income of the issuer.
(2) Holder. If a taxable debt instrument is acquired at a premium
within the meaning of Sec. 1.171-1 and the holder elects to amortize
the premium, any amount deductible as a bond premium deduction under
section 171(a)(1) and Sec. 1.171-2(a)(4)(i)(A) or (C) is treated as
interest expense of the holder.
(B) Treatment of ordinary income or loss on certain debt
instruments. If an issuer of a contingent payment debt instrument
subject to Sec. 1.1275-4(b), a nonfunctional currency contingent
payment debt instrument subject to Sec. 1.988-6, or an inflation-
indexed debt instrument subject to Sec. 1.1275-7 recognizes ordinary
income on the debt instrument in accordance with the rules in Sec.
1.1275-4(b), Sec. 1.988-6(b)(2), or Sec. 1.1275-7(f), whichever is
applicable, the ordinary income is treated as interest income of the
issuer. If a holder of a contingent payment debt instrument subject to
Sec. 1.1275-4(b), a nonfunctional currency contingent payment debt
instrument subject to Sec. 1.988-6, or an inflation-indexed debt
instrument subject to Sec. 1.1275-7 recognizes an ordinary loss on the
debt instrument in accordance with the rules in Sec. 1.1275-4(b),
Sec. 1.988-6(b)(2), or Sec. 1.1275-7(f), whichever is applicable, the
ordinary loss is treated as interest expense of the holder.
(C) Substitute interest payments. A substitute interest payment
described in Sec. 1.861-2(a)(7) is treated as interest expense to the
payor only if the payment relates to a sale-repurchase agreement or a
securities lending transaction that is not entered into by the payor in
the ordinary course of the payor's business. A substitute interest
payment described in Sec. 1.861-2(a)(7) is treated as interest income
to the recipient only if the payment relates to a sale-repurchase
agreement or a securities lending transaction that is not entered into
by the recipient in the ordinary course of the recipient's business;
however, in the case of a sale-repurchase agreement or a securities
lending transaction relating to tax-exempt bonds, the recipient of a
substitute payment does not receive tax-exempt interest income. This
paragraph (b)(22)(iii)(C) does not apply to an amount described in
paragraph (b)(22)(i)(N) of this section.
(D) Section 1258 gain. Any gain treated as ordinary gain under
section 1258 is treated as interest income.
(E) Factoring income. The excess of the amount that a taxpayer
collects on a factored receivable (or realizes upon
[[Page 56766]]
the sale or other disposition of the factored receivable) over the
amount paid for the factored receivable by the taxpayer is treated as
interest income. For purposes of this paragraph (b)(22)(iii)(E), the
term factored receivable includes any account receivable or other
evidence of indebtedness, whether or not issued at a discount and
whether or not bearing stated interest, arising out of the disposition
of property or the performance of services by any person, if such
account receivable or evidence of indebtedness is acquired by a person
other than the person who disposed of the property or provided the
services that gave rise to the account receivable or evidence of
indebtedness. This paragraph (b)(22)(iii)(E) does not apply to an
amount described in paragraph (b)(22)(i)(C) or (E) of this section.
(F) [Reserved]
(iv) Anti-avoidance rules--(A) Principal purpose to reduce interest
expense--(1) Treatment as interest expense. Any expense or loss
economically equivalent to interest is treated as interest expense if a
principal purpose of structuring the transaction(s) is to reduce an
amount incurred by the taxpayer that otherwise would have been
described in paragraph (b)(22)(i), (ii), or (iii) of this section. For
this purpose, the fact that the taxpayer has a business purpose for
obtaining the use of funds does not affect the determination of whether
the manner in which the taxpayer structures the transaction(s) is with
a principal purpose of reducing the taxpayer's interest expense. In
addition, the fact that the taxpayer has obtained funds at a lower pre-
tax cost based on the structure of the transaction(s) does not affect
the determination of whether the manner in which the taxpayer
structures the transaction(s) is with a principal purpose of reducing
the taxpayer's interest expense. For purposes of this paragraph
(b)(22)(iv)(A)(1), any expense or loss is economically equivalent to
interest to the extent that the expense or loss is--
(i) Deductible by the taxpayer;
(ii) Incurred by the taxpayer in a transaction or series of
integrated or related transactions in which the taxpayer secures the
use of funds for a period of time;
(iii) Substantially incurred in consideration of the time value of
money; and
(iv) Not described in paragraph (b)(22)(i), (ii), or (iii) of this
section.
(2) Corresponding treatment of amounts as interest income. If a
taxpayer knows that an expense or loss is treated by the payor as
interest expense under paragraph (b)(22)(iv)(A)(1) of this section, the
taxpayer provides the use of funds for a period of time in the
transaction(s) subject to paragraph (b)(22)(iv)(A)(1) of this section,
the taxpayer earns income or gain with respect to the transaction(s),
and such income or gain is substantially earned in consideration of the
time value of money provided by the taxpayer, such income or gain is
treated as interest income to the extent of the expense or loss treated
by the payor as interest expense under paragraph (b)(22)(iv)(A)(1) of
this section.
(B) Interest income artificially increased. Notwithstanding
paragraphs (b)(22)(i) through (iii) of this section, any income
realized by a taxpayer in a transaction or series of integrated or
related transactions is not treated as interest income of the taxpayer
if and to the extent that a principal purpose for structuring the
transaction(s) is to artificially increase the taxpayer's business
interest income. For this purpose, the fact that the taxpayer has a
business purpose for holding interest generating assets does not affect
the determination of whether the manner in which the taxpayer
structures the transaction(s) is with a principal purpose of
artificially increasing the taxpayer's business interest income.
(C) Principal purpose. Whether a transaction or a series of
integrated or related transactions is entered into with a principal
purpose described in paragraph (b)(22)(iv)(A) or (B) of this section
depends on all the facts and circumstances related to the
transaction(s), except for those facts described in paragraph
(b)(22)(iv)(A) or (B) of this section. A purpose may be a principal
purpose even though it is outweighed by other purposes (taken together
or separately). Factors to be taken into account in determining whether
one of the taxpayer's principal purposes for entering into the
transaction(s) include the taxpayer's normal borrowing rate in the
taxpayer's functional currency, whether the taxpayer would enter into
the transaction(s) in the ordinary course of the taxpayer's trade or
business, whether the parties to the transaction(s) are related persons
(within the meaning of section 267(b) or section 707(b)), whether there
is a significant and bona fide business purpose for the structure of
the transaction(s), whether the transactions are transitory, for
example, due to a circular flow of cash or other property, and the
substance of the transaction(s).
(D) Coordination with anti-avoidance rule in Sec. 1.163(j)-2(j).
The anti-avoidance rules in paragraphs (b)(22)(iv)(A) through (C) of
this section, rather than the anti-avoidance rules in Sec. 1.163(j)-
2(j), apply to determine whether an item is treated as interest expense
or interest income.
(v) Examples. The examples in this paragraph (b)(22)(v) illustrate
the application of paragraph (b)(22)(iv) of this section. Unless
otherwise indicated, A, B, C, D, and Bank are domestic C corporations
that are publicly traded; the exemption for certain small businesses in
Sec. 1.163(j)-2(d) does not apply; A is not engaged in an excepted
trade or business; and all amounts of interest expense are deductible
except for the potential application of section 163(j).
(A) Example 1--(1) Facts. A is engaged in a manufacturing business
and uses the calendar year as its annual accounting period. A's
functional currency is the U.S. dollar and A conducts virtually all of
its business in the U.S. dollar. A has no connection to Japan or the
Japanese yen in the ordinary course of business. A projects that it
will have business interest expense of $100x on an existing loan
obligation with a stated principal amount of $2,000x (Loan 1) and no
business interest income in its taxable year ending December 31, 2021.
In early 2021, A enters into the following transactions, which A would
not have entered into in the ordinary course of A's trade or business:
(i) A enters into a loan obligation in which A borrows Japanese yen
from Bank in an amount equivalent to $2,000x with an interest rate of 1
percent (Loan 2) (at the time of the loan, the U.S. dollar equivalent
interest rate on a loan of $2,000x is 5 percent);
(ii) A enters into a foreign currency swap transaction (FX Swap)
with Bank with a notional principal amount of $2,000x under which A
receives Japanese yen at 1 percent multiplied by the amount of Japanese
yen borrowed from Bank (which for 2021 equals $20x) and pays U.S.
dollars at 5 percent multiplied by a notional amount of $2,000x ($100x
per year);
(iii) The FX Swap is not integrated with Loan 2 under Sec. 1.988-
5; and
(iv) A enters into a spot transaction with Bank to convert the
proceeds of Loan 2 into $2,000x U.S. dollars and A uses the U.S.
dollars to repay Loan 1.
(2) Analysis. A principal purpose of A entering into the
transactions with Bank was to try to reduce the amount incurred by A
that otherwise would be interest expense; in effect, A sought to alter
A's cost of borrowing by converting a substantial portion of its
interest expense deductions on Loan 1 into
[[Page 56767]]
section 165 deductions on the FX Swap ($100x interest expense related
to Loan 1 compared to $20x interest expense related to Loan 2 and $80x
section 165 deduction). A's functional currency is the U.S. dollar and
A conducts virtually all of its business in the U.S. dollar. A has no
connection to Japan or the Japanese yen and would not have entered into
the transactions in the ordinary course of A's trade or business. The
section 165 deductions related to the FX Swap were incurred by A in a
series of transactions in which A secured the use of funds for a period
of time and were substantially incurred in consideration of the time
value of money. As a result, under paragraph (b)(22)(iv)(A)(1) of this
section, for purposes of section 163(j), the $80x paid by A to Bank on
the FX Swap is treated by A as interest expense.
(B) Example 2--(1) Facts. A is engaged in a manufacturing business
and uses the calendar year as its annual accounting period. A does not
use gold in its manufacturing business. In 2021, A expects to borrow
$1,000x for six months. In January 2021, A borrows from B two ounces of
gold at a time when the spot price for gold is $500x per ounce. A
agrees to return the two ounces of gold in six months. A sells the two
ounces of gold to C for $1,000x. A then enters into a contract with D
to purchase two ounces of gold six months in the future for $1,013x. In
exchange for the use of $1,000x in cash for six months, A has sustained
a loss of $13x in connection with these related transactions. A would
not have entered into the gold transactions in the ordinary course of
A's trade or business.
(2) Analysis. In a series of related transactions, A has obtained
the use of $1,000x for six months and created a loss of $13x
substantially incurred in consideration of the time value of money. A
would not have entered into the gold transactions in the ordinary
course of A's trade or business. A entered into the transactions with a
principal purpose of structuring the transactions to reduce its
interest expense (in effect, A sought to convert what otherwise would
be interest expense into a loss through the transactions). As a result,
under paragraph (b)(22)(iv)(A)(1) of this section, for purposes of
section 163(j), the loss of $13x is treated by A as interest expense.
(C) Example 3--(1) Facts. A is engaged in a manufacturing business
and uses the calendar year as its annual accounting period. A's
functional currency is the U.S. dollar and A conducts virtually all of
its business in the U.S. dollar. A has no connection to Argentina or
the Argentine peso as part of its ordinary course of business. As of
January 1, 2021, A expects to have adjusted taxable income (as defined
in paragraph (b)(1) of this section) of $200x in the taxable year
ending December 31, 2021. A also projects that it will have business
interest expense of $70x on an existing loan in 2021. A has cash
equivalents of $100x on which A expects to earn $5x of business
interest income. In early 2021, A enters into the following
transactions, which A would not have entered into in the ordinary
course of A's trade or business:
(i) A enters into a spot transaction with Bank to convert the $100x
of cash equivalents into an amount in Argentine pesos equivalent to
$100x and A uses the Argentine pesos to purchase an Argentine peso note
(Note) issued by a subsidiary of Bank for the Argentine peso equivalent
of $100x; the Note pays interest at a 10 percent rate; and
(ii) A enters into a foreign currency swap transaction (FX Swap)
with Bank with a notional principal amount of $100x under which A pays
Argentine pesos at 10 percent multiplied by the amount of Argentine
peso principal amount on the Note (which for 2021 equals $10x) and
receives U.S. dollars at 5 percent multiplied by a notional amount of
$100x ($5x per year).
(2) Analysis. A principal purpose of A entering into the
transactions was to increase the amount of business interest income
received by A; in effect, A increased its business interest income by
separately accounting for its net deduction of $5x per year on the FX
Swap. A's functional currency is the U.S. dollar and A conducts
virtually all of its business in the U.S. dollar. A has no connection
to Argentina or the Argentine peso and would not have entered into the
transactions in the ordinary course of A's trade or business. The FX
Swap was incurred by A as a part of a transaction that A entered into
with a principal purpose of artificially increasing its business
interest income. As a result, under paragraph (b)(22)(iv)(B) of this
section, for purposes of section 163(j), the $10x business interest
income earned on the Note by A is reduced by $5x (the net $5x paid by A
on the FX Swap).
(D) Example 4--(1) Facts. A is wholly owned by FC, a foreign
corporation organized in foreign country X. A uses the calendar year
for its annual accounting period. FC has a better credit rating than A.
A needs to borrow $2,000x in the taxable year ending December 31, 2021,
to fund its business operations. A also projects that, if it borrows
$2,000x on January 1, 2021, and pays a market rate of interest, it will
have business interest expense of $100x in its taxable year ending
December 31, 2021. In early 2021, A enters into the following
transactions:
(i) A enters into a loan obligation in which A borrows $2,000x from
Bank with an interest rate of 3 percent (Loan 1);
(ii) FC and Bank enter into a guarantee arrangement (Guarantee)
under which FC agrees to guarantee Bank that Bank will be timely paid
all of the amounts due on Loan 1; and
(iii) A enters into a guarantee fee agreement with FC (Guarantee
Fee Agreement) under which A agrees to pay FC $40x in return for FC
entering into the Guarantee, which was not an agreement that A would
have entered into in the ordinary course of A's trade or business.
(2) Analysis. A principal purpose of A entering into the
transactions was to reduce the amount incurred by A that otherwise
would be interest expense; in effect, A sought to convert a substantial
portion of its interest expense deductions on Loan 1 into section 162
deductions on the Guarantee Fee Agreement ($100x interest expense had A
borrowed without the Guarantee compared to $60x interest expense
related to Loan 1 and $40x section 162 deduction). A would not have
entered into the Guarantee Fee Agreement in the ordinary course of A's
trade or business. The $40x section 162 deductions related to the
Guarantee Fee Agreement were incurred by A in a series of transactions
in which A secured the use of funds for a period of time and were
substantially incurred in consideration of the time value of money. As
a result, under paragraph (b)(22)(iv)(A)(1) of this section, for
purposes of section 163(j), the $40x paid by A to FC on the Guarantee
Fee Agreement is treated by A as interest expense.
(E) Example 5--(1) Facts. A, B, and C are equal partners in ABC
partnership. ABC is considering acquiring an additional loan from a
third-party lender to expand its business operations. However, ABC
already has significant debt and interest expense. For the purpose of
reducing the amount of additional interest expense ABC would have
otherwise incurred by borrowing, A agrees to make an additional
contribution to ABC for use in its business operations in exchange for
a guaranteed payment for the use of capital under section 707(c).
(2) Analysis. The guaranteed payment is deductible by ABC, incurred
by ABC in a transaction in which ABC secures the use of funds for a
period of time, substantially incurred in consideration of the time
value of money, and not
[[Page 56768]]
described in paragraph (b)(22)(i), (ii), or (iii) of this section. As a
result, the guaranteed payment to A is economically equivalent to the
interest that ABC would have incurred on an additional loan from a
third-party lender. A principal purpose of A making a contribution in
exchange for a guaranteed payment for the use of capital was to reduce
the amount incurred by ABC that otherwise would be interest expense. As
a result, under paragraph (b)(22)(iv)(A)(1) of this section, for
purposes of section 163(j), such guaranteed payment is treated as
interest expense of ABC for purposes of section 163(j). In addition,
under paragraph (b)(22)(iv)(A)(2) of this section, if A knows that the
guaranteed payment is treated as interest expense of ABC, because A
provides the use of funds for a period of time in a transaction subject
to paragraph (b)(22)(iv)(A)(1) of this section, A earns income or gain
with respect to the transaction, and such income or gain is
substantially earned in consideration of the time value of money
provided by A, the guaranteed payment is treated as interest income of
A for purposes of section 163(j).
(23) Interest expense. The term interest expense means interest
that is paid or accrued, or treated as paid or accrued, for the taxable
year.
(24) Interest income. The term interest income means interest that
is included in gross income for the taxable year.
(25) Member. The term member has the meaning provided in Sec.
1.1502-1(b).
(26) Motor vehicle. The term motor vehicle means a motor vehicle as
defined in section 163(j)(9)(C).
(27) Old section 163(j). The term old section 163(j) means section
163(j) immediately prior to its amendment by Public Law 115-97, 131
Stat. 2054 (2017).
(28) Ownership change. The term ownership change has the meaning
provided in section 382 and the regulations in this part under section
382 of the Code.
(29) Ownership date. The term ownership date has the meaning
provided in section 382 and the regulations in this part under section
382 of the Code.
(30) Real estate investment trust. The term real estate investment
trust (REIT) has the meaning provided in section 856.
(31) Real property. The term real property includes--
(i) Real property as defined in Sec. 1.469-9(b)(2); and
(ii) Any direct or indirect right, including a license or other
contractual right, to share in the appreciation in value of, or the
gross or net proceeds or profits generated by, an interest in real
property, including net proceeds or profits associated with tolls,
rents or other similar fees.
(32) Regulated investment company. The term regulated investment
company (RIC) has the meaning provided in section 851.
(33) Relevant foreign corporation. The term relevant foreign
corporation means any foreign corporation whose classification is
relevant under Sec. 301.7701-3(d)(1) for a taxable year, other than
solely pursuant to section 881 or 882.
(34) S corporation. The term S corporation has the meaning provided
in section 1361(a)(1).
(35) [Reserved]
(36) Section 163(j) limitation. The term section 163(j) limitation
means the limit on the amount of business interest expense that a
taxpayer may deduct in a taxable year under section 163(j) and Sec.
1.163(j)-2(b).
(37) Section 163(j) regulations. The term section 163(j)
regulations means this section and Sec. Sec. 1.163(j)-2 through
1.163(j)-11.
(38) Separate return limitation year. The term separate return
limitation year (SRLY) has the meaning provided in Sec. 1.1502-1(f).
(39) Separate return year. The term separate return year has the
meaning provided in Sec. 1.1502-1(e).
(40) Separate tentative taxable income. The term separate tentative
taxable income with respect to a taxpayer and a taxable year has the
meaning provided in Sec. 1.1502-12, but for this purpose computed
without regard to the application of the section 163(j) limitation and
with the addition of the adjustments made in paragraph (b)(43)(ii) of
this section and Sec. 1.163(j)-4(d)(2)(iv).
(41) Tax-exempt corporation. The term tax-exempt corporation means
any tax-exempt organization that is organized as a corporation.
(42) Tax-exempt organization. The term tax-exempt organization
means any entity subject to tax under section 511.
(43) Tentative taxable income--(i) In general. The term tentative
taxable income, with respect to a taxpayer and a taxable year,
generally is determined in the same manner as taxable income under
section 63 but for this purpose computed without regard to the
application of the section 163(j) limitation. Tentative taxable income
is computed without regard to any disallowed business interest expense
carryforwards.
(ii) [Reserved]
(iii) Special rules for defining tentative taxable income. (A) For
special rules defining the tentative taxable income of a RIC or REIT,
see Sec. 1.163(j)-4(b)(4)(ii).
(B) For special rules defining the tentative taxable income of
consolidated groups, see Sec. 1.163(j)-4(d)(2)(iv).
(C) For special rules defining the tentative taxable income of a
partnership, see Sec. 1.163(j)-6(d)(1).
(D) For special rules defining the tentative taxable income of an S
corporation, see Sec. 1.163(j)-6(l)(3).
(E) For special rules clarifying that tentative taxable income
takes sections 461(l), 465, and 469 into account, see Sec. 1.163(j)-
3(b)(4).
(F) For special rules clarifying that tentative taxable income
takes sections 461(l), 465, and 469 into account, see Sec. 1.163(j)-
3(b)(4).
(G) For special rules clarifying that tentative taxable income
takes sections 461(l), 465, and 469 into account, see Sec. 1.163(j)-
3(b)(4).
(44) Trade or business--(i) In general. The term trade or business
means a trade or business within the meaning of section 162.
(ii) Excepted trade or business. The term excepted trade or
business means the trade or business of performing services as an
employee, an electing real property trade or business, an electing
farming business, or an excepted regulated utility trade or business.
For additional rules related to excepted trades or businesses,
including elections made under section 163(j)(7)(B) and (C), see Sec.
1.163(j)-9.
(iii) Non-excepted trade or business. The term non-excepted trade
or business means any trade or business that is not an excepted trade
or business.
(45) Unadjusted basis. The term unadjusted basis means the basis as
determined under section 1012 or other applicable sections of chapter 1
of subtitle A of the Code, including subchapters O (relating to gain or
loss on dispositions of property), C (relating to corporate
distributions and adjustments), K (relating to partners and
partnerships), and P (relating to capital gains and losses) of the
Code. Unadjusted basis is determined without regard to any adjustments
described in section 1016(a)(2) or (3), any adjustments for tax credits
claimed by the taxpayer (for example, under section 50(c)), or any
adjustments for any portion of the basis that the taxpayer has elected
to treat as an expense (for example, under section 179, 179B, or 179C).
[[Page 56769]]
(46) United States shareholder. The term United States shareholder
has the meaning provided in section 951(b).
(c) Applicability date--(1) In general. Except as provided in
paragraphs (c)(2) and (3) of this section, this section applies to
taxable years beginning on or after November 13, 2020. However,
taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of this section to
a taxable year beginning after December 31, 2017, and before November
13, 2020 so long as the taxpayers and their related parties
consistently apply the rules of the section 163(j) regulations, and, if
applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1,
1.382-2, 1.382-5, 1.382-6, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they
effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and
1.383-1), and 1.1504-4, to that taxable year. Additionally, taxpayers
and their related parties within the meaning of sections 267(b) and
707(b)(1), otherwise relying on the notice of proposed rulemaking that
was published on December 28, 2018, in the Federal Register (83 FR
67490) in its entirety under Sec. 1.163(j)-1(c), may alternatively
choose to follow Sec. 1.163(j)-1(b)(1)(iii), rather than proposed
Sec. 1.163(j)-1(b)(1)(iii).
(2) Anti-avoidance rules. The anti-avoidance rules in paragraph
(b)(22)(iv) of this section apply to transactions entered into on or
after September 14, 2020.
(3) Swaps with significant nonperiodic payments--(i) In general.
Except as provided in paragraph (c)(3)(ii) of this section, the rules
provided in paragraph (b)(22)(ii) of this section apply to notional
principal contracts entered into on or after September 14, 2021.
However, taxpayers may choose to apply the rules provided in paragraph
(b)(22)(ii) of this section to notional principal contracts entered
into before September 14, 2021.
(ii) Anti-avoidance rule. The anti-avoidance rules in paragraph
(b)(22)(iv) of this section (applied without regard to the references
to paragraph (b)(22)(ii) of this section) apply to a notional principal
contract entered into on or after September 14, 2020.
Sec. 1.163(j)-2 Deduction for business interest expense limited.
(a) Overview. This section provides general rules regarding the
section 163(j) limitation. Paragraph (b) of this section provides rules
regarding the basic computation of the section 163(j) limitation.
Paragraph (c) of this section provides rules for disallowed business
interest expense carryforwards. Paragraph (d) of this section provides
rules regarding the small business exemption from the section 163(j)
limitation. Paragraph (e) of this section that is part of provides
rules regarding real estate mortgage investment conduits (REMICs).
Paragraph (f) of this section provides rules regarding the calculation
of ATI with respect to certain beneficiaries. Paragraph (g) of this
section provides rules regarding tax-exempt organizations. Paragraph
(h) of this section provides examples illustrating the application of
this section. Paragraph (i) of this section is reserved. Paragraph (j)
of this section provides an anti-avoidance rule.
(b) General rule--(1) In general. Except as otherwise provided in
this section or in Sec. Sec. 1.163(j)-3 through 1.163(j)-11, the
amount allowed as a deduction for business interest expense for the
taxable year cannot exceed the sum of--
(i) The taxpayer's business interest income for the taxable year;
(ii) 30 percent of the taxpayer's ATI for the taxable year, or zero
if the taxpayer's ATI for the taxable year is less than zero; and
(iii) The taxpayer's floor plan financing interest expense for the
taxable year.
(2) 50 percent ATI limitation for taxable years beginning in 2019
or 2020--(i) In general. Except as otherwise provided in section
163(j)(10) and paragraph (b)(2) of this section, for any taxable year
beginning in 2019 or 2020, paragraph (b)(1)(ii) of this section is
applied by substituting 50 percent for 30 percent. The 50 percent ATI
limitation does not apply to partnerships for taxable years beginning
in 2019. Further, for a partnership taxable year beginning in 2020 for
which an election out of section 163(j)(10)(A)(i) has not been made,
Sec. 1.163(j)-6(f)(2)(xi) is applied by substituting two for ten-
thirds when grossing up each partner's final ATI capacity excess
amount.
(ii) Election out of the 50 percent ATI limitation. A taxpayer may
elect to not have paragraph (b)(2)(i) of this section apply for any
taxable year beginning in 2019 or 2020. In the case of a partnership,
the election must be made by the partnership and may be made only for
taxable years beginning in 2020.
(3) Election to use 2019 ATI in 2020--(i) In general. Subject to
paragraph (b)(3)(ii), a taxpayer may elect to use the taxpayer's ATI
for the last taxable year beginning in 2019 (2019 ATI) as the ATI for
any taxable year beginning in 2020.
(ii) Short taxable years. If an election is made under paragraph
(b)(3)(i) of this section for a taxable year beginning in 2020 that is
a short taxable year, the ATI for such taxable year is equal to the
amount that bears the same ratio to 2019 ATI as the number of months in
the short taxable year bears to 12.
(4) Time and manner of making or revoking the elections. The rules
and procedures regarding the time and manner of making, or revoking, an
election under paragraphs (b)(2) and (3) of this section are provided
in Revenue Procedure 2020-22, 2020-18 I.R.B. 745, or in other guidance
that may be issued (see Sec. Sec. 601.601(d) and 601.602 of this
chapter).
(c) Disallowed business interest expense carryforward--(1) In
general. Any business interest expense disallowed under paragraph (b)
of this section, or any disallowed disqualified interest that is
properly allocable to a non-excepted trade or business under Sec.
1.163(j)-10, is carried forward to the succeeding taxable year as a
disallowed business interest expense carryforward, and is therefore
business interest expense that is subject to paragraph (b) of this
section in such succeeding taxable year. Disallowed business interest
expense carryforwards are not re-allocated between non-excepted and
excepted trades or businesses in a succeeding taxable year. Instead,
the carryforwards continue to be treated as allocable to a non-excepted
trade or business. See Sec. 1.163(j)-10(c)(4).
(2) Coordination with small business exemption. If disallowed
business interest expense is carried forward under the rules of
paragraph (c)(1) of this section to a taxable year in which the small
business exemption in paragraph (d) of this section applies to the
taxpayer, then the general rule in paragraph (b) of this section does
not apply to limit the deduction of the disallowed business interest
expense carryforward of the taxpayer in that taxable year. See Sec.
1.163(j)-6(m)(3) for rules applicable to the treatment of excess
business interest expense from a partnership that is not subject to
section 163(j) in a succeeding taxable year, and see Sec. 1.163(j)-
6(m)(4) for rules applicable to S corporations with disallowed business
interest expense carryforwards that are not subject to section 163(j)
in a succeeding taxable year.
(3) Cross-references--(i) For special rules regarding disallowed
business interest expense carryforwards for taxpayers that are C
corporations, including members of a consolidated group, see Sec.
1.163(j)-5.
[[Page 56770]]
(ii) For special rules regarding disallowed business interest
expense carryforwards of S corporations, see Sec. Sec. 1.163(j)-
5(b)(2) and 1.163(j)-6(l)(5).
(iii) For special rules regarding disallowed business interest
expense carryforwards from partnerships, see Sec. 1.163(j)-6.
(iv)-(v) [Reserved]
(d) Small business exemption--(1) Exemption. The general rule in
paragraph (b) of this section does not apply to any taxpayer, other
than a tax shelter as defined in section 448(d)(3), in any taxable year
in which the taxpayer meets the gross receipts test of section 448(c)
and the regulations in this part under section 448 of the Code for the
taxable year. See Sec. 1.163(j)-9(b) for elections available under
section 163(j)(7)(B) and 163(j)(7)(C) for real property trades or
businesses or farming businesses that also may be exempt small
businesses. See Sec. 1.163(j)-6(m) for rules applicable to
partnerships and S corporations not subject to section 163(j).
(2) Application of the gross receipts test--(i) In general. In the
case of any taxpayer that is not a corporation or a partnership, and
except as provided in paragraphs (d)(2)(ii), (iii), and (iv) of this
section, the gross receipts test of section 448(c) and the regulations
in this part under section 448 of the Code are applied in the same
manner as if such taxpayer were a corporation or partnership.
(ii) Gross receipts of individuals. Except as provided in paragraph
(d)(2)(iii) of this section (regarding partnership and S corporation
interests), an individual taxpayer's gross receipts include all items
specified as gross receipts in regulations under section 448(c),
whether or not derived in the ordinary course of the taxpayer's trade
or business. For purposes of section 163(j), an individual taxpayer's
gross receipts do not include inherently personal amounts, including,
but not limited to, personal injury awards or settlements with respect
to an injury of the individual taxpayer, disability benefits, Social
Security benefits received by the taxpayer during the taxable year, and
wages received as an employee that are reported on Form W-2.
(iii) Partners and S corporation shareholders. Except when the
aggregation rules of section 448(c) apply, each partner in a
partnership includes a share of partnership gross receipts in
proportion to such partner's distributive share (as determined under
section 704) of items of gross income that were taken into account by
the partnership under section 703. Additionally, each shareholder in an
S corporation includes a pro rata share of S corporation gross
receipts.
(iv) Tax-exempt organizations. For purposes of section 163(j), the
gross receipts of a tax-exempt organization include only gross receipts
taken into account in determining its unrelated business taxable
income.
(e) REMICs. For the treatment of interest expense by a REMIC as
defined in section 860D, see Sec. 1.860C-2(b)(2)(ii).
(f) Trusts--(i) Calculation of ATI with respect to certain trusts
and estates. The ATI of a trust or a decedent's estate taxable under
section 641 is computed without regard to deductions under sections
642(c), 651, and 661.
(ii) Calculation of ATI with respect to certain beneficiaries. The
ATI of a beneficiary (including a tax-exempt beneficiary) of a trust or
a decedent's estate is reduced by any income (including any
distributable net income) received from the trust or estate by the
beneficiary to the extent such income was necessary to permit a
deduction under section 163(j)(1)(B) and Sec. 1.163(j)-2(b) for any
business interest expense of the trust or estate that was in excess of
any business interest income of the trust or estate.
(g) Tax-exempt organizations. Except as provided in paragraph (d)
of this section, the section 163(j) limitation applies to tax-exempt
organizations for purposes of computing their unrelated business
taxable income under section 512. For rules on determining the gross
receipts of a tax-exempt organization for purposes of the small
business exemption, see paragraph (d)(2)(iv) of this section. For
special rules applicable to tax-exempt beneficiaries of a trust or a
decedent's estate, see Sec. 1.163(j)-2(f). For special rules
applicable to tax-exempt corporations, see Sec. 1.163(j)-4. For
special allocation rules applicable to tax-exempt organizations, see
Sec. 1.163(j)-10(a)(5).
(h) Examples. The examples in this paragraph (h) illustrate the
application of section 163(j) and the provisions of this section.
Unless otherwise indicated, X and Y are domestic C corporations; C and
D are U.S. resident individuals not subject to any foreign income tax;
PRS is a domestic partnership with partners who are all individuals;
all taxpayers use a calendar taxable year; the exemption for certain
small businesses in section 163(j)(3) and paragraph (d) of this section
does not apply; and the interest expense would be deductible but for
section 163(j).
(1) Example 1: Limitation on business interest expense deduction--
(i) Facts. During its taxable year ending December 31, 2021, X has ATI
of $100x. X has business interest expense of $50x, which includes $10x
of floor plan financing interest expense, and business interest income
of $20x.
(ii) Analysis. For the 2021 taxable year, X's section 163(j)
limitation is $60x, which is the sum of its business interest income
($20x), plus 30 percent of its ATI ($100x x 30 percent = $30x), plus
its floor plan financing interest expense ($10x). See Sec. 1.163(j)-
2(b). Because X's business interest expense ($50x) does not exceed X's
section 163(j) limitation ($60x), X can deduct all $50x of its business
interest expense for the 2021 taxable year.
(2) Example 2: Carryforward of business interest expense--(i)
Facts. The facts are the same as in Example 1 in paragraph (h)(1)(i) of
this section, except that X has $80x of business interest expense,
which includes $10x of floor plan financing interest expense.
(ii) Analysis. As in Example 1 in paragraph (h)(1)(ii) of this
section, X's section 163(j) limitation is $60x. Because X's business
interest expense ($80x) exceeds X's section 163(j) limitation ($60x), X
may only deduct $60x of its business interest expense for the 2021
taxable year, and the remaining $20x of its business interest expense
will be carried forward to the succeeding taxable year as a disallowed
business interest expense carryforward. See Sec. 1.163(j)-2(c).
(3) Example 3: ATI computation--(i) Facts. During the 2020 taxable
year, Y has tentative taxable income of $30x, which is determined
without regard to the application of the section 163(j) limitation on
business interest expense. Y's tentative taxable income includes the
following: $20x of business interest income; $50x of business interest
expense, which includes $10x of floor plan financing interest expense;
$25x of net operating loss deduction under section 172; and $15x of
depreciation under section 167, of which $10x is capitalized to
inventory under section 263A. Of the $10x capitalized to inventory,
only $7x is recovered through cost of goods sold during the 2020
taxable year and $3x remains in ending inventory at the end of the 2020
taxable year. The $3x of ending inventory is recovered through cost of
goods sold during the 2021 taxable year. Y also has a disallowed
business interest expense carryforward from the prior year of $8x.
(ii) Analysis. (A) For purposes of determining the section 163(j)
limitation for 2020, Y's disallowed business interest expense
carryforward is not taken into account in determining tentative taxable
income or ATI. Y's ATI is $90x, calculated as follows:
[[Page 56771]]
Table 1 to Paragraph (h)(3)(ii)(A)
------------------------------------------------------------------------
------------------------------------------------------------------------
Tentative taxable income................................. $30x
Less:
Floor plan financing interest............................ 10x
Business interest income................................. 20x
----------
0x
------------------------------------------------------------------------
(B) Plus:
Table 2 to Paragraph (h)(3)(ii)(B)
------------------------------------------------------------------------
------------------------------------------------------------------------
Business interest expense $50x
Net operating loss deduction 25x
Depreciation 15x
----------
ATI 90x
------------------------------------------------------------------------
(C) For Y's 2021 taxable year, the $3x of ending inventory that is
recovered through cost of goods sold in 2021 is not added back to
tentative taxable income (TTI) in determining ATI because it was
already included as an addback in ATI in Y's 2020 taxable year. See
Sec. 1.163(j)-1(b)(1)(iii).
(4) Example 4: Floor plan financing interest expense--(i) Facts. C
is the sole proprietor of an automobile dealership that uses a cash
method of accounting. In the 2021 taxable year, C paid $30x of interest
on a loan that was obtained to purchase sedans for sale by the
dealership. The indebtedness is secured by the sedans purchased with
the loan proceeds. In addition, C paid $20x of interest on a loan,
secured by the dealership's office equipment, which C obtained to
purchase convertibles for sale by the dealership.
(ii) Analysis. For the purpose of calculating C's section 163(j)
limitation, only the $30x of interest paid on the loan to purchase the
sedans is floor plan financing interest expense. The $20x paid on the
loan to purchase the convertibles is not floor plan financing interest
expense for purposes of section 163(j) because the indebtedness was not
secured by the inventory of convertibles. However, because under Sec.
1.163(j)-10 the interest paid on the loan to purchase the convertibles
is properly allocable to C's dealership trade or business, and because
floor plan financing interest expense is also business interest
expense, C has $50x of business interest expense for the 2021 taxable
year.
(5) Example 5: Interest not properly allocable to non-excepted
trade or business--(i) Facts. The facts are the same as in Example 4 in
paragraph (h)(4)(i) of this section, except that the $20x of interest C
pays is on acquisition indebtedness obtained to purchase C's personal
residence and not to purchase convertibles for C's dealership trade or
business.
(ii) Analysis. Because the $20x of interest expense is not properly
allocable to a non-excepted trade or business, and therefore is not
business interest expense, C's only business interest expense is the
$30x that C pays on the loan used to purchase sedans for sale in C's
dealership trade or business. C deducts the $20x of interest related to
his residence under the rules of section 163(h), without regard to
section 163(j).
(6) Example 6: Small business exemption--(i) Facts. During the 2021
taxable year, D, the sole proprietor of a trade or business reported on
Schedule C, has interest expense properly allocable to that trade or
business. D does not conduct an electing real property trade or
business or an electing farming business. D also earns gross income
from providing services as an employee that is reported on a Form W-2.
Under section 448(c) and the regulations in this part under section
448, D has average annual gross receipts of $21 million, including $1
million of wages in each of the three prior taxable years and $2
million of income from investments not related to a trade or business
in each of the three prior taxable years. Also, in each of the three
prior taxable years, D received $5 million in periodic payments of
compensatory damages awarded in a personal injury lawsuit.
(ii) Analysis. Section 163(j) does not apply to D for the taxable
year, because D qualifies for the small business exemption under Sec.
1.163(j)-2(d). The wages that D receives as an employee and the
compensatory damages that D received from D's personal injury lawsuit
are not gross receipts, as provided in Sec. 1.163(j)-2(d)(2)(ii). D
may deduct all of its business interest expense for the 2021 taxable
year without regard to section 163(j).
(7) Example 7: Partnership with excess business interest expense
qualifies for the small business exemption in a succeeding taxable
year--(i) Facts. X and Y are equal partners in partnership PRS. In
addition to being partners in PRS, X and Y each operate their own sole
proprietorships. For the taxable year ending December 31, 2021, PRS is
subject to section 163(j) and has excess business interest expense of
$10x. For the taxable year ending December 31, 2022, PRS has $40x of
business interest expense, and X and Y have $20x of business interest
expense from their respective sole proprietorships. For the taxable
year ending December 31, 2022, PRS and Y qualify for the small business
exemption under Sec. 1.163(j)-2(d), while X is subject to section
163(j) and has a section 163(j) limitation of $22x.
(ii) Partnership-level analysis. For the 2021 taxable year, PRS
allocates the $10x of excess business interest expense equally to X and
Y ($5x each). See Sec. 1.163(j)-6(f)(2). For the 2022 taxable year,
section 163(j) does not apply to PRS because PRS qualifies for the
small business exemption. As a result, none of PRS's $40x of business
interest expense for the 2022 taxable year is subject to the section
163(j) limitation at the partnership level.
(iii) Partner-level analysis. For the 2022 taxable year, each
partner treats its $5x of excess business interest expense from PRS as
paid or accrued in that year. See Sec. 1.163(j)-6(m)(3). This amount
becomes business interest expense that each partner must subject to its
own section 163(j) limitation, if any. With this $5x, each partner has
$25x of business interest expense for the 2022 taxable year ($20x from
its sole proprietorship, plus $5x of excess business interest expense
treated as paid or accrued in the 2020 taxable year). X deducts $22x of
its business interest expense pursuant to its section 163(j) limitation
and carries forward the remainder ($3x) as a disallowed business
interest expense carryforward to the taxable year ending December 31,
2023. Y is not subject to section 163(j) because Y qualifies for the
small business exemption. Y therefore deducts all $25x of its business
interest expense for the 2022 taxable year.
(8) Example 8: Aggregation of gross receipts--(i) Facts. X and Y
are domestic C corporations under common control, within the meaning of
section 52(a) and Sec. 1.52-1(b). X's only trade or business is a
farming business described in Sec. 1.263A-4(a)(4). During the taxable
year ending December 31, 2020, X has average annual gross receipts
under section 448(c) of $6 million. During the same taxable year, Y has
average annual gross receipts under section 448(c) of $21 million.
(ii) Analysis. Because X and Y are under common control, they must
aggregate gross receipts for purposes of section 448(c) and the small
business exemption in Sec. 1.163(j)-2(d). See section 448(c)(2).
Therefore, X and Y are both considered to have $27 million in average
annual gross receipts for 2020. X and Y must separately apply section
163(j) to determine any limitation on the deduction for business
interest expense. Assuming X otherwise meets the requirements in Sec.
1.163(j)-9 in 2020, X may elect for its farming business to be an
excepted trade or business.
(i) [Reserved]
(j) Anti-avoidance rule--(1) In general. Arrangements entered into
with a principal purpose of avoiding the
[[Page 56772]]
rules of section 163(j) or the section 163(j) regulations, including
the use of multiple entities to avoid the gross receipts test of
section 448(c), may be disregarded or recharacterized by the
Commissioner of the IRS to the extent necessary to carry out the
purposes of section 163(j).
(2) Examples. The examples in this paragraph (j)(2) illustrate the
application of this section.
(i) Example 1--(A) Facts. Individual A operates an excepted trade
or business (Business X) and a non-excepted trade or business (Business
Y). With a principal purpose of avoiding the rules of section 163(j) or
the regulations in this part under section 163(j) of the Code, A
contributes Business X to newly-formed C corporation B in exchange for
stock; A then causes B to borrow funds from a third party and
distributes a portion of the borrowed funds to A for use in Business Y.
B takes the position that its interest payments on the debt are not
subject to the section 163(j) limitation because B is engaged solely in
an excepted trade or business.
(B) Analysis. A has entered into an arrangement with a principal
purpose of avoiding the rules of section 163(j) or the regulations in
this part under section 163(j). Thus, under paragraph (j)(1) of this
section, the Commissioner of the IRS may disregard or recharacterize
this transaction to the extent necessary to carry out the purposes of
section 163(j). In this case, payments of interest on the debt may be
recharacterized as payments of interest properly allocable to a non-
excepted trade or business subject to the section 163(j) limitation.
(ii) Example 2--(A) Facts. Partnership UTP has two non-excepted
trades or businesses. Business A has gross income of $1000x and gross
deductions of $200x. Business B has gross income of $100x and gross
deductions of $600x. With a principal purpose of avoiding the rules in
section 163(j) or the regulations in this part under section 163(j),
UTP and a partner of UTP form partnership LTP and UTP contributes
Business B to LTP prior to borrowing funds. UTP takes the position that
it does not take its share of LTP gross deductions into account when
computing its ATI.
(B) Analysis. UTP has entered into an arrangement with a principal
purpose of avoiding the rules of section 163(j) or the regulations in
this part under section 163(j). Thus, under paragraph (j)(1) of this
section, the Commissioner of the IRS may disregard or recharacterize
this transaction to the extent necessary to carry out the purposes of
section 163(j). In this case, UTP's share of gross deductions from LTP
may be recharacterized as gross deductions incurred directly by UTP
solely for purposes of computing UTP's ATI.
(k) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
Sec. 1.163(j)-3 Relationship of the section 163(j) limitation to
other provisions affecting interest.
(a) Overview. This section contains rules regarding the
relationship between section 163(j) and certain other provisions of the
Code. Paragraph (b) of this section provides the general rules
concerning the relationship between section 163(j) and certain other
provisions of the Code. Paragraph (c) of this section provides examples
illustrating the application of this section. For rules regarding the
relationship between sections 163(j) and 704(d), see Sec. 1.163(j)-
6(h)(1) and (2).
(b) Coordination of section 163(j) with certain other provisions--
(1) In general. Section 163(j) and the regulations in this part under
section 163(j) of the Code generally apply only to business interest
expense that would be deductible in the current taxable year without
regard to section 163(j). Thus, for example, a taxpayer must apply
Sec. 1.163-8T, if applicable, to determine which items of interest
expense are investment interest under section 163(d) before applying
the rules in this section to interest expense. Except as otherwise
provided in this section, section 163(j) applies after the application
of provisions that subject interest expense to disallowance, deferral,
capitalization, or other limitation. For the rules that must be applied
in determining whether excess business interest is paid or accrued by a
partner, see section 163(j)(4)(B)(ii) and Sec. 1.163(j)-6.
(2) Disallowed interest provisions. For purposes of section 163(j),
business interest expense does not include interest expense that is
permanently disallowed as a deduction under another provision of the
Code, such as in section 163(e)(5)(A)(i), (f), (l), or (m), or section
264(a), 265, 267A, or 279.
(3) Deferred interest provisions. Other than sections 461(l), 465,
and 469, Code provisions that defer the deductibility of interest
expense, such as section 163(e)(3) and (e)(5)(A)(ii), 267(a)(2) and
(3), 1277, or 1282, apply before the application of section 163(j).
(4) At risk rules, passive activity loss provisions, and limitation
on excess business losses of noncorporate taxpayers. Section 163(j)
generally applies to limit the deduction for business interest expense
before the application of sections 461(l), 465, and 469. However, in
determining tentative taxable income for purposes of computing ATI,
sections 461(l), 465, and 469 are taken into account.
(5) Capitalized interest expenses. Section 163(j) applies after the
application of provisions that require the capitalization of interest,
such as sections 263A and 263(g). Capitalized interest expense under
those sections is not treated as business interest expense for purposes
of section 163(j). For ordering rules that determine whether interest
expense is capitalized under section 263A(f), see the regulations under
section 263A(f), including Sec. 1.263A-9(g).
(6) Reductions under section 246A. Section 246A applies before
section 163(j). Any reduction in the dividends received deduction under
section 246A reduces the amount of interest expense taken into account
under section 163(j).
(7) Section 381. Disallowed business interest expense carryforwards
are items to which an acquiring corporation succeeds under section
381(a). See section 381(c)(20) and Sec. Sec. 1.163(j)-5(c) and
1.381(c)(20)-1.
(8) Section 382. For rules governing the interaction of sections
163(j) and 382, see section 382(d)(3) and (k)(1), Sec. Sec. 1.163(j)-
5(e) and 1.163(j)-11(c), the regulations in this part under sections
382 and 383 of the Code, and Sec. Sec. 1.1502-91 through 1.1502-99.
(c) Examples. The examples in this paragraph (c) illustrate the
application of section 163(j) and the provisions of this section.
Unless otherwise indicated, X and Y are calendar-year domestic C
corporations; D is a U.S. resident individual not subject to any
foreign income tax; none of the taxpayers have floor plan financing
interest expense; and the exemption for certain small
[[Page 56773]]
businesses in Sec. 1.163(j)-2(d) does not apply.
(1) Example 1: Disallowed interest expense--(i) Facts. In 2021, X
has $30x of interest expense. Of X's interest expense, $10x is
permanently disallowed under section 265. X's business interest income
is $3x and X's ATI is $90x.
(ii) Analysis. Under paragraph (b)(2) of this section, the $10x
interest expense that is permanently disallowed under section 265
cannot be taken into consideration for purposes of section 163(j) in
the 2021 taxable year. X's section 163(j) limitation, or the amount of
business interest expense that X may deduct is limited to $30x under
Sec. 1.163(j)-2(b), determined by adding X's business interest income
($3x) and 30 percent of X's 2019 ATI ($27x). Therefore, in the 2021
taxable year, none of the $20x of X's deduction for its business
interest expense is disallowed under section 163(j).
(2) Example 2: Deferred interest expense--(i) Facts. In 2021, Y has
no business interest income, $120x of ATI, and $70x of interest
expense. Of Y's interest expense, $30x is not currently deductible
under section 267(a)(2). The $30x expense is allowed as a deduction
under section 267(a)(2) in 2022.
(ii) Analysis. Under paragraph (b)(3) of this section, section
267(a)(2) is applied before section 163(j). Accordingly, $30x of Y's
interest expense cannot be taken into consideration for purposes of
section 163(j) in 2021 because it is not currently deductible under
section 267(a)(2). Accordingly, in 2021, if the interest expense is
properly allocable to a non-excepted trade or business, Y will have $4x
of disallowed business interest expense because the $40x of business
interest expense in 2021 ($70x-$30x) exceeds 30 percent of its ATI for
the taxable year ($36x). The $30x of interest expense not allowed as a
deduction in the 2021 taxable year under section 267(a)(2) will be
taken into account in determining the business interest expense
deduction under section 163(j) in 2022, the taxable year in which it is
allowed as a deduction under section 267(a)(2), if it is allocable to a
trade or business. Additionally, the $4x of disallowed business
interest expense in 2021 will be carried forward to 2022 as a
disallowed business interest expense carryforward. See Sec. 1.163(j)-
2(c).
(3) Example 3: Passive activity loss--(i) Facts. D is engaged in a
rental activity treated as a passive activity within the meaning of
section 469. For the 2021 taxable year, D receives $200x of rental
income and incurs $300x of expenses all properly allocable to the
rental activity, consisting of $150x of interest expense, $60x of
maintenance expenses, and $90x of depreciation expense. D's ATI is
$400x.
(ii) Analysis. Under paragraph (b)(4) of this section, section
163(j) is applied before the section 469 passive loss rules apply,
except that section 469 is taken into account in the determination of
tentative taxable income for purposes of computing ATI. D's section
163(j) limitation is $120x, determined by adding to D's business
interest income ($0), floor plan financing ($0), and 30 percent of D's
ATI ($120x). See Sec. 1.163(j)-2(b). Because D's business interest
expense of $150x exceeds D's section 163(j) limitation for 2021, $30x
of D's business interest expense is disallowed under section 163(j) and
will be carried forward as a disallowed business interest expense
carryforward. See Sec. 1.163(j)-2(c). Because the section 163(j)
limitation is applied before the limitation under section 469, only
$120x of the business interest expense allowable under section 163(j)
is included in determining D's passive activity loss limitation for the
2021 tax year under section 469. The $30x of disallowed business
interest expense is not an allowable deduction under section 163(j)
and, therefore, is not a deduction under section 469 in the current
taxable year. See Sec. 1.469-2(d)(8).
(4) Example 4: Passive activity loss by taxpayer that also
participates in a non-passive activity--(i) Facts. For 2021, D has no
business interest income and ATI of $1,000x, entirely attributable to a
passive activity within the meaning of section 469. D has business
interest expense of $1,000x, $900x of which is properly allocable to a
passive activity and $100x of which is properly allocable to a non-
passive activity in which D materially participates. D has other
business deductions that are not subject to section 469 of $600x, and a
section 469 passive loss from the previous year of $250x.
(ii) Analysis. Under paragraph (b)(4) of this section, section
163(j) is applied before the section 469 passive loss rules apply. D's
section 163(j) limitation is $300x, determined by adding D's business
interest income ($0), floor plan financing ($0), and 30 percent of D's
ATI ($300x)). Next, applying the limitation under section 469 to the
$300x business interest expense deduction allowable under section
163(a) and (j), $270x (a proportionate amount of the $300x (0.90 x
$300x)) is business interest expense included in determining D's
passive activity loss limitation under section 469, and $30x (a
proportionate amount of the $300x (0.10 x $300)) is business interest
expense not included in determining D's passive activity loss
limitation under section 469. Because D's interest expense of $1,000x
exceeds 30 percent of its ATI for 2021, $700x of D's interest expense
is disallowed under section 163(j) and will be carried forward as a
disallowed business interest expense carryforward. Section 469 does not
apply to any portion of the $700x disallowed business interest expense
because that business interest expense is not an allowable deduction
under section 163(j) and, therefore, is not an allowable deduction
under section 469 in the current taxable year. See Sec. 1.469-2(d)(8).
(5) Example 5: ATI calculation with passive activity loss--(i)
Facts. D is an individual who engages in a trade or business, V, as a
sole proprietorship. D relies on employees to perform most of the work
and, as a result, D does not materially participate in V. Therefore, V
is a passive activity of D. V is not an excepted trade or business. In
Year 1, V generates $500x of passive income, $400x of business interest
expense, and $600x of ordinary and necessary expenses deductible under
section 162 (not including any interest described in Sec. 1.163(j)-
1(b)(22)). No disallowed business interest expense carryforward has
been carried to Year 1 from a prior year, and no amounts have been
carried over to Year 1 from a prior year under either section 465(a)(2)
or section 469(b).
(ii) Tentative taxable income. Under Sec. 1.163(j)-1(b)(43),
tentative taxable income is determined as though all business interest
expense was not subject to the section 163(j) limitation. Sections
461(l), 465, and 469 apply in the determination of tentative taxable
income. For year 1, D has $500x of allowable deductions and a $500x
tentative passive activity loss under section 469, because D's $1000x
of passive expenses exceeds D's $500x of passive income from V. The
tentative disallowance of $500x is generally allocated pro rata between
D's passive expenses under Sec. 1.469-1T(f)(2)(ii)(A). In this case,
fifty percent ($500x of passive activity loss divided by $1000x of
total passive expenses) of each category of passive expense is
tentatively disallowed: $200x of business interest expense and $300x of
section 162 expense. D's tentative taxable income is $0 (zero), which
is determined by reducing $500x of gross income by the remaining $200x
of business interest expense and $300x of section 162 expense ($500x-
$200x-$300x).
(iii) ATI. Under section Sec. 1.163(j)-1(b)(1), to determine ATI,
D must add
[[Page 56774]]
business interest expense to tentative taxable income, but only to the
extent that the business interest expense reduced tentative taxable
income, or $200x. The $200x of business interest expense that was
tentatively disallowed under section 469 is not added to tentative
taxable income to determine ATI. D's ATI is $200x, which is determined
by adding the $200x of business interest expense that reduced tentative
taxable income to D's tentative taxable income, or $0 (0 + $200x).
(iv) Section 163(j) limitation. D's section 163(j) limitation in
Year 1 is D's business interest income, or $0, plus 30 percent of ATI,
or $60x (30 percent x $200x ATI), plus D's floor plan financing, or $0,
for a total of $60x ($0 + $60x + $0). Before the application of section
469, D has $60x of deductible business interest expense and $340x of
disallowed business interest expense carryforward under Sec. 1.163(j)-
2(c).
(v) Passive activity loss. Because D's passive deductions exceed
the passive income from V, and D does not have any passive income from
other sources, section 469 applies to limit D's passive loss from V.
Having first applied section 163(j), D has $660x of passive expenses,
determined by adding D's $60x of business interest expense that is
allowed by section 163(j) as a deduction and $600x of section 162
expense ($60x + $600x). D offsets $500x of the passive expenses against
$500x of passive income; therefore, D has a passive activity loss of
$160x in Year 1, determined as the excess of D's total passive expenses
over D's passive income ($660x-$500x). The amount of D's loss from the
passive activity that is disallowed under section 469 ($160x) is
generally ratably allocated to each of D's passive activity deductions
under Sec. 1.469-1T(f)(2)(ii)(A). As a general rule, each deduction is
multiplied by the ratio of the total passive loss to total passive
expenses (160x/660x). Of D's $60x business interest expense, $14.55x
(($160x/$660x) x $60x) is disallowed in Year 1. Additionally, of D's
$600x section 162 expense, $145.45x (($160x/$660x) x $600x) is
disallowed. The amounts disallowed under section 469(a)(1) and Sec.
1.469-2T(f)(2) are carried over to the succeeding taxable year under
section 469(b) and Sec. 1.469-1(f)(4).
(6) Example 6: Effect of passive activity loss carryforwards--(i)
Facts. The facts are the same as in Example 5 in paragraph (c)(5)(i) of
this section. In Year 2, V generates $500x of passive income, $100x of
business interest expense, and $0 (zero) of other deductible expenses.
D is not engaged in any other trade or business activities. A
disallowed business interest expense carryforward of $340x has been
carried to Year 2 from Year 1. Under section 469, D has a suspended
loss from Year 1 that includes $14.55x of business interest expense and
$145.45x of section 162 expense. These amounts are treated as passive
activity deductions in Year 2.
(ii) Tentative taxable income. To determine D's tentative taxable
income, D must first determine D's allowable deductions. In year 2, D
has $260x of allowable deductions, which includes $100x of business
interest expense generated Year 2, $14.55x of business interest expense
disallowed in Year 1 by section 469, and $145.45x of section 162
expense disallowed in Year 1 by section 469 ($100x + $14.55x +
$145.45x)). D's disallowed business interest expense carryforward from
Year 1 is not taken into account in determining tentative taxable
income. See Sec. 1.163(j)-1(b)(43). Additionally, the $14.55x of
business interest expense disallowed in Year 1 by section 469 is not
business interest expense in Year 2 because it was deductible after the
application of section 163(j) (but before the application of section
469) in Year 1. D does not have a tentative passive activity loss in
Year 2, because D's $500x of passive income from V exceeds D's $260x of
tentative passive expenses. Therefore, D's tentative taxable income in
Year 2 is $240x, which is determined by subtracting D's allowable
deductions other than disallowed business interest expense
carryforwards, or $260x, from D's gross income, or $500x ($500x-$260x).
(iii) ATI. D's ATI in Year 2 is $340x, which is determined by
adding D's business interest expense, or $100x, to D's tentative
taxable income, or $240x ($240x + $100x). Because disallowed business
interest expense carryforwards are not taken into account in
determining tentative taxable income, there is no corresponding
adjustment for disallowed business interest expense carryforwards in
calculating ATI. Therefore, there is no adjustment for D's $340x of
disallowed business interest expense carryforward in calculating D's
ATI. D has no other adjustments to determine ATI.
(iv) Section 163(j) limitation. D's section 163(j) limitation in
Year 2 is $102x, which is determined by adding D's business interest
income, or $0, 30 percent of D's ATI for year 2, $102 ($340x x 30
percent), and D's floor plan financing for Year 2, or $0 ($0 + ($102x)
+ $0). Accordingly, before the application of section 469 in Year 2,
$102x of D's $440x of total business interest expense (determined by
adding $340x of disallowed business interest expense carryforward from
Year 1 and $100x of business interest expense in Year 2) is deductible.
D has $338x of disallowed business interest expense carryforward that
will carry forward to subsequent taxable years under Sec. 1.163(j)-
2(c), determined by subtracting D's deductible business interest
expense in Year 2, or $102x, from D's total business interest expense
in Year 2, or $440x ($440x-$102x).
(v) Section 469. After applying the section 163(j) limitation, D
applies section 469 to determine if any amount of D's expense is a
disallowed passive activity loss. For Year 2, D has $262x of passive
expenses, determined by adding D's business interest expense deduction
allowed by section 163(j) ($102x), D's section 162 expense carried
forward from Year 1 under section 469 ($145.45x), and D's interest
expense carried forward from Year 1 under section 469 which is not
business interest expense in Year 2, or $14.55x ($102x + $145.45x +
$14.55x). Therefore, D has $238x of net passive income in Year 2,
determined by reducing D's total passive income in Year 2 ($500x), by
D's disallowed passive activity loss, or $262x ($500x-$262x). D does
not have a passive activity loss in Year 2, and no part of D's $262x of
passive expenses is disallowed in Year 2 under section 469.
(7) Example 7: Capitalized interest expense--(i) Facts. In 2020, X
has $50x of interest expense. Of X's interest expense, $10x is required
to be capitalized under section 263A. X capitalizes this interest
expense to a depreciable asset. X's business interest income is $9x and
X's ATI is $80x. X makes the election in Sec. 1.163(j)-2(b)(2)(ii) to
use 30 percent, rather than 50 percent, of ATI in determining X's
section 163(j) limitation for the 2020 taxable year.
(ii) Analysis. Under paragraph (b)(5) of this section, section 263A
is applied before section 163(j). Accordingly, $10x of X's interest
expense cannot be taken into consideration for purposes of section
163(j) in 2020. Additionally, under paragraph (b)(5) of this section,
X's $10 of capitalized interest expense is not business interest
expense for purposes of section 163(j). As a result, when X recovers
its capitalized interest expense through depreciation deductions, such
capitalized interest expense will not be taken into account as business
interest expense in determining X's section 163(j) limitation. X's
section 163(j) limitation in 2020, or the amount of business interest
expense that X may deduct, is limited to $33x under Sec. 1.163(j)-
2(b), determined by adding X's business
[[Page 56775]]
interest income ($9x) and 30 percent of X's 2020 ATI ($24x). X
therefore has $7x of disallowed business interest expense in 2020 that
will be carried forward to 2021 as a disallowed business interest
expense carryforward.
(d) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
Sec. 1.163(j)-4 General rules applicable to C corporations
(including REITs, RICs, and members of consolidated groups) and tax-
exempt corporations.
(a) Scope. This section provides rules regarding the computation of
items of income and expense under section 163(j) for taxpayers that are
C corporations, including, for example, members of a consolidated
group, REITs, RICs, tax-exempt corporations, and cooperatives.
Paragraph (b) of this section provides rules regarding the
characterization of items of income, gain, deduction, or loss.
Paragraph (c) of this section provides rules regarding adjustments to
earnings and profits. Paragraph (d) of this section provides rules
applicable to members of a consolidated group. Paragraph (e) of this
section provides rules governing the ownership of partnership interests
by members of a consolidated group. Paragraph (f) of this section
provides cross-references to other rules within the 163(j) regulations
that may be applicable to C corporations.
(b) Characterization of items of income, gain, deduction, or loss--
(1) Interest expense and interest income. Solely for purposes of
section 163(j), all interest expense of a taxpayer that is a C
corporation is treated as properly allocable to a trade or business.
Similarly, solely for purposes of section 163(j), all interest income
of a taxpayer that is a C corporation is treated as properly allocable
to a trade or business. For rules governing the allocation of interest
expense and interest income between excepted and non-excepted trades or
businesses, see Sec. 1.163(j)-10.
(2) Adjusted taxable income. Solely for purposes of section 163(j),
all items of income, gain, deduction, or loss of a taxpayer that is a C
corporation are treated as properly allocable to a trade or business.
For rules governing the allocation of tax items between excepted and
non-excepted trades or businesses, see Sec. 1.163(j)-10.
(3) Investment interest, investment income, investment expenses,
and certain other tax items of a partnership with a C corporation
partner--(i) Characterization as expense or income properly allocable
to a trade or business. For purposes of section 163(j), any investment
interest, investment income, or investment expense (within the meaning
of section 163(d)) that a partnership pays, receives, or accrues and
that is allocated to a C corporation partner as a separately stated
item is treated by the C corporation partner as properly allocable to a
trade or business of that partner. Similarly, for purposes of section
163(j), any other tax items of a partnership that are neither properly
allocable to a trade or business of the partnership nor described in
section 163(d) and that are allocated to a C corporation partner as
separately stated items are treated as properly allocable to a trade or
business of that partner.
(ii) Effect of characterization on partnership. The
characterization of a partner's tax items pursuant to paragraph
(b)(3)(i) of this section does not affect the characterization of these
items at the partnership level.
(iii) Separately stated interest expense and interest income of a
partnership not treated as excess business interest expense or excess
taxable income of a C corporation partner. Investment interest expense
and other interest expense of a partnership that is treated as business
interest expense by a C corporation partner under paragraph (b)(3)(i)
of this section is not treated as excess business interest expense of
the partnership. Investment interest income and other interest income
of a partnership that is treated as business interest income by a C
corporation partner under paragraph (b)(3)(i) of this section is not
treated as excess taxable income of the partnership. For rules
governing excess business interest expense and excess taxable income,
see Sec. 1.163(j)-6.
(iv) Treatment of deemed inclusions of a domestic partnership that
are not allocable to any trade or business. If a United States
shareholder that is a domestic partnership includes amounts in gross
income under sections 951(a) or 951A(a) that are not properly allocable
to a trade or business of the domestic partnership, then,
notwithstanding paragraph (b)(3)(i) of this section, to the extent a C
corporation partner, including an indirect partner in the case of
tiered partnerships, takes such amounts into account as a distributive
share in accordance with section 702 and Sec. 1.702-1(a)(8)(ii), the C
corporation partner may not treat such amounts as properly allocable to
a trade or business of the C corporation partner.
(4) Application to RICs and REITs--(i) In general. Except as
otherwise provided in paragraphs (b)(4)(ii) and (iii) of this section,
the rules in this paragraph (b) apply to RICs and REITs.
(ii) Tentative taxable income of RICs and REITs. The tentative
taxable income of a RIC or REIT for purposes of calculating ATI is the
tentative taxable income of the corporation, without any adjustment
that would be made under section 852(b)(2) or 857(b)(2) to compute
investment company taxable income or real estate investment trust
taxable income, respectively. For example, the tentative taxable income
of a RIC or REIT is not reduced by the deduction for dividends paid,
but is reduced by the dividends received deduction (DRD) and the other
deductions described in sections 852(b)(2)(C) and 857(b)(2)(A). See
paragraph (b)(4)(iii) of this section for an adjustment to ATI in
respect of these items.
(iii) Other adjustments to adjusted taxable income for RICs and
REITs. In the case of a taxpayer that, for a taxable year, is a RIC to
which section 852(b) applies or a REIT to which section 857(b) applies,
the taxpayer's ATI for the taxable year is increased by the amounts of
any deductions described in section 852(b)(2)(C) or 857(b)(2)(A).
(5) Application to tax-exempt corporations. The rules in this
paragraph (b) apply to a tax-exempt corporation only with respect to
that corporation's items of income, gain, deduction, or loss that are
taken into account in computing the corporation's unrelated business
taxable income, as defined in section 512.
(6) Adjusted taxable income of cooperatives. Solely for purposes of
computing the ATI of a cooperative under Sec. 1.163(j)-1(b)(1),
tentative taxable income is not reduced by the amount of any patronage
dividend under section 1382(b)(1) or by any amount paid in redemption
of nonqualified written notices of allocation distributed as patronage
dividends under section 1382(b)(2) (for cooperatives subject to
taxation under sections 1381 through 1388), any amount described in
section 1382(c) (for
[[Page 56776]]
cooperatives described in section 1381(a)(1) and section 521), or any
equivalent amount deducted by an organization that operates on a
cooperative basis but is not subject to taxation under sections 1381
through 1388.
(7) Examples. The principles of this paragraph (b) are illustrated
by the following examples. For purposes of the examples in this
paragraph (b)(7) of this section, T is a taxable domestic C corporation
whose taxable year ends on December 31; T is neither a consolidated
group member nor a RIC or a REIT; neither T nor PS1, a domestic
partnership, owns at least 80 percent of the stock of any corporation;
neither T nor PS1 qualifies for the small business exemption in Sec.
1.163(j)-2(d) or is engaged in an excepted trade or business; T has no
floor plan financing expense; all interest expense is deductible except
for the potential application of section 163(j); and the facts set
forth the only corporate or partnership activity.
(i) Example 1: C corporation items properly allocable to a trade or
business--(A) Facts. In taxable year 2021, T's tentative taxable income
(without regard to the application of section 163(j)) is $320x. This
amount is comprised of the following tax items: $1,000x of revenue from
inventory sales; $500x of ordinary and necessary business expenses
(excluding interest and depreciation); $200x of interest expense; $50x
of interest income; $50x of depreciation deductions under section 168;
and a $20x gain on the sale of stock.
(B) Analysis. For purposes of section 163(j), each of T's tax items
is treated as properly allocable to a trade or business. Thus, T's ATI
for the 2021 taxable year is $520x ($320x of tentative taxable income +
$200x business interest expense-$50x business interest income + $50x
depreciation deductions = $520x), and its section 163(j) limitation for
the 2021 taxable year is $206x ($50x of business interest income + 30
percent of its ATI (30 percent x $520x) = $206x). As a result, all
$200x of T's interest expense is deductible in the 2021 taxable year
under section 163(j).
(C) Taxable year beginning in 2022. The facts are the same as in
Example 1 in paragraph (b)(7)(i)(A) of this section, except that the
taxable year begins in 2022 and therefore depreciation deductions are
not added back to ATI under Sec. 1.163(j)-1(b)(1)(i)(E). As a result,
T's ATI for 2022 is $470x ($320x of tentative taxable income + $200x
business interest expense-$50x business interest income = $470x), and
its section 163(j) limitation for the 2022 taxable year is $191x ($50x
of business interest income + 30 percent of its ATI (30 percent x
$470x) = $191x). As a result, T may only deduct $191x of its business
interest expense for the taxable year, and the remaining $9x is carried
forward to the 2023 taxable year as a disallowed business interest
expense carryforward. See Sec. 1.163(j)-2(c).
(ii) Example 2: C corporation partner--(A) Facts. T and individual
A each own a 50 percent interest in PS1, a general partnership. PS1
borrows funds from a third party (Loan 1) and uses those funds to buy
stock in publicly-traded corporation X. PS1's only activities are
holding X stock (and receiving dividends) and making payments on Loan
1. In the 2021 taxable year, PS1 receives $150x in dividends and pays
$100x in interest on Loan 1.
(B) Analysis. For purposes of section 163(d) and (j), PS1 has
investment interest expense of $100x and investment income of $150x,
and PS1 has no interest expense or interest income that is properly
allocable to a trade or business. PS1 allocates its investment interest
expense and investment income equally to its two partners pursuant to
Sec. 1.163(j)-6(k). Pursuant to paragraph (b)(3) of this section, T's
allocable share of PS1's investment interest expense is treated as a
business interest expense of T, and T's allocable share of PS1's
investment income is treated as properly allocable to a trade or
business of T. This business interest expense is not treated as excess
business interest expense, and this income is not treated as excess
taxable income. See paragraph (b)(3)(iii) of this section. T's
treatment of its allocable share of PS1's investment interest expense
and investment income as business interest expense and income properly
allocable to a trade or business, respectively, does not affect the
character of these items at the PS1 level and does not affect the
character of A's allocable share of PS1's investment interest and
investment income.
(C) Partnership engaged in a trade or business. The facts are the
same as in Example 2 in paragraph (b)(7)(ii)(A) of this section, except
that PS1 also is engaged in Business 1, and PS1 borrows funds from a
third party to finance Business 1 (Loan 2). In 2021, Business 1 earns
$150x of net income (excluding interest expense and depreciation), and
PS1 pays $100x of interest on Loan 2. For purposes of section 163(d)
and (j), PS1 treats the interest paid on Loan 2 as properly allocable
to a trade or business. As a result, PS1 has investment interest
expense of $100x (attributable to Loan 1), business interest expense of
$100x (attributable to Loan 2), $150x of investment income, and $150x
of income from Business 1. PS1's ATI is $150x (its net income from
Business 1 excluding interest and depreciation), and its section 163(j)
limitation is $45x (30 percent x $150x). Pursuant to Sec. 1.163(j)-6,
PS1 has $55x of excess business interest expense ($100x-$45x), half of
which ($27.5x) is allocable to T. Additionally, pursuant to paragraph
(b)(3)(i) of this section, T's allocable share of PS1's investment
interest expense ($50x) is treated as a business interest expense of T
for purposes of section 163(j), and T's allocable share of PS1's
investment income ($75x) is treated as properly allocable to a trade or
business of T. Therefore, with respect to T's interest in PS1, T is
treated as having $50x of business interest expense that is not treated
as excess business interest expense, $75x of income that is properly
allocable to a trade or business, and $27.5x of excess business
interest expense.
(c) Effect on earnings and profits--(1) In general. In the case of
a taxpayer that is a domestic C corporation, except as otherwise
provided in paragraph (c)(2) of this section, the disallowance and
carryforward under Sec. 1.163(j)-2 (and Sec. 1.163(j)-5, in the case
of a taxpayer that is a consolidated group member) of a deduction for
business interest expense of the taxpayer or of a partnership in which
the taxpayer is a partner does not affect whether or when the business
interest expense reduces the taxpayer's earnings and profits. In the
case of a foreign corporation, the disallowance and carryforward of a
deduction for the corporation's business interest expense under Sec.
1.163(j)-2 does not affect whether and when such business interest
expense reduces the corporation's earnings and profits. Thus, for
example, if a United States person has elected under section 1295 to
treat a passive foreign investment company (as defined in section 1297)
(PFIC) as a qualified electing fund, then the disallowance and
carryforward of a deduction for the PFIC's business interest expense
under Sec. 1.163(j)-2 does not affect whether or when such business
interest expense reduces the PFIC's earnings and profits.
(2) Special rule for RICs and REITs. In the case of a taxpayer that
is a RIC or a REIT for the taxable year in which a deduction for the
taxpayer's business interest expense is disallowed under Sec.
1.163(j)-2(b), or in which the RIC or REIT is allocated any excess
business interest expense from a partnership under section
163(j)(4)(B)(i) and Sec. 1.163(j)-6, the taxpayer's earnings and
profits are adjusted in the taxable year
[[Page 56777]]
or years in which the business interest expense is deductible or, if
earlier, in the first taxable year for which the taxpayer no longer is
a RIC or a REIT.
(3) Special rule for partners that are C corporations. If a
taxpayer that is a C corporation is allocated any excess business
interest expense from a partnership, and if all or a portion of the
excess business interest expense has not yet been treated as business
interest expense by the taxpayer at the time of the taxpayer's
disposition of all or a portion of its interest in the partnership, the
taxpayer must increase its earnings and profits immediately prior to
the disposition by an amount equal to the amount of the basis
adjustment required under section 163(j)(4)(B)(iii)(II) and Sec.
1.163(j)-6(h)(3).
(4) Examples. The principles of this paragraph (c) are illustrated
by the following examples. For purposes of the examples in this
paragraph (c)(4), except as otherwise provided in the examples, X is a
taxable domestic C corporation whose taxable year ends on December 31;
X is not a member of a consolidated group; X does not qualify for the
small business exemption under Sec. 1.163(j)-2(d); X is not engaged in
an excepted trade or business; X has no floor plan financing
indebtedness; all interest expense is deductible except for the
potential application of section 163(j); X has no accumulated earnings
and profits at the beginning of the 2021 taxable year; and the facts
set forth the only corporate activity.
(i) Example 1: Earnings and profits of a taxable domestic C
corporation other than a RIC or a REIT--(A) Facts. X is a corporation
that does not intend to qualify as a RIC or a REIT for its 2021 taxable
year. In that year, X has tentative taxable income (without regard to
the application of section 163(j)) of $0, which includes $100x of gross
income and $100x of interest expense on a loan from an unrelated third
party. X also makes a $100x distribution to its shareholders that year.
(B) Analysis. The $100x of interest expense is business interest
expense for purposes of section 163(j) (see paragraph (b)(1) of this
section). X's ATI in the 2021 taxable year is $100x ($0 of tentative
taxable income computed without regard to $100x of business interest
expense). Thus, X may deduct $30x of its $100x of business interest
expense in the 2021 taxable year under Sec. 1.163(j)-2(b) (30 percent
x $100x), and X may carry forward the remainder ($70x) to X's 2022
taxable year as a disallowed business interest expense carryforward
under Sec. 1.163(j)-2(c). Although X may not currently deduct all
$100x of its business interest expense in the 2021 taxable year, X must
reduce its earnings and profits in that taxable year by the full amount
of its business interest expense ($100x) in that taxable year. As a
result, no portion of X's distribution of $100x to its shareholders in
the 2021 taxable year is a dividend within the meaning of section
316(a).
(ii) Example 2: RIC adjusted taxable income and earnings and
profits--(A) Facts. X is a corporation that intends to qualify as a RIC
for its 2021 taxable year. In that taxable year, X's only items are
$100x of interest income, $50x of dividend income from C corporations
that only issue common stock and in which X has less than a twenty
percent interest (by vote and value), $10x of net capital gain, and
$125x of interest expense. None of the dividends are received on debt
financed portfolio stock under section 246A. The DRD determined under
section 243(a) with respect to X's $50x of dividend income is $25x. X
pays $42x in dividends to its shareholders, meeting the requirements of
section 562 during X's 2021 taxable year, including $10x that X reports
as capital gain dividends in written statements furnished to X's
shareholders.
(B) Analysis. (1) Under paragraph (b) of this section, all of X's
interest expense is considered business interest expense, all of X's
interest income is considered business interest income, and all of X's
other income is considered to be properly allocable to a trade or
business. Under paragraph (b)(4)(ii) of this section, prior to the
application of section 163(j), X's tentative taxable income is $10x
($100x business interest income + $50x dividend income + $10x net
capital gain-$125x business interest expense-$25x DRD = $10x). Under
paragraph (b)(4)(iii) of this section, X's ATI is increased by the DRD.
As such, X's ATI for the 2021 taxable year is $60x ($10x tentative
taxable income + $125x business interest expense-$100x business
interest income + $25x DRD = $60x).
(2) X may deduct $118x of its $125x of business interest expense in
the 2021 taxable year under section 163(j)(1) ($100x business interest
income + (30 percent x $60x of ATI) = $118x), and X may carry forward
the remainder ($7x) to X's 2022 taxable year. See Sec. 1.163(j)-2(b)
and (c).
(3) After the application of section 163(j), X has taxable income
of $17x ($100x interest income + $50x dividend income + $10x capital
gain-$25x DRD-$118x allowable interest expense = $17x) for the 2021
taxable year. X will have investment company taxable income (ICTI) in
the amount of $0 ($17x taxable income-$10x capital gain + $25x DRD-$32x
dividends paid deduction for ordinary dividends = $0). The excess of
X's net capital gain ($10x) over X's dividends paid deduction
determined with reference to capital gain dividends ($10x) is also $0.
(4) Under paragraph (c)(2) of this section, X will not reduce its
earnings and profits by the amount of interest expense disallowed as a
deduction in the 2021 taxable year under section 163(j). Thus, X has
current earnings and profits in the amount of $42x ($100x interest
income + $50x dividend income + $10x capital gain-$118x allowable
business interest expense = $42x) before giving effect to dividends
paid during the 2021 taxable year.
(iii) Example 3: Carryforward of disallowed interest expense--(A)
Facts. The facts are the same as the facts in Example 2 in paragraph
(c)(4)(ii)(A) of this section for the 2021 taxable year. In addition, X
has $50x of interest income and $20x of interest expense for the 2022
taxable year.
(B) Analysis. Under paragraph (b) of this section, all of X's
interest expense is considered business interest expense, all of X's
interest income is considered business interest income, and all of X's
other income is considered to be properly allocable to a trade or
business. Because X's $50x of business interest income exceeds the $20x
of business interest expense from the 2022 taxable year and the $7x of
disallowed business interest expense carryforward from the 2021 taxable
year, X may deduct $27x of business interest expense in the 2022
taxable year. Under paragraph (c)(2) of this section, X must reduce its
current earnings and profits for the 2022 taxable year by the full
amount of the deductible business interest expense ($27x).
(iv) Example 4: REIT adjusted taxable income and earnings and
profits--(A) Facts. X is a corporation that intends to qualify as a
REIT for its 2021 taxable year. X is not engaged in an excepted trade
or business and is not engaged in a trade or business that is eligible
to make any election under section 163(j)(7). In that year, X's only
items are $100x of mortgage interest income, $30x of dividend income
from C corporations that only issue common stock and in which X has
less than a ten percent interest (by vote and value), $10x of net
capital gain from the sale of mortgages on real property that is not
property described in section 1221(a)(1), and $125x of interest
expense. None of the dividends are received on debt financed portfolio
stock under section 246A. The DRD determined under section 243(a)
[[Page 56778]]
with respect to X's $30x of dividend income is $15x. X pays $28x in
dividends meeting the requirements of section 562 during X's 2021
taxable year, including $10x that X properly designates as capital gain
dividends under section 857(b)(3)(B).
(B) Analysis. (1) Under paragraph (b) of this section, all of X's
interest expense is considered business interest expense, all of X's
interest income is considered business interest income, and all of X's
other income is considered to be properly allocable to a trade or
business. Under paragraph (b)(4)(ii) of this section, prior to the
application of section 163(j), X's tentative taxable income is $0
($100x business interest income + $30x dividend income + $10x net
capital gain-$125x business interest expense-$15x DRD = $0). Under
paragraph (b)(4)(iii) of this section, X's ATI is increased by the DRD.
As such, X's ATI for the 2021 taxable year is $40x ($0 tentative
taxable income + $125x business interest expense-$100x business
interest income + $15x DRD = $40x).
(2) X may deduct $112x of its $125x of business interest expense in
the 2021 taxable year under section 163(j)(1) ($100x business interest
income + (30 percent x $40x of ATI) = $112x), and X may carry forward
the remainder of its business interest expense ($13x) to X's 2022
taxable year.
(3) After the application of section 163(j), X has taxable income
of $13x ($100x business interest income + $30x dividend income + $10x
capital gain-$15x DRD-$112x allowable business interest expense = $13x)
for the 2021 taxable year. X will have real estate investment trust
taxable income (REITTI) in the amount of $0 ($13x taxable income + $15x
of DRD-$28x dividends paid deduction = $0).
(4) Under paragraph (c)(2) of this section, X will not reduce
earnings and profits by the amount of business interest expense
disallowed as a deduction in the 2021 taxable year. Thus, X has current
earnings and profits in the amount of $28x ($100x business interest
income + $30x dividend income + $10x capital gain-$112x allowable
business interest expense = $28x) before giving effect to dividends
paid during X's 2021 taxable year.
(v) Example 5: Carryforward of disallowed interest expense--(A)
Facts. The facts are the same as in Example 4 in paragraph
(c)(4)(iv)(A) of this section for the 2021 taxable year. In addition, X
has $50x of mortgage interest income and $20x of interest expense for
the 2022 taxable year. X has no other tax items for the 2022 taxable
year.
(B) Analysis. Because X's $50x of business interest income exceeds
the $20x of business interest expense from the 2022 taxable year and
the $13x of disallowed business interest expense carryforwards from the
2021 taxable year, X may deduct $33x of business interest expense in
2022. Under paragraph (c)(2) of this section, X must reduce its current
earnings and profits for 2022 by the full amount of the deductible
interest expense ($33x).
(d) Special rules for consolidated groups--(1) Scope. This
paragraph (d) provides rules applicable to members of a consolidated
group. For all members of a consolidated group for a consolidated
return year, the computations required by section 163(j) and the
regulations in this part under section 163(j) are made in accordance
with the rules of this paragraph (d) unless otherwise provided
elsewhere in the section 163(j) regulations. For rules governing the
ownership of partnership interests by members of a consolidated group,
see paragraph (e) of this section.
(2) Calculation of the section 163(j) limitation for members of a
consolidated group--(i) In general. A consolidated group has a single
section 163(j) limitation, the absorption of which is governed by Sec.
1.163(j)-5(b)(3)(ii).
(ii) Interest. For purposes of determining whether amounts, other
than amounts in respect of intercompany obligations (as defined in
Sec. 1.1502-13(g)(2)(ii)), intercompany items (as defined in Sec.
1.1502-13(b)(2)), or corresponding items (as defined in Sec. 1.1502-
13(b)(3)), are treated as interest within the meaning of Sec.
1.163(j)-1(b)(22), all members of a consolidated group are treated as a
single taxpayer.
(iii) Calculation of business interest expense and business
interest income for a consolidated group. For purposes of calculating
the section 163(j) limitation for a consolidated group, the
consolidated group's current-year business interest expense and
business interest income, respectively, are the sum of each member's
current-year business interest expense and business interest income,
including amounts treated as business interest expense and business
interest income under paragraph (b)(3) of this section.
(iv) Calculation of adjusted taxable income. For purposes of
calculating the ATI for a consolidated group, the tentative taxable
income is the consolidated group's consolidated taxable income,
determined under Sec. 1.1502-11 but without regard to any
carryforwards or disallowances under section 163(j). Further, for
purposes of calculating the ATI of the group, intercompany items and
corresponding items are disregarded to the extent that they offset in
amount. Thus, for example, certain portions of the intercompany items
and corresponding items of a group member engaged in a non-excepted
trade or business will not be included in ATI to the extent that the
counterparties to the relevant intercompany transactions are engaged in
one or more excepted trades or businesses.
(v) Treatment of intercompany obligations--(A) In general. Except
as otherwise provided in paragraph (d)(2)(v)(B) of this section, for
purposes of determining a member's business interest expense and
business interest income, and for purposes of calculating the
consolidated group's ATI, all intercompany obligations, as defined in
Sec. 1.1502-13(g)(2)(ii), are disregarded. Therefore, except as
otherwise provided in paragraph (d)(2)(v)(B) of this section, interest
expense and interest income from intercompany obligations are not
treated as business interest expense and business interest income.
(B) Repurchase premium. This paragraph (d)(2)(v)(B) applies if a
member of a consolidated group purchases an obligation of another
member of the same consolidated group in a transaction to which Sec.
1.1502-13(g)(5) applies. Notwithstanding the general rule of paragraph
(d)(2)(v)(A) of this section, if, as a result of the deemed
satisfaction of the obligation under Sec. 1.1502-13(g)(5)(ii), the
debtor member has repurchase premium that is deductible under Sec.
1.163-7(c), such repurchase premium is treated as interest that is
subject to the section 163(j) limitation. See Sec. 1.163(j)-
1(b)(22)(i)(H).
(3) Investment adjustments. For rules governing investment
adjustments within a consolidated group, see Sec. 1.1502-32(b).
(4) Examples. The principles in this paragraph (d) are illustrated
by the following examples. For purposes of the examples in this
paragraph (d)(4), S is a member of the calendar-year consolidated group
of which P is the common parent; the P group does not qualify for the
small business exemption in Sec. 1.163(j)-2(d); no member of the P
group is engaged in an excepted trade or business; all interest expense
is deductible except for the potential application of section 163(j);
and the facts set forth the only corporate activity.
(i) Example 1: Calculation of the section 163(j) limitation--(A)
Facts. In the 2021 taxable year, P has $50x of separate tentative
taxable income after taking into account $65x of interest paid
[[Page 56779]]
on a loan from a third party (without regard to any disallowance under
section 163(j)) and $35x of depreciation deductions under section 168.
In turn, S has $40x of separate tentative taxable income in the 2021
taxable year after taking into account $10x of depreciation deductions
under section 168. S has no interest expense in the 2021 taxable year.
The P group's tentative taxable income the 2021 taxable year is $90x,
determined under Sec. 1.1502-11 without regard to any disallowance
under section 163(j).
(B) Analysis. As provided in paragraph (b)(1) of this section, P's
interest expense is treated as business interest expense for purposes
of section 163(j). If P and S were to apply the section 163(j)
limitation on a separate-entity basis, then P's ATI would be $150x
($50x + $65x + $35x = $150x), its section 163(j) limitation would be
$45x (30 percent x $150x = $45x), and a deduction for $20x of its $65x
of business interest expense would be disallowed in the 2021 taxable
year under section 163(j). However, as provided in paragraph (d)(2) of
this section, the P group computes a single section 163(j) limitation,
and that computation begins with the P group's tentative taxable income
(as determined prior to the application of section 163(j)), or $90x.
The P group's ATI is $200x ($50x + $40x + $65x + $35x + $10x = $200x).
Thus, the P group's section 163(j) limitation for the 2021 taxable year
is $60x (30 percent x $200x = $60x). As a result, all but $5x of the P
group's business interest expense is deductible in the 2021 taxable
year. P carries over the $5x of disallowed business interest expense to
the succeeding taxable year.
(ii) Example 2: Intercompany obligations--(A) Facts. On January 1,
2021, G, a corporation unrelated to P and S, lends P $100x in exchange
for a note that accrues interest at a 10 percent annual rate. A month
later, P lends $100x to S in exchange for a note that accrues interest
at a 12 percent annual rate. In 2021, P accrues and pays $10x of
interest to G on P's note, and S accrues and pays $12x of interest to P
on S's note. For that year, the P group's only other items of income,
gain, deduction, and loss are $40x of income earned by S from the sale
of inventory, and a $30x deductible expense arising from P's payment of
tort liability claims.
(B) Analysis. As provided in paragraph (d)(2)(v) of this section,
the intercompany obligation between P and S is disregarded in
determining P and S's business interest expense and business interest
income and in determining the P group's ATI. For purposes of section
163(j), P has $10x of business interest expense and a $30x deduction
for the payment of tort liability claims, and S has $40x of income. The
P group's ATI is $10x ($40x-$30x = $10x), and its section 163(j)
limitation is $3x (30 percent x $10x = $3x). The P group may deduct $3x
of its business interest expense in the 2021 taxable year. A deduction
for P's remaining $7x of business interest expense is disallowed in the
2021 taxable year, and this amount is carried forward to the 2022
taxable year.
(e) Ownership of partnership interests by members of a consolidated
group.
(1) [Reserved]
(2) Change in status of a member. A change in status of a member
(that is, becoming or ceasing to be a member of the group) is not
treated as a disposition for purposes of section 163(j)(4)(B)(iii)(II)
and Sec. 1.163(j)-6(h)(3).
(3) Basis adjustments under Sec. 1.1502-32. A member's allocation
of excess business interest expense from a partnership and the
resulting decrease in basis in the partnership interest under section
163(j)(4)(B)(iii)(I) is not a noncapital, nondeductible expense for
purposes of Sec. 1.1502-32(b)(3)(iii). Additionally, an increase in a
member's basis in a partnership interest under section
163(j)(4)(B)(iii)(II) to reflect excess business interest expense not
deducted by the consolidated group is not tax-exempt income for
purposes of Sec. 1.1502-32(b)(3)(ii). Investment adjustments are made
under Sec. 1.1502-32(b)(3)(i) when the excess business interest
expense from the partnership is converted into business interest
expense, deducted, and absorbed by the consolidated group. See Sec.
1.1502-32(b).
(4) Excess business interest expense and Sec. 1.1502-36. Excess
business interest expense is a Category D asset within the meaning of
Sec. 1.1502-36(d)(4)(i).
(f) Cross-references. For rules governing the treatment of
disallowed business interest expense carryforwards for C corporations,
including rules governing the treatment of disallowed business interest
expense carryforwards when members enter or leave a consolidated group,
see Sec. 1.163(j)-5. For rules governing the application of section
163(j) to a C corporation or a consolidated group engaged in both
excepted and non-excepted trades or businesses, see Sec. 1.163(j)-10.
(g) Applicability date--(1) In general. This section applies to
taxable years beginning on or after November 13, 2020. However,
taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of this section to
a taxable year beginning after December 31, 2017, so long as the
taxpayers and their related parties consistently apply the rules of the
section 163(j) regulations, and, if applicable, Sec. Sec. 1.263A-9,
1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7,
1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3,
1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to
that taxable year.
(2) [Reserved]
Sec. 1.163(j)-5 General rules governing disallowed business interest
expense carryforwards for C corporations.
(a) Scope and definitions--(1) Scope. This section provides rules
regarding disallowed business interest expense carryforwards for
taxpayers that are C corporations, including members of a consolidated
group. Paragraph (b) of this section provides rules regarding the
treatment of disallowed business interest expense carryforwards.
Paragraph (c) of this section provides a cross-reference to other rules
regarding disallowed business interest expense carryforwards in
transactions to which section 381(a) applies. Paragraph (d) of this
section provides rules regarding limitations on disallowed business
interest expense carryforwards from separate return limitation years
(SRLYs). Paragraph (e) of this section provides cross-references to
other rules regarding the application of section 382 to disallowed
business interest expense carryforwards. Paragraph (f) of this section
provides a cross-reference to other rules regarding the overlap of the
SRLY limitation with section 382. Paragraph (g) of this section
references additional rules that may limit the deductibility of
interest or the use of disallowed business interest expense
carryforwards.
(2) Definitions--(i) Allocable share of the consolidated group's
remaining section 163(j) limitation. The term allocable share of the
consolidated group's remaining section 163(j) limitation means, with
respect to any member of a consolidated group, the product of the
consolidated group's remaining section 163(j) limitation and the
member's remaining current-year interest ratio.
(ii) Consolidated group's remaining section 163(j) limitation. The
term consolidated group's remaining section 163(j) limitation means the
amount of the consolidated group's section 163(j) limitation calculated
pursuant to
[[Page 56780]]
Sec. 1.163(j)-4(d)(2), reduced by the amount of interest deducted by
members of the consolidated group pursuant to paragraph
(b)(3)(ii)(C)(2) of this section.
(iii) Remaining current-year interest ratio. The term remaining
current-year interest ratio means, with respect to any member of a
consolidated group for a particular taxable year, the ratio of the
remaining current-year business interest expense of the member after
applying the rule in paragraph (b)(3)(ii)(C)(2) of this section, to the
sum of the amounts of remaining current-year business interest expense
for all members of the consolidated group after applying the rule in
paragraph (b)(3)(ii)(C)(2) of this section.
(b) Treatment of disallowed business interest expense
carryforwards--(1) In general. The amount of any business interest
expense of a C corporation not allowed as a deduction for any taxable
year as a result of the section 163(j) limitation is carried forward to
the succeeding taxable year as a disallowed business interest expense
carryforward under section 163(j)(2) and Sec. 1.163(j)-2(c).
(2) Deduction of business interest expense. For a taxpayer that is
a C corporation, current-year business interest expense is deducted in
the current taxable year before any disallowed business interest
expense carryforwards from a prior taxable year are deducted in that
year. Disallowed business interest expense carryforwards are deducted
in the order of the taxable years in which they arose, beginning with
the earliest taxable year, subject to certain limitations (for example,
the limitation under section 382). For purposes of section 163(j),
disallowed disqualified interest is treated as carried forward from the
taxable year in which a deduction was disallowed under old section
163(j).
(3) Consolidated groups--(i) In general. A consolidated group's
disallowed business interest expense carryforwards for the current
consolidated return year (the current year) are the carryforwards from
the group's prior consolidated return years plus any carryforwards from
separate return years.
(ii) Deduction of business interest expense--(A) General rule. All
current-year business interest expense of members of a consolidated
group is deducted in the current year before any disallowed business
interest expense carryforwards from prior taxable years are deducted in
the current year. Disallowed business interest expense carryforwards
from prior taxable years are deducted in the order of the taxable years
in which they arose, beginning with the earliest taxable year, subject
to the limitations described in this section.
(B) Section 163(j) limitation equals or exceeds the current-year
business interest expense and disallowed business interest expense
carryforwards from prior taxable years. If a consolidated group's
section 163(j) limitation for the current year equals or exceeds the
aggregate amount of its members' current-year business interest expense
and disallowed business interest expense carryforwards from prior
taxable years that are available for deduction, then none of the
current-year business interest expense or disallowed business interest
expense carryforwards is subject to disallowance in the current year
under section 163(j). However, a deduction for the members' business
interest expense may be subject to limitation under other provisions of
the Code or the Income Tax Regulations (see, for example, paragraphs
(c), (d), (e), and (f) of this section).
(C) Current-year business interest expense and disallowed business
interest expense carryforwards exceed section 163(j) limitation. If the
aggregate amount of members' current-year business interest expense and
disallowed business interest expense carryforwards from prior taxable
years exceeds the consolidated group's section 163(j) limitation for
the current year, then the following rules apply in the order provided:
(1) The group first determines whether its section 163(j)
limitation for the current year equals or exceeds the aggregate amount
of the members' current-year business interest expense.
(i) If the group's section 163(j) limitation for the current year
equals or exceeds the aggregate amount of the members' current-year
business interest expense, then no amount of the group's current-year
business interest expense is subject to disallowance in the current
year under section 163(j). Once the group has taken into account its
members' current-year business interest expense, the group applies the
rules of paragraph (b)(3)(ii)(C)(4) of this section.
(ii) If the aggregate amount of members' current-year business
interest expense exceeds the group's section 163(j) limitation for the
current year, then the group applies the rule in paragraph
(b)(3)(ii)(C)(2) of this section.
(2) If this paragraph (b)(3)(ii)(C)(2) applies (see paragraph
(b)(3)(ii)(C)(1)(ii) of this section), then each member with current-
year business interest expense and with current-year business interest
income or floor plan financing interest expense deducts current-year
business interest expense in an amount that does not exceed the sum of
the member's business interest income and floor plan financing interest
expense for the current year.
(3) After applying the rule in paragraph (b)(3)(ii)(C)(2) of this
section, if the group has any section 163(j) limitation remaining for
the current year, then each member with remaining current-year business
interest expense deducts a portion of its expense based on its
allocable share of the consolidated group's remaining section 163(j)
limitation.
(4) If this paragraph (b)(3)(ii)(C)(4) applies (see paragraph
(b)(3)(ii)(C)(1)(i) of this section), and if the group has any section
163(j) limitation remaining for the current year after applying the
rules in paragraph (b)(3)(ii)(C)(1) of this section, then disallowed
business interest expense carryforwards permitted to be deducted
(including under paragraph (d)(1)(A) of this section) in the current
year are to be deducted in the order of the taxable years in which they
arose, beginning with the earliest taxable year. Disallowed business
interest expense carryforwards from taxable years ending on the same
date that are available to offset tentative taxable income for the
current year generally are to be deducted on a pro rata basis under the
principles of paragraph (b)(3)(ii)(C)(3) of this section. For example,
assume that P and S are the only members of a consolidated group with a
section 163(j) limitation for the current year (Year 2) of $200x; the
amount of current-year business interest expense deducted in Year 2 is
$100x; and P and S, respectively, have $140x and $60x of disallowed
business interest expense carryforwards from Year 1 that are not
subject to limitation under paragraph (c), (d), or (e) of this section.
Under these facts, P would be allowed to deduct $70x of its
carryforwards from Year 1 ($100x x ($140x/($60x + $140x)) = $70x), and
S would be allowed to deduct $30x of its carryforwards from Year 1
($100x x ($60x/($60x + $140x)) = $30x). But see Sec. 1.383-
1(d)(1)(ii), providing that, if losses subject to and not subject to
the section 382 limitation are carried from the same taxable year,
losses subject to the limitation are deducted before losses not subject
to the limitation.
(5) Each member with remaining business interest expense after
applying the rules of this paragraph (b)(3)(ii), taking into account
the limitations in paragraphs (c), (d), (e), and (f) of this section,
carries the expense forward to the succeeding taxable year as a
disallowed business interest expense
[[Page 56781]]
carryforward under section 163(j)(2) and Sec. 1.163(j)-2(c).
(iii) Departure from group. If a corporation ceases to be a member
during a consolidated return year, the corporation's current-year
business interest expense from the taxable period ending on the day of
the corporation's change in status as a member, as well as the
corporation's disallowed business interest expense carryforwards from
prior taxable years that are available to offset tentative taxable
income in the consolidated return year, are first made available for
deduction during that consolidated return year. See Sec. 1.1502-
76(b)(1)(i); see also Sec. 1.1502-36(d) (regarding reductions of
deferred deductions on the transfer of loss shares of subsidiary
stock). Only the amount that is neither deducted by the group in that
consolidated return year nor otherwise reduced under the Code or
regulations may be carried to the corporation's first separate return
year after its change in status.
(iv) Example: Deduction of interest expense--(A) Facts. (1) P
wholly owns A, which is a member of the consolidated group of which P
is the common parent. P and A each borrow money from Z, an unrelated
third party. The business interest expense of P and A in Years 1, 2,
and 3, and the P group's section 163(j) limitation for those years, are
as follows:
Table 1 To Paragraph (b)(3)(iv)(A)(1)
----------------------------------------------------------------------------------------------------------------
P's business A's business P group's
Year interest interest section 163(j)
expense expense limitation
----------------------------------------------------------------------------------------------------------------
1............................................................... $150x $50x $100x
2............................................................... 60x 90x 120x
3............................................................... 25x 50x 185x
----------------------------------------------------------------------------------------------------------------
(2) P and A have neither business interest income nor floor plan
financing interest expense in Years 1, 2, and 3. Additionally, the P
group is neither eligible for the small business exemption in Sec.
1.163(j)-2(d) nor engaged in an excepted trade or business.
(B) Analysis--(1) Year 1. In Year 1, the aggregate amount of the P
group members' current-year business interest expense ($150x + $50x)
exceeds the P group's section 163(j) limitation ($100x). As a result,
the rules of paragraph (b)(3)(ii)(C) of this section apply. Because the
P group members' current-year business interest expense exceeds the
group's section 163(j) limitation for Year 1, P and A must apply the
rule in paragraph (b)(3)(ii)(C)(2) of this section. Pursuant to
paragraph (b)(3)(ii)(C)(2) of this section, each of P and A must deduct
its current-year business interest expense to the extent of its
business interest income and floor plan financing interest expense.
Neither P nor A has business interest income or floor plan financing
interest expense in Year 1. Next, pursuant to paragraph
(b)(3)(ii)(C)(3) of this section, each of P and A must deduct a portion
of its current-year business interest expense based on its allocable
share of the consolidated group's remaining section 163(j) limitation
($100x). P's allocable share is $75x ($100x x ($150x/$200x) = $75x),
and A's allocable share is $25x ($100x x ($50x/$200x) = $25x).
Accordingly, in Year 1, P deducts $75x of its current-year business
interest expense, and A deducts $25x of its current-year business
interest expense. P has a disallowed business interest expense
carryforward from Year 1 of $75x ($150x-$75x = $75x), and A has a
disallowed business interest expense carryforward from Year 1 of $25x
($50x-$25x = $25x).
(2) Year 2. In Year 2, the aggregate amount of the P group members'
current-year business interest expense ($60x + $90x) and disallowed
business interest expense carryforwards ($75x + $25x) exceeds the P
group's section 163(j) limitation ($120x). As a result, the rules of
paragraph (b)(3)(ii)(C) of this section apply. Because the P group
members' current-year business interest expense exceeds the group's
section 163(j) limitation for Year 2, P and A must apply the rule in
paragraph (b)(3)(ii)(C)(2) of this section. Pursuant to paragraph
(b)(3)(ii)(C)(2) of this section, each of P and A must deduct its
current-year business interest expense to the extent of its business
interest income and floor plan financing interest expense. Neither P
nor A has business interest income or floor plan financing interest
expense in Year 2. Next, pursuant to paragraph (b)(3)(ii)(C)(3) of this
section, each of P and A must deduct a portion of its current-year
business interest expense based on its allocable share of the
consolidated group's remaining section 163(j) limitation ($120x). P's
allocable share is $48x (($120x x ($60x/$150x)) = $48x), and A's
allocable share is $72x (($120x x ($90x/$150x)) = $72x). Accordingly,
in Year 2, P deducts $48x of current-year business interest expense,
and A deducts $72x of current-year business interest expense. P has a
disallowed business interest expense carryforward from Year 2 of $12x
($60x-$48x = $12x), and A has a disallowed business interest expense
carryforward from Year 2 of $18x ($90x-$72x = $18x). Additionally,
because the P group has no section 163(j) limitation remaining after
deducting current-year business interest expense in Year 2, the full
amount of P and A's disallowed business interest expense carryforwards
from Year 1 ($75x and $25x, respectively) also are carried forward to
Year 3. As a result, at the beginning of Year 3, P and A's respective
disallowed business interest expense carryforwards are as follows:
Table 2 to Paragraph (b)(3)(iv)(B)(2)
----------------------------------------------------------------------------------------------------------------
Year 1 Year 2 Total
disallowed disallowed disallowed
business business business
interest interest interest
expense expense expense
carryforwards carryforwards carryforwards
----------------------------------------------------------------------------------------------------------------
P............................................................... $75x $12x $87x
A............................................................... 25x 18x 43x
-----------------------------------------------
[[Page 56782]]
Total....................................................... 100x 30x 130x
----------------------------------------------------------------------------------------------------------------
(3) Year 3. In Year 3, the aggregate amount of the P group members'
current-year business interest expense ($25x + $50x = $75x) and
disallowed business interest expense carryforwards ($130x) exceeds the
P group's section 163(j) limitation ($185x). As a result, the rules of
paragraph (b)(3)(ii)(C) of this section apply. Because the P group's
section 163(j) limitation for Year 3 equals or exceeds the P group
members' current-year business interest expense, no amount of the
members' current-year business interest expense is subject to
disallowance under section 163(j) (see paragraph (b)(3)(ii)(C)(1) of
this section). After each of P and A deducts its current-year business
interest expense, the P group has $110x of section 163(j) limitation
remaining for Year 3 ($185x-$25x-$50x = $110x). Next, pursuant to
paragraph (b)(3)(ii)(C)(4) of this section, $110x of disallowed
business interest expense carryforwards are deducted on a pro rata
basis, beginning with carryforwards from Year 1. Because the total
amount of carryforwards from Year 1 ($100x) is less than the section
163(j) limitation remaining after the deduction of Year 3 business
interest expense ($110x), all of the Year 1 carryforwards are deducted
in Year 3. After current-year business interest expense and Year 1
carryforwards are deducted, the P group's remaining section 163(j)
limitation in Year 3 is $10x. Because the Year 2 carryforwards ($30x)
exceed the remaining section 163(j) limitation ($10x), under paragraph
(b)(3)(ii)(C)(4) of this section, each of P and A will deduct a portion
of its Year 2 carryforwards based on its allocable share of the
consolidated group's remaining section 163(j) limitation. P's allocable
share is $4x (($10x x ($12x/$30x)) = $4x), and A's allocable share is
$6x (($10x x ($18x/$30x)) = $6x). Accordingly, P and A may deduct $4x
and $6x, respectively, of their Year 2 carryforwards. For Year 4, P and
A have $8x and $12x of disallowed business interest expense
carryforwards from Year 2, respectively.
(c) Disallowed business interest expense carryforwards in
transactions to which section 381(a) applies. For rules governing the
application of section 381(c)(20) to disallowed business interest
expense carryforwards, including limitations on an acquiring
corporation's use of the disallowed business interest expense
carryforwards of the transferor or distributor corporation in the
acquiring corporation's first taxable year ending after the date of
distribution or transfer, see Sec. 1.381(c)(20)-1.
(d) Limitations on disallowed business interest expense
carryforwards from separate return limitation years--(1) General rule--
(A) Cumulative section 163(j) SRLY limitation. This paragraph (d)
applies to disallowed business interest expense carryforwards of a
member arising in a SRLY (see Sec. 1.1502-1(f))) or treated as arising
in a SRLY under the principles of Sec. 1.1502-21(c) and (g). The
amount of the carryforwards described in the preceding sentence that
are included in the consolidated group's business interest expense
deduction for any taxable year under paragraph (b) of this section may
not exceed the aggregate section 163(j) limitation for all consolidated
return years of the group, determined by reference only to the member's
items of income, gain, deduction, and loss, and reduced (including
below zero) by the member's business interest expense (including
disallowed business interest expense carryforwards) absorbed by the
group in all consolidated return years (cumulative section 163(j) SRLY
limitation). For purposes of computing the member's cumulative section
163(j) SRLY limitation, intercompany items referred to in Sec.
1.163(j)-4(d)(2)(iv) are included, with the exception of interest items
with regard to intercompany obligations. See Sec. 1.163(j)-4(d)(2)(v).
Thus, for purposes of this paragraph (d), income and expense items
arising from intercompany transactions (other than interest income and
expense with regard to intercompany obligations) are included in the
calculation of the cumulative section 163(j) SRLY limitation. In
addition, items of interest expense with regard to intercompany
obligations are not characterized as business interest expense for
purposes of the reduction described in the second sentence of this
paragraph (d)(1)(A).
(B) Subgrouping. For purposes of this paragraph (d), the SRLY
subgroup principles of Sec. 1.1502-21(c)(2)(i) (with regard to
carryovers of SRLY losses) apply with appropriate adjustments.
(2) Deduction of disallowed business interest expense carryforwards
arising in a SRLY. Notwithstanding paragraph (d)(1) of this section,
disallowed business interest expense carryforwards of a member arising
in a SRLY are available for deduction by the consolidated group in the
current year only to the extent the group has remaining section 163(j)
limitation for the current year after the deduction of current-year
business interest expense and disallowed business interest expense
carryforwards from earlier taxable years that are permitted to be
deducted in the current year (see paragraph (b)(3)(ii)(A) of this
section). SRLY-limited disallowed business interest expense
carryforwards are deducted on a pro rata basis (under the principles of
paragraph (b)(3)(ii)(C)(3) of this section) with non-SRLY limited
disallowed business interest expense carryforwards from taxable years
ending on the same date. See also Sec. 1.1502-21(b)(1).
(3) Examples. The principles of this paragraph (d) are illustrated
by the following examples. For purposes of the examples in this
paragraph (d)(3), unless otherwise stated, P, R, S, and T are taxable
domestic C corporations that are not RICs or REITs and that file their
tax returns on a calendar-year basis; none of P, R, S, or T qualifies
for the small business exemption under section 163(j)(3) or is engaged
in an excepted trade or business; all interest expense is deductible
except for the potential application of section 163(j); and the facts
set forth the only corporate activity.
(i) Example 1: Determination of SRLY limitation--(A) Facts.
Individual A owns P. In 2021, A forms T, which pays or accrues a $100x
business interest expense for which a deduction is disallowed under
section 163(j) and that is carried forward to 2022. P does not pay or
accrue business interest expense in 2021, and P has no disallowed
[[Page 56783]]
business interest expense carryforwards from prior taxable years. At
the close of 2021, P acquires all of the stock of T, which joins with P
in filing a consolidated return beginning in 2022. Neither P nor T pays
or accrues business interest expense in 2022, and the P group has a
section 163(j) limitation of $300x in that year. This limitation would
be $70x if determined by reference solely to T's items for all
consolidated return years of the P group.
(B) Analysis. T's $100x of disallowed business interest expense
carryforwards from 2021 arose in a SRLY. P's acquisition of T was not
an ownership change as defined by section 382(g); thus, T's disallowed
business interest expense carryforwards are subject to the SRLY
limitation in paragraph (d)(1) of this section. T's cumulative section
163(j) SRLY limitation for 2022 is the P group's section 163(j)
limitation, determined by reference solely to T's items for all
consolidated return years of the P group ($70x). See paragraph (d)(1)
of this section. Thus, $70x of T's disallowed business interest expense
carryforwards are available to be deducted by the P group in 2022, and
the remaining $30x of T's disallowed business interest expense
carryforwards are carried forward to 2023. After the P group deducts
$70x of T's disallowed business interest expense carryforwards, T's
cumulative section 163(j) SRLY limitation is reduced by $70x to $0.
(C) Cumulative section 163(j) SRLY limitation of $0. The facts are
the same as in Example 1 in paragraph (d)(3)(i)(A) of this section,
except that T's cumulative section 163(j) SRLY limitation for 2022 is
$0. Because the amount of T's disallowed business interest expense
carryforwards that may be deducted by the P group in 2022 may not
exceed T's cumulative section 163(j) SRLY limitation, none of T's
carryforwards from 2021 may be deducted by the P group in 2022. Because
none of T's disallowed business interest expense carryforwards are
absorbed by the P group in 2022, T's cumulative section 163(j) SRLY
limitation remains at $0 entering 2023.
(ii) Example 2: Cumulative section 163(j) SRLY limitation less than
zero--(A) Facts. P and S are the only members of a consolidated group.
P has neither current-year business interest expense nor disallowed
business interest expense carryforwards. For the current year, the P
group has a section 163(j) limitation of $150x, $25x of which is
attributable to P, and $125x of which is attributable to S. S has $100x
of disallowed business interest expense carryforwards that arose in a
SRLY and $150x of current-year business interest expense. S's
cumulative section 163(j) SRLY limitation entering the current year
(computed by reference solely to S's items for all consolidated return
years of the P group) is $0.
(B) Analysis. Under paragraph (d)(1) of this section, S's
cumulative section 163(j) SRLY limitation is increased by $125x to
reflect S's tax items for the current year. The P group's section
163(j) limitation permits the P group to deduct all $150x of S's
current-year business interest expense. S's cumulative section 163(j)
SRLY limitation is reduced by the $150x of S's business interest
expense absorbed by the P group in the current year, which results in a
-$25x balance. Thus, none of S's SRLY'd disallowed business interest
expense carryforwards may be deducted by the P group in the current
year. Entering the subsequent year, S's cumulative section 163(j) SRLY
limitation remains -$25x.
(iii) Example 3: Pro rata absorption of SRLY-limited disallowed
business interest expense carryforwards--(A) Facts. P, R, and S are the
only members of a consolidated group, and no member has floor plan
financing or business interest income. P has $60x of current-year
business interest expense and $40x of disallowed business interest
expense carryforwards from the previous year, which was not a separate
return year. R has $120x of current-year business interest expense and
$80x of disallowed business interest expense carryforwards from the
previous year, which was not a separate return year. S has $70x of
current-year business interest expense and $30x of disallowed business
interest expense carryforwards from the previous year, which was a
separate return year. The P group has a section 163(j) limitation of
$300x, $50x of which is attributable to P, $90x to R, and $160x to S.
S's cumulative section 163(j) SRLY limitation entering the current year
(computed by reference solely to S's items for all consolidated return
years of the P group) is $0.
Table 3 to Paragraph (d)(3)(iii)(A)
----------------------------------------------------------------------------------------------------------------
Disallowed
business
Current-year interest
business expense Section 163(j)
interest carryforwards limitation
expense from prior
taxable year
----------------------------------------------------------------------------------------------------------------
P............................................................... $60x $40x $50x
R............................................................... 120x 80x 90x
S............................................................... 70x (SRLY) 30x 160x
-----------------------------------------------
Total....................................................... 250x 150x 300x
----------------------------------------------------------------------------------------------------------------
(B) Analysis. Under paragraph (d)(1) of this section, S's
cumulative section 163(j) SRLY limitation is increased in the current
year by $160x. The P group's section 163(j) limitation permits the P
group to deduct all $70x of S's current-year business interest expense
(and all $180x of P and R's current-year business interest expense).
S's cumulative section 163(j) SRLY limitation is reduced by the $70x of
S's business interest expense absorbed by the P group in the current
year, resulting in a $90x balance. Because the P group has $50x of
section 163(j) limitation remaining after the absorption of current-
year business interest expense, the P group can absorb $50x of its
members' disallowed business interest expense carryforwards. Under
paragraph (d)(2) of this section, SRLY-limited disallowed business
interest expense carryforwards are deducted on a pro rata basis with
other disallowed business interest expense carryforwards from the same
taxable year. Accordingly, the P group can deduct $10x ($50x x ($30x/
$150x)) of S's SRLY-limited disallowed business interest expense
carryforwards. S's cumulative section 163(j) SRLY limitation is reduced
(to $80x) by the $10x of SRLY-limited disallowed business interest
carryforwards
[[Page 56784]]
absorbed by the P group in the current year.
(C) Cumulative section 163(j) SRLY limitation of -$75x. The facts
are the same as in Example 3 in paragraph (d)(3)(iii)(A) of this
section, except that S's cumulative section 163(j) SRLY limitation
entering the current year is -$75x. After adjusting for S's tax items
for the current year ($160x) and the P group's absorption of S's
current-year business interest expense ($70x), S's cumulative section
163(j) SRLY limitation is $15x (-$75x + $160x-$70x). Because S's
cumulative section 163(j) SRLY limitation ($15x) is less than the
amount of S's SRLY-limited disallowed business interest expense
carryforwards ($30x), the pro rata calculation under paragraph (d)(2)
of this section is applied to $15x (rather than $30x) of S's
carryforwards. Accordingly, the P group can deduct $5.56x ($50x x
($15x/$135x)) of S's SRLY-limited disallowed business interest expense
carryforwards. S's cumulative section 163(j) SRLY limitation is reduced
(to $9.44x) by the $5.56x of SRLY-limited disallowed business interest
carryforwards absorbed by the P group in the current year.
(e) Application of section 382--(1) Pre-change loss. For rules
governing the treatment of a disallowed business interest expense as a
pre-change loss for purposes of section 382, see Sec. Sec. 1.382-2(a)
and 1.382-6. For rules governing the application of section 382 to
disallowed disqualified interest carryforwards, see Sec. 1.163(j)-
11(c)(4).
(2) Loss corporation. For rules governing when a disallowed
business interest expense causes a corporation to be a loss corporation
within the meaning of section 382(k)(1), see Sec. 1.382-2(a). For the
application of section 382 to disallowed disqualified interest
carryforwards, see Sec. 1.163(j)-11(c)(4).
(3) Ordering rules for utilization of pre-change losses and for
absorption of the section 382 limitation. For ordering rules for the
utilization of disallowed business interest expense, net operating
losses, and other pre-change losses, and for the absorption of the
section 382 limitation, see Sec. 1.383-1(d).
(4) Disallowed business interest expense from the pre-change period
in the year of a testing date. For rules governing the treatment of
disallowed business interest expense from the pre-change period (within
the meaning of Sec. 1.382-6(g)(2)) in the year of a testing date, see
Sec. 1.382-2.
(5) Recognized built-in loss. For a rule providing that a section
382 disallowed business interest carryforward (as defined in Sec.
1.382-2(a)(7)) is not treated as a recognized built-in loss for
purposes of section 382, see Sec. 1.382-7(d)(5).
(f) Overlap of SRLY limitation with section 382. For rules
governing the overlap of the application of section 382 and the
application of the SRLY rules, see Sec. 1.1502-21(g).
(g) Additional limitations. Additional rules provided under the
Code or regulations also apply to limit the use of disallowed business
interest expense carryforwards. For rules governing the relationship
between section 163(j) and other provisions affecting the deductibility
of interest, see Sec. 1.163(j)-3.
(h) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
Sec. 1.163(j)-6 Application of the section 163(j) limitation to
partnerships and subchapter S corporations.
(a) Overview. If a deduction for business interest expense of a
partnership or an S corporation is subject to the section 163(j)
limitation, section 163(j)(4) provides that the section 163(j)
limitation applies at the partnership or S corporation level and any
deduction for business interest expense is taken into account in
determining the nonseparately stated taxable income or loss of the
partnership or S corporation. Once a partnership or an S corporation
determines its business interest expense, business interest income,
ATI, and floor plan financing interest expense, the partnership or S
corporation calculates its section 163(j) limitation by applying the
rules of Sec. 1.163(j)-2(b) and this section. Paragraph (b) of this
section provides definitions used in this section. Paragraph (c) of
this section provides rules regarding the character of a partnership's
deductible business interest expense and excess business interest
expense. Paragraph (d) of this section provides rules regarding the
calculation of a partnership's ATI and floor plan financing interest
expense. Paragraph (e) of this section provides rules regarding a
partner's ATI and business interest income. Paragraph (f) of this
section provides an eleven-step computation necessary for properly
allocating a partnership's deductible business interest expense and
section 163(j) excess items to its partners. Paragraph (g) of this
section applies carryforward rules at the partner level if a
partnership has excess business interest expense. Paragraph (h) of this
section provides basis adjustment rules, and paragraph (k) of this
section provides rules regarding investment items of a partnership.
Paragraph (l) of this section provides rules regarding S corporations.
Paragraph (m) of this section provides rules for partnerships and S
corporations not subject to section 163(j). Paragraph (o) of this
section provides examples illustrating the rules of this section.
(b) Definitions. In addition to the definitions contained in Sec.
1.163(j)-1, the following definitions apply for purposes of this
section.
(1) Section 163(j) items. The term section 163(j) items means the
partnership or S corporation's business interest expense, business
interest income, and items comprising ATI.
(2) Partner basis items. The term partner basis items means any
items of income, gain, loss, or deduction resulting from either an
adjustment to the basis of partnership property used in a non-excepted
trade or business made pursuant to section 743(b) or the operation of
section 704(c)(1)(C)(i) with respect to such property. Partner basis
items also include section 743(b) basis adjustments used to increase or
decrease a partner's share of partnership gain or loss on the sale of
partnership property used in a non-excepted trade or business (as
described in Sec. 1.743-1(j)(3)(i)) and amounts resulting from the
operation of section 704(c)(1)(C)(i) used to decrease a partner's share
of partnership gain or increase a partner's share of partnership loss
on the sale of such property.
(3) Remedial items. The term remedial items means any allocation to
a partner of remedial items of income, gain, loss, or deduction
pursuant to section 704(c) and Sec. 1.704-3(d).
(4) Excess business interest income. The term excess business
interest income means the amount by which a partnership's or S
corporation's business interest income exceeds its
[[Page 56785]]
business interest expense in a taxable year.
(5) Deductible business interest expense. The term deductible
business interest expense means the amount of a partnership's or S
corporation's business interest expense that is deductible under
section 163(j) in the current taxable year following the application of
the limitation contained in Sec. 1.163(j)-2(b).
(6) Section 163(j) excess items. The term section 163(j) excess
items means the partnership's excess business interest expense, excess
taxable income, and excess business interest income.
(7) Non-excepted assets. The term non-excepted assets means assets
from a non-excepted trade or business.
(8) Excepted assets. The term excepted assets means assets from an
excepted trade or business.
(c) Business interest income and business interest expense of a
partnership--
(1)-(2) [Reserved]
(3) Character of business interest expense. If a partnership has
deductible business interest expense, such deductible business interest
expense is not subject to any additional application of section 163(j)
at the partner-level because it is taken into account in determining
the nonseparately stated taxable income or loss of the partnership.
However, for all other purposes of the Code, deductible business
interest expense and excess business interest expense retain their
character as business interest expense at the partner-level. For
example, for purposes of section 469, such business interest expense
retains its character as either passive or non-passive in the hands of
the partner. Additionally, for purposes of section 469, deductible
business interest expense and excess business interest expense from a
partnership remain interest derived from a trade or business in the
hands of a partner even if the partner does not materially participate
in the partnership's trade or business activity. For additional rules
regarding the interaction between sections 465, 469, and 163(j), see
Sec. 1.163(j)-3.
(d) Adjusted taxable income of a partnership--(1) Tentative taxable
income of a partnership. For purposes of computing a partnership's ATI
under Sec. 1.163(j)-1(b)(1), the tentative taxable income of a
partnership is the partnership's taxable income determined under
section 703(a), but computed without regard to the application of the
section 163(j) limitation.
(2) Section 734(b), partner basis items, and remedial items. A
partnership takes into account items resulting from adjustments made to
the basis of its property pursuant to section 734(b) for purposes of
calculating its ATI pursuant to Sec. 1.163(j)-1(b)(1). However,
partner basis items and remedial items are not taken into account in
determining a partnership's ATI under Sec. 1.163(j)-1(b)(1). Instead,
partner basis items and remedial items are taken into account by the
partner in determining the partner's ATI pursuant to Sec. 1.163(j)-
1(b)(1). See Example 6 in paragraph (o)(6) of this section.
(e) Adjusted taxable income and business interest income of
partners--(1) Modification of adjusted taxable income for partners. The
ATI of a partner in a partnership generally is determined in accordance
with Sec. 1.163(j)-1(b)(1), without regard to such partner's
distributive share of any items of income, gain, deduction, or loss of
such partnership, except as provided for in paragraph (m) of this
section, and is increased by such partner's distributive share of such
partnership's excess taxable income determined under paragraph (f) of
this section. For rules regarding corporate partners, see Sec.
1.163(j)-4(b)(3).
(2) Partner basis items and remedial items. Partner basis items and
remedial items are taken into account as items derived directly by the
partner in determining the partner's ATI for purposes of the partner's
section 163(j) limitation. If a partner is allocated remedial items,
such partner's ATI is increased or decreased by the amount of such
items. Additionally, to the extent a partner is allocated partner basis
items, such partner's ATI is increased or decreased by the amount of
such items. See Example 6 in paragraph (o)(6) of this section.
(3) Disposition of partnership interests. If a partner recognizes
gain or loss upon the disposition of interests in a partnership, and
the partnership in which the interest is being disposed owns only non-
excepted trade or business assets, the gain or loss on the disposition
of the partnership interest is included in the partner's ATI. See Sec.
1.163(j)-10(b)(4)(ii) for dispositions of interests in partnerships
that own--
(i) Non-excepted assets and excepted assets; or
(ii) Investment assets; or
(iii) Both.
(4) Double counting of business interest income and floor plan
financing interest expense prohibited. For purposes of calculating a
partner's section 163(j) limitation, the partner does not include--
(i) Business interest income from a partnership that is subject to
section 163(j), except to the extent the partner is allocated excess
business interest income from that partnership pursuant to paragraph
(f)(2) of this section; and
(ii) The partner's allocable share of the partnership's floor plan
financing interest expense, because such floor plan financing interest
expense already has been taken into account by the partnership in
determining its nonseparately stated taxable income or loss for
purposes of section 163(j).
(f) Allocation and determination of section 163(j) excess items
made in the same manner as nonseparately stated taxable income or loss
of the partnership--(1) Overview--(i) In general. The purpose of this
paragraph is to provide guidance regarding how a partnership must
allocate its deductible business interest expense and section 163(j)
excess items, if any, among its partners. For purposes of section
163(j)(4) and this section, allocations and determinations of
deductible business interest expense and section 163(j) excess items
are considered made in the same manner as the nonseparately stated
taxable income or loss of the partnership if, and only if, such
allocations and determinations are made in accordance with the eleven-
step computation set forth in paragraphs (f)(2)(i) through (xi) of this
section. A partnership first determines its section 163(j) limitation,
total amount of deductible business interest expense, and section
163(j) excess items under paragraph (f)(2)(i) of this section. The
partnership then applies paragraphs (f)(2)(ii) through (xi) of this
section, in that order, to determine how those items of the partnership
are allocated among its partners. At the conclusion of the eleven-step
computation set forth in paragraphs (f)(2)(i) through (xi) of this
section, the total amount of deductible business interest expense and
section 163(j) excess items allocated to each partner will equal the
partnership's total amount of deductible business interest expense and
section 163(j) excess items.
(ii) Relevance solely for purposes of section 163(j). No rule set
forth in paragraph (f)(2) of this section prohibits a partnership from
making an allocation to a partner of any item of partnership income,
gain, loss, or deduction that is otherwise permitted under section 704
and the regulations under section 704 of the Code. Accordingly, any
calculations in paragraphs (f)(2)(i) through (xi) of this section are
solely for the purpose of determining each partner's deductible
business interest expense and section 163(j) excess items and do not
otherwise affect any other provision under the Code, such as section
704(b). Additionally, floor plan financing
[[Page 56786]]
interest expense is not allocated in accordance with paragraph (f)(2)
of this section. Instead, floor plan financing interest expense of a
partnership is allocated to its partners under section 704(b) and is
taken into account as a nonseparately stated item of loss for purposes
of section 163(j).
(2) Steps for allocating deductible business interest expense and
section 163(j) excess items--(i) Partnership-level calculation required
by section 163(j)(4)(A). First, a partnership must determine its
section 163(j) limitation pursuant to Sec. 1.163(j)-2(b). This
calculation determines a partnership's total amounts of excess business
interest income, excess taxable income, excess business interest
expense (that is, the partnership's section 163(j) excess items), and
deductible business interest expense under section 163(j) for a taxable
year.
(ii) Determination of each partner's relevant section 163(j) items.
Second, a partnership must determine each partner's allocable share of
each section 163(j) item under section 704(b) and the regulations under
section 704 of the Code, including any allocations under section
704(c), other than remedial items. Only section 163(j) items that were
actually taken into account in the partnership's section 163(j)
calculation under paragraph (f)(2)(i) of this section are taken into
account for purposes of this paragraph (f)(2)(ii). Partner basis items,
allocations of investment income and expense, remedial items, and
amounts determined for the partner under Sec. 1.163-8T are not taken
into account for purposes of this paragraph (f)(2)(ii). For purposes of
paragraphs (f)(2)(ii) through (xi) of this section, the term allocable
ATI means a partner's distributive share of the partnership's ATI (that
is, a partner's distributive share of gross income and gain items
comprising ATI less such partner's distributive share of gross loss and
deduction items comprising ATI), the term allocable business interest
income means a partner's distributive share of the partnership's
business interest income, and the term allocable business interest
expense means a partner's distributive share of the partnership's
business interest expense that is not floor plan financing interest
expense. If the partnership determines that each partner has a pro rata
share of allocable ATI, allocable business interest income, and
allocable business interest expense, then the partnership may bypass
paragraphs (f)(2)(iii) through (xi) of this section and allocate its
section 163(j) excess items in the same proportion. See Example 1
through Example 16 in paragraphs (o)(1) through (16), respectively.
This pro-rata exception does not result in allocations of section
163(j) excess items that vary from the array of allocations of section
163(j) excess items that would have resulted had paragraphs (f)(2)(iii)
through (xi) been applied.
(iii) Partner-level comparison of business interest income and
business interest expense. Third, a partnership must compare each
partner's allocable business interest income to such partner's
allocable business interest expense. Paragraphs (f)(2)(iii) through (v)
of this section determine how a partnership must allocate its excess
business interest income among its partners, as well as the amount of
each partner's allocable business interest expense that is not
deductible business interest expense after taking the partnership's
business interest income into account. To the extent a partner's
allocable business interest income exceeds its allocable business
interest expense, the partner has an allocable business interest income
excess. The aggregate of all the partners' allocable business interest
income excess amounts is the total allocable business interest income
excess. To the extent a partner's allocable business interest expense
exceeds its allocable business interest income, the partner has an
allocable business interest income deficit. The aggregate of all the
partners' allocable business interest income deficit amounts is the
total allocable business interest income deficit. These amounts are
required to perform calculations in paragraphs (f)(2)(iv) and (v) of
this section, which appropriately reallocate allocable business
interest income excess to partners with allocable business interest
income deficits in order to reconcile the partner-level calculation
under paragraph (f)(2)(iii) of this section with the partnership-level
result under paragraph (f)(2)(i) of this section.
(iv) Matching partnership and aggregate partner excess business
interest income. Fourth, a partnership must determine each partner's
final allocable business interest income excess. A partner's final
allocable business interest income excess is determined by reducing,
but not below zero, such partner's allocable business interest income
excess (if any) by the partner's step four adjustment amount. A
partner's step four adjustment amount is the product of the total
allocable business interest income deficit and the ratio of such
partner's allocable business interest income excess to the total
allocable business interest income excess. The rules of this paragraph
(f)(2)(iv) ensure that, following the application of paragraph
(f)(2)(xi) of this section, the aggregate of all the partners'
allocations of excess business interest income equals the total amount
of the partnership's excess business interest income as determined in
paragraph (f)(2)(i) of this section.
(v) Remaining business interest expense determination. Fifth, a
partnership must determine each partner's remaining business interest
expense. A partner's remaining business interest expense is determined
by reducing, but not below zero, such partner's allocable business
interest income deficit (if any) by such partner's step five adjustment
amount. A partner's step five adjustment amount is the product of the
total allocable business interest income excess and the ratio of such
partner's allocable business interest income deficit to the total
allocable business interest income deficit. Generally, a partner's
remaining business interest expense is a partner's allocable business
interest income deficit adjusted to reflect a reallocation of allocable
business interest income excess from other partners. Determining a
partner's remaining business interest expense is necessary to perform
an ATI calculation that begins in paragraph (f)(2)(vii) of this
section.
(vi) Determination of final allocable ATI. Sixth, a partnership
must determine each partner's final allocable ATI. Paragraphs
(f)(2)(vi) through (x) of this section determine how a partnership must
allocate its excess taxable income and excess business interest expense
among its partners.
(A) Positive allocable ATI. To the extent a partner's income and
gain items comprising its allocable ATI exceed its deduction and loss
items comprising its allocable ATI, the partner has positive allocable
ATI. The aggregate of all the partners' positive allocable ATI amounts
is the total positive allocable ATI.
(B) Negative allocable ATI. To the extent a partner's deduction and
loss items comprising its allocable ATI exceed its income and gain
items comprising its allocable ATI, the partner has negative allocable
ATI. The aggregate of all the partners' negative allocable ATI amounts
is the total negative allocable ATI.
(C) Final allocable ATI. Any partner with a negative allocable ATI,
or an allocable ATI of $0, has a positive allocable ATI of $0. Any
partner with a positive allocable ATI of $0 has a final allocable ATI
of $0. The final allocable ATI of any partner with a positive allocable
ATI greater than $0 is such partner's positive allocable ATI reduced,
but not below zero, by the partner's step six adjustment amount. A
[[Page 56787]]
partner's step six adjustment amount is the product of the total
negative allocable ATI and the ratio of such partner's positive
allocable ATI to the total positive allocable ATI. The total of the
partners' final allocable ATI amounts must equal the partnership's ATI
amount used to compute its section 163(j) limitation pursuant to Sec.
1.163(j)-2(b).
(vii) Partner-level comparison of 30 percent of adjusted taxable
income and remaining business interest expense. Seventh, a partnership
must compare each partner's ATI capacity to such partner's remaining
business interest expense as determined under paragraph (f)(2)(v) of
this section. A partner's ATI capacity is the amount that is 30 percent
of such partner's final allocable ATI as determined under paragraph
(f)(2)(vi) of this section. A partner's final allocable ATI is grossed
down to 30 percent prior to being compared to its remaining business
interest expense in this calculation to parallel the partnership's
adjustment to its ATI under section 163(j)(1)(B). To the extent a
partner's ATI capacity exceeds its remaining business interest expense,
the partner has an ATI capacity excess. The aggregate of all the
partners' ATI capacity excess amounts is the total ATI capacity excess.
To the extent a partner's remaining business interest expense exceeds
its ATI capacity, the partner has an ATI capacity deficit. The
aggregate of all the partners' ATI capacity deficit amounts is the
total ATI capacity deficit. These amounts (which may be subject to
adjustment under paragraph (f)(2)(viii) of this section) are required
to perform calculations in paragraphs (f)(2)(ix) and (x) of this
section, which appropriately reallocate ATI capacity excess to partners
with ATI capacity deficits in order to reconcile the partner-level
calculation under paragraph (f)(2)(vii) of this section with the
partnership-level result under paragraph (f)(2)(i) of this section.
(viii) Partner priority right to ATI capacity excess determination.
(A) Eighth, the partnership must determine whether it is required to
make any adjustments described in this paragraph (f)(2)(viii) and, if
it is, make such adjustments. The rules of this paragraph (f)(2)(viii)
are necessary to account for adjustments made to a partner's allocable
ATI in paragraph (f)(2)(vi) of this section to ensure that the partners
who had a negative allocable ATI do not inappropriately benefit under
the rules of paragraphs (f)(2)(ix) through (xi) of this section to the
detriment of the partners who had positive allocable ATI. The
partnership must perform the calculations and make the necessary
adjustments described under paragraphs (f)(2)(viii)(B) and (C) or
paragraph (f)(2)(viii)(D) of this section if, and only if, there is--
(1) An excess business interest expense amount greater than $0
under paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI amount greater than $0 under
paragraph (f)(2)(vi) of this section; and
(3) A total ATI capacity excess amount greater than $0 under
paragraph (f)(2)(vii) of this section.
(B) A partnership must determine each partner's priority amount and
usable priority amount. A partner's priority amount is 30 percent of
the amount by which a partner's positive allocable ATI under paragraph
(f)(2)(vi)(A) of this section exceeds such partner's final allocable
ATI under paragraph (f)(2)(vi)(C) of this section. However, only
partners with an ATI capacity deficit as determined under paragraph
(f)(2)(vii) of this section can have a priority amount greater than $0.
The aggregate of all the partners' priority amounts is the total
priority amount. A partner's usable priority amount is the lesser of
such partner's priority amount or such partner's ATI capacity deficit
as determined under paragraph (f)(2)(vii) of this section. The
aggregate of all the partners' usable priority amounts is the total
usable priority amount. If the total ATI capacity excess amount, as
determined under paragraph (f)(2)(vii) of this section, is greater than
or equal to the total usable priority amount, then the partnership must
perform the adjustments described in paragraph (f)(2)(viii)(C) of this
section. If the total usable priority amount is greater than the total
ATI capacity excess amount, as determined under paragraph (f)(2)(vii)
of this section, then the partnership must perform the adjustments
described in paragraph (f)(2)(viii)(D) of this section.
(C) For purposes of paragraph (f)(2)(ix) of this section, each
partner's final ATI capacity excess amount is $0. For purposes of
paragraph (f)(2)(x) of this section, the following terms have the
following meanings for each partner:
(1) Each partner's ATI capacity deficit is such partner's ATI
capacity deficit as determined under paragraph (f)(2)(vii) of this
section, reduced by such partner's usable priority amount.
(2) The total ATI capacity deficit is the total ATI capacity
deficit as determined under paragraph (f)(2)(vii) of this section,
reduced by the total usable priority amount.
(3) The total ATI capacity excess is the total ATI capacity excess
as determined under paragraph (f)(2)(vii) of this section, reduced by
the total usable priority amount.
(D) Any partner with a priority amount greater than $0 is a
priority partner. Any partner that is not a priority partner is a non-
priority partner. For purposes of paragraph (f)(2)(ix) of this section,
each partner's final ATI capacity excess amount is $0. For purposes of
paragraph (f)(2)(x) of this section, each non-priority partner's final
ATI capacity deficit amount is such partner's ATI capacity deficit as
determined under paragraph (f)(2)(vii) of this section. For purposes of
paragraph (f)(2)(x) of this section, the following terms have the
following meanings for priority partners.
(1) Each priority partner must determine its step eight excess
share. A partner's step eight excess share is the product of the total
ATI capacity excess as determined under paragraph (f)(2)(vii) of this
section and the ratio of the partner's priority amount to the total
priority amount.
(2) To the extent a priority partner's step eight excess share
exceeds its ATI capacity deficit as determined under paragraph
(f)(2)(vii) of this section, such excess amount is the priority
partner's ATI capacity excess for purposes of paragraph (f)(2)(x) of
this section. The total ATI capacity excess is the aggregate of the
priority partners' ATI capacity excess amounts as determined under this
paragraph (f)(2)(viii)(D)(2).
(3) To the extent a priority partner's ATI capacity deficit as
determined under paragraph (f)(2)(vii) of this section exceeds its step
eight excess share, such excess amount is the priority partner's ATI
capacity deficit for purposes of paragraph (f)(2)(x) of this section.
The total ATI capacity deficit is the aggregate of the priority
partners' ATI capacity deficit amounts as determined under this
paragraph (f)(2)(viii)(D)(3).
(ix) Matching partnership and aggregate partner excess taxable
income. Ninth, a partnership must determine each partner's final ATI
capacity excess. A partner's final ATI capacity excess amount is
determined by reducing, but not below zero, such partner's ATI capacity
excess (if any) by the partner's step nine adjustment amount. A
partner's step nine adjustment amount is the product of the total ATI
capacity deficit and the ratio of such partner's ATI capacity excess to
the total ATI capacity excess. The rules of this paragraph (f)(2)(ix)
ensure that, following the application of paragraph (f)(2)(xi) of this
section, the aggregate of all the partners' allocations of excess
taxable income equals the total amount of the partnership's excess
taxable
[[Page 56788]]
income as determined in paragraph (f)(2)(i) of this section.
(x) Matching partnership and aggregate partner excess business
interest expense. Tenth, a partnership must determine each partner's
final ATI capacity deficit. A partner's final ATI capacity deficit
amount is determined by reducing, but not below zero, such partner's
ATI capacity deficit (if any) by the partner's step ten adjustment
amount. A partner's step ten adjustment amount is the product of the
total ATI capacity excess and the ratio of such partner's ATI capacity
deficit to the total ATI capacity deficit. Generally, a partner's final
ATI capacity deficit is a partner's ATI capacity deficit adjusted to
reflect a reallocation of ATI capacity excess from other partners. The
rules of this paragraph (f)(2)(x) ensure that, following the
application of paragraph (f)(2)(xi) of this section, the aggregate of
all the partners' allocations of excess business interest expense
equals the total amount of the partnership's excess business interest
expense as determined in paragraph (f)(2)(i) of this section.
(xi) Final section 163(j) excess item and deductible business
interest expense allocation. Eleventh, a partnership must allocate
section 163(j) excess items and deductible business interest expense to
its partners. Excess business interest income calculated under
paragraph (f)(2)(i) of this section, if any, is allocated dollar for
dollar by the partnership to its partners with final allocable business
interest income excess amounts. Excess business interest expense
calculated under paragraph (f)(2)(i) of this section, if any, is
allocated dollar for dollar to partners with final ATI capacity deficit
amounts. After grossing up each partner's final ATI capacity excess
amount by ten-thirds, excess taxable income calculated under paragraph
(f)(2)(i) of this section, if any, is allocated dollar for dollar to
partners with final ATI capacity excess amounts. A partner's allocable
business interest expense is deductible business interest expense to
the extent it exceeds such partner's share of excess business interest
expense. See Example 17 through Example 21 in paragraphs (o)(17)
through (21) of this section, respectively.
(g) Carryforwards--(1) In general. The amount of any business
interest expense not allowed as a deduction to a partnership by reason
of Sec. 1.163(j)-2(b) and paragraph (f)(2) of this section for any
taxable year is--
(i) Not treated as business interest expense of the partnership in
the succeeding taxable year; and
(ii) Subject to paragraph (g)(2) of this section, treated as excess
business interest expense, which is allocated to each partner pursuant
to paragraph (f)(2) of this section.
(2) Treatment of excess business interest expense allocated to
partners. If a partner is allocated excess business interest expense
from a partnership under paragraph (f)(2) of this section for any
taxable year and the excess business interest expense is treated as
such under paragraph (h)(2) of this section--
(i) Solely for purposes of section 163(j), such excess business
interest expense is treated as business interest expense paid or
accrued by the partner in the next succeeding taxable year in which the
partner is allocated excess taxable income or excess business interest
income from such partnership, but only to the extent of such excess
taxable income or excess business interest income; and
(ii) Any portion of such excess business interest expense remaining
after the application of paragraph (g)(2)(i) of this section is excess
business interest expense that is subject to the limitations of
paragraph (g)(2)(i) of this section in succeeding taxable years, unless
paragraph (m)(3) of this section applies. See Example 1 through Example
16 in paragraphs (o)(1) through (16) of this section, respectively.
(3) Excess taxable income and excess business interest income
ordering rule. In the event a partner has excess business interest
expense from a prior taxable year and is allocated excess taxable
income or excess business interest income from the same partnership in
a succeeding taxable year, the partner must treat, for purposes of
section 163(j), the excess business interest expense as business
interest expense paid or accrued by the partner in an amount equal to
the partner's share of the partnership's excess taxable income or
excess business interest income in such succeeding taxable year. See
Example 2 through Example 16 in paragraphs (o)(2) through (16) of this
section, respectively.
(h) Basis adjustments--(1) Section 704(d) ordering. Deductible
business interest expense and excess business interest expense are
subject to section 704(d). If a partner is subject to a limitation on
loss under section 704(d) and a partner is allocated losses from a
partnership in a taxable year, Sec. 1.704-1(d)(2) requires that the
limitation on losses under section 704(d) be apportioned amongst these
losses based on the character of each loss (each grouping of losses
based on character being a section 704(d) loss class). If there are
multiple section 704(d) loss classes in a given year, Sec. 1.704-
1(d)(2) requires the partner to apportion the limitation on losses
under section 704(d) to each section 704(d) loss class proportionately.
For purposes of applying this proportionate rule, any deductible
business interest expense and business interest expense of an exempt
entity (whether allocated to the partner in the current taxable year or
suspended under section 704(d) in a prior taxable year), any excess
business interest expense allocated to the partner in the current
taxable year, and any excess business interest expense from a prior
taxable year that was suspended under section 704(d) (negative section
163(j) expense) shall comprise the same section 704(d) loss class. Once
the partner determines the amount of limitation on losses apportioned
to this section 704(d) loss class, any deductible business interest
expense is taken into account before any excess business interest
expense or negative section 163(j) expense. See Example 7 in paragraph
(o)(7) of this section.
(2) Excess business interest expense basis adjustments. The
adjusted basis of a partner in a partnership interest is reduced, but
not below zero, by the amount of excess business interest expense
allocated to the partner pursuant to paragraph (f)(2) of this section.
Negative section 163(j) expense is not treated as excess business
interest expense in any subsequent year until such negative section
163(j) expense is no longer suspended under section 704(d). Therefore,
negative section 163(j) expense does not affect, and is not affected
by, any allocation of excess taxable income to the partner.
Accordingly, any excess taxable income allocated to a partner from a
partnership while the partner still has negative section 163(j) expense
will be included in the partner's ATI. However, once the negative
section 163(j) expense is no longer suspended under section 704(d), it
becomes excess business interest expense, which is subject to the
general rules in paragraph (g) of this section. See Example 8 in
paragraph (o)(8) of this section.
(3) Partner basis adjustment upon disposition of partnership
interest. If a partner (transferor) disposes of an interest in a
partnership, the adjusted basis of the partnership interest being
disposed of (transferred interest) is increased immediately before the
disposition by the amount of the excess (if any) of the amount of the
basis reduction under paragraph (h)(2) of this section over the portion
of any excess business interest expense allocated to the transferor
under paragraph (f)(2) of this section which has previously been
treated under paragraph (g) of this
[[Page 56789]]
section as business interest expense paid or accrued by the transferor,
multiplied by the ratio of the fair market value of the transferred
interest to the total fair market value of the transferor's partnership
interest immediately prior to the disposition. Therefore, the adjusted
basis of the transferred interest is not increased immediately before
the disposition by any allocation of excess business interest expense
from the partnership that did not reduce the transferor's adjusted
basis in its partnership interest pursuant to paragraph (h) of this
section prior to the disposition, or by any excess business interest
expense that was treated under paragraph (g) of this section as
business interest expense paid or accrued by the transferor prior to
the disposition. If the transferor disposes of all of its partnership
interest, no deduction under section 163(j) is allowed to the
transferor or transferee under chapter 1 of subtitle A of the Code for
any excess business interest expense or negative section 163(j)
expense. If the transferor disposes of a portion of its partnership
interest, no deduction under section 163(j) is allowed to the
transferor or transferee under chapter 1 of subtitle A of the Code for
the amount of excess business interest expense proportionate to the
transferred interest. The amount of excess business interest expense
proportionate to the partnership interest retained by the transferor
shall remain as excess business interest expense of the transferor
until such time as such excess business interest expense is treated as
business interest expense paid or accrued by the transferor pursuant to
paragraph (g) of this section. Further, if the transferor disposes of a
portion of its partnership interest, any negative section 163(j)
expense shall remain negative section 163(j) expense of the transferor
partner until such negative section 163(j) expense is no longer
suspended under section 704(d). For purposes of this paragraph, a
disposition includes a distribution of money or other property by the
partnership to a partner in complete liquidation of its interest in the
partnership. Further, solely for purposes of this section, each partner
is considered to have disposed of its partnership interest if the
partnership terminates under section 708(b)(1). See Example 9 and
Example 10 in paragraphs (o)(9) and (o)(10) of this section,
respectively.
(i)-(j) [Reserved]
(k) Investment items and certain other items. Any item of a
partnership's income, gain, deduction, or loss that is investment
interest income or expense pursuant to Sec. 1.163-8T, and any other
tax item of a partnership that is neither properly allocable to a trade
or business of the partnership nor described in section 163(d), is
allocated to each partner in accordance with section 704(b) and the
regulations under section 704 of the Code, and the effect of such
allocation for purposes of section 163 is determined at the partner-
level. See Sec. 1.163(j)-4(b)(3), section 163(d), and Sec. 1.163-8T.
(l) S corporations--(1) In general--(i) Corporate level limitation.
In the case of any S corporation, the section 163(j) limitation is
applied at the S corporation level, and any deduction allowed for
business interest expense is taken into account in determining the
nonseparately stated taxable income or loss of the S corporation. An S
corporation determines its section 163(j) limitation in the same manner
as set forth in Sec. 1.163(j)-2(b). Allocations of excess taxable
income and excess business interest income are made in accordance with
the shareholders' pro rata interests in the S corporation pursuant to
section 1366(a)(1) after determining the S corporation's section 163(j)
limitation pursuant to Sec. 1.163(j)-2(b). See Example 22 and Example
23 in paragraphs (o)(22) and (23) of this section, respectively.
(ii) Short taxable periods. For rules on applying the section
163(j) limitation where an S corporation has a two short taxable
periods or where its taxable year consists of two separate taxable
years see Sec. Sec. 1.1362-3(c), 1.1368-1(g), and 1.1377-1(b).
(2) Character of deductible business interest expense. If an S
corporation has deductible business interest expense, such deductible
business interest expense is not subject to any additional application
of section 163(j) at the shareholder-level because such deductible
business interest expense is taken into account in determining the
nonseparately stated taxable income or loss of the S corporation.
However, for all other purposes of the Code, deductible business
interest expense retains its character as business interest expense at
the shareholder-level. For example, for purposes of section 469, such
deductible business interest expense retains its character as either
passive or non-passive in the hands of the shareholder. Additionally,
for purposes of section 469, deductible business interest expense from
an S corporation remains interest derived from a trade or business in
the hands of a shareholder even if the shareholder does not materially
participate in the S corporation's trade or business activity. For
additional rules regarding the interaction between sections 465, 469,
and 163(j), see Sec. 1.163(j)-3.
(3) Adjusted taxable income of an S corporation. The ATI of an S
corporation generally is determined in accordance with Sec. 1.163(j)-
1(b)(1). For purposes of computing the S corporation's ATI, the
tentative taxable income of the S corporation is determined under
section 1363(b) and includes--
(i) Any item described in section 1363(b)(1); and
(ii) Any item described in Sec. 1.163(j)-1(b)(1), to the extent
such item is consistent with subchapter S of the Code.
(4) Adjusted taxable income and business interest income of S
corporation shareholders--(i) Adjusted taxable income of S corporation
shareholders. The ATI of an S corporation shareholder is determined in
accordance with Sec. 1.163(j)-1(b)(1) without regard to such
shareholder's distributive share of any items of income, gain,
deduction, or loss of such S corporation, except as provided in
paragraph (m), and is increased by such shareholder's distributive
share of such S corporation's excess taxable income.
(ii) Disposition of S corporation stock. If a shareholder of an S
corporation recognizes gain or loss upon the disposition of stock of
the S corporation, and the corporation the stock of which is being
disposed of only owns non-excepted trade or business assets, the gain
or loss on the disposition of the stock is included in the
shareholder's ATI. See Sec. 1.163(j)-10(b)(4)(ii) for dispositions of
stock of S corporations that own--
(A) Non-excepted assets and excepted assets; or
(B) Investment assets; or
(C) Both.
(iii) Double counting of business interest income and floor plan
financing interest expense prohibited. For purposes of calculating an S
corporation shareholder's section 163(j) limitation, the shareholder
does not include--
(A) Business interest income from an S corporation that is subject
to section 163(j), except to the extent the shareholder is allocated
excess business interest income from that S corporation pursuant to
paragraph (l)(1) of this section; and
(B) The shareholder's share of the S corporation's floor plan
financing interest expense, because such floor plan financing interest
expense already has been taken into account by the S corporation in
determining its nonseparately stated taxable income or loss for
purposes of section 163(j).
[[Page 56790]]
(5) Carryforwards. The amount of any business interest expense not
allowed as a deduction for any taxable year by reason of the limitation
contained in Sec. 1.163(j)-2(b) is carried forward in the succeeding
taxable year as a disallowed business interest expense carryforward
under the rules set forth in Sec. 1.163(j)-2(c) (whether to an S
corporation taxable year or a C corporation taxable year). For purposes
of applying section 163(j), S corporations are subject to the same
ordering rules as a C corporation that is not a member of a
consolidated group. See Sec. 1.163(j)-5(b)(2).
(6) Basis adjustments and disallowed business interest expense
carryforwards. An S corporation shareholder's adjusted basis in its S
corporation stock is reduced, but not below zero, when a disallowed
business interest expense carryforward becomes deductible under section
163(j).
(7) Accumulated adjustment accounts. The accumulated adjustment
account of an S corporation is adjusted to take into account business
interest expense in the year in which the S corporation treats such
business interest expense as deductible under the section 163(j)
limitation. See section 1368(e)(1).
(8) Termination of qualified subchapter S subsidiary election. If a
corporation's qualified subchapter S subsidiary election terminates and
any disallowed business interest expense carryforward is attributable
to the activities of the qualified subchapter S subsidiary at the time
of termination, such disallowed business interest expense carryforward
remains with the parent S corporation, and no portion of these items is
allocable to the former qualified subchapter S subsidiary.
(9) Investment items. Any item of an S corporation's income, gain,
deduction, or loss that is investment interest income or expense
pursuant to Sec. 1.163-8T is allocated to each shareholder in
accordance with the shareholders' pro rata interests in the S
corporation pursuant to section 1366(a)(1). See section 163(d) and
Sec. 1.163-8T.
(10) Application of section 382. In the event of an ownership
change, within the meaning of section 382(g), the S corporation's
business interest expense is subject to section 382. Therefore, the
allocation of the S corporation's business interest expense between the
pre-change period (as defined in Sec. 1.382-6(g)(2)) and the post-
change period (as defined in Sec. 1.382-6(g)(3)), and the
determination of the amount that is deducted and carried forward, is
determined pursuant to Sec. 1.382-6. If the date of the ownership
change is also the date of a qualifying disposition (as defined in
Sec. 1.1368-1(g)(2)) or the date for a termination of shareholder
interest (as defined in Sec. 1.1377-1(b)(4)), then--
(i) The rules of this paragraph govern the S corporation's business
interest expense;
(ii) The S corporation must make an election under Sec. 1.382-6(b)
with respect to such date if it also makes an election under Sec.
1.1368-1(g)(2) or a shareholder termination election to apply normal
tax accounting rules, as applicable, with respect to such date; and
(iii) The S corporation may not make an election under Sec. 1.382-
6(b) with respect to such date if it does not make an election under
Sec. 1.1368-1(g)(2) or a termination election under Sec. 1.1377-
1(b)(1), as applicable, with respect to such date.
(m) Partnerships and S corporations not subject to section 163(j)--
(1) Exempt partnerships and S corporations. If the small business
exemption in Sec. 1.163(j)-2(d) applies to a partnership or an S
corporation in a taxable year (exempt entity), the general rule in
Sec. 1.163(j)-2 and this section does not apply to limit the deduction
for business interest expense of the exempt entity in that taxable
year. Additionally, if a partner or S corporation shareholder is
allocated business interest expense from an exempt entity, such
business interest expense is not subject to the section 163(j)
limitation at the partner's or S corporation shareholder's level.
However, see paragraph (h)(1) of this section. Further, a partner or S
corporation shareholder of an exempt entity includes its share of non-
excepted trade or business items of income, gain, loss, and deduction
(including business interest expense and business interest income) of
such exempt entity when calculating its ATI. However, if a partner's or
S corporation shareholder's allocations of non-excepted trade or
business items of loss and deduction from an exempt entity exceed its
allocations of non-excepted trade or business items of income and gain
from such exempt entity (net loss allocation), then such net loss
allocation will not reduce a partner's or S corporation shareholder's
ATI. See Example 11 and Example 12 in paragraphs (o)(11) and (12) of
this section, respectively.
(2) Partnerships and S corporations engaged in excepted trades or
businesses. To the extent a partnership or an S corporation is engaged
in an excepted trade or business, the general rule in Sec. 1.163(j)-2
and this section does not apply to limit the deduction for business
interest expense that is allocable to such excepted trade or business.
If a partner or S corporation shareholder is allocated any section
163(j) item that is allocable to an excepted trade or business of the
partnership or S corporation (excepted 163(j) items), such excepted
163(j) items are excluded from the partner's or shareholder's section
163(j) deduction calculation. See Sec. 1.163(j)-10(c) (regarding the
allocation of items between excepted and non-excepted trades or
businesses). See also Example 13 in paragraph (o)(13) of this section.
(3) Treatment of excess business interest expense from partnerships
that are exempt entities in a succeeding taxable year. If a partner is
allocated excess business interest expense from a partnership and, in a
succeeding taxable year, such partnership is an exempt entity, then the
partner shall treat any of its excess business interest expense that
was previously allocated from such partnership as business interest
expense paid or accrued by the partner in such succeeding taxable year,
which is potentially subject to limitation at the partner level under
section 163(j). However, if a partner is allocated excess business
interest expense from a partnership and, in a succeeding taxable year,
such partnership engages in excepted trades or businesses, then the
partner shall not treat any of its excess business interest expense
that was previously allocated from such partnership as business
interest expense paid or accrued by the partner in such succeeding
taxable year by reason of the partnership engaging in excepted trades
or businesses. See Example 14 through Example 16 in paragraphs (o)(14)
through (o)(16) of this section, respectively. For rules regarding the
treatment of excess business interest expense from a partnership that
terminates under section 708(b)(1), see paragraph (h)(3) of this
section.
(4) S corporations with disallowed business interest expense
carryforwards prior to becoming exempt entities. If an S corporation
has a disallowed business interest expense carryforward for a taxable
year and, in a succeeding taxable year, such S corporation is an exempt
entity, then such disallowed business interest expense carryforward--
(i) Continues to be carried forward at the S corporation level;
(ii) Is no longer subject to the section 163(j) limitation; and
(iii) Is taken into account in determining the nonseparately stated
taxable income or loss of the S corporation.
(n) [Reserved]
(o) Examples. The examples in this paragraph illustrate the
provisions of section 163(j) as applied to partnerships and subchapter
S corporations. For purposes of these examples, unless
[[Page 56791]]
stated otherwise, each partnership and S corporation is subject to the
provisions of section 163(j), is only engaged in non-excepted trades or
businesses, was created or organized in the United States, and uses the
calendar year for its annual accounting period. Unless stated
otherwise, all partners and shareholders are subject to the provisions
of section 163(j), are not subject to a limitation under section 704(d)
or 1366(d), have no tax items other than those listed in the example,
are U.S. citizens, and use the calendar year for their annual
accounting period. The phrase ``section 163(j) limit'' shall equal the
maximum potential deduction allowed under section 163(j)(1). Unless
stated otherwise, business interest expense means business interest
expense that is not floor plan financing interest expense. With respect
to partnerships, all allocations are in accordance with section 704(b)
and the regulations in this part under section 704 of the Code.
(1) Example 1--(i) Facts. X and Y are equal partners in partnership
PRS. In Year 1, PRS has $100 of ATI and $40 of business interest
expense. PRS allocates the items comprising its $100 of ATI $50 to X
and $50 to Y. PRS allocates its $40 of business interest expense $20 to
X and $20 to Y. X has $100 of ATI and $20 of business interest expense
from its sole proprietorship. Y has $0 of ATI and $20 of business
interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 1, PRS's section 163(j) limit is 30
percent of its ATI, or $30 ($100 x 30 percent). Thus, PRS has $30 of
deductible business interest expense and $10 of excess business
interest expense. Such $30 of deductible business interest expense is
includable in PRS's nonseparately stated income or loss, and is not
subject to further limitation under section 163(j) at the partners'
level.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $15 of deductible business interest
expense and $5 of excess business interest expense. At the end of Year
1, X and Y each have $5 of excess business interest expense from PRS,
which is not treated as paid or accrued by the partner until such
partner is allocated excess taxable income or excess business interest
income from PRS in a succeeding taxable year. Pursuant to Sec.
1.163(j)-6(e)(1), X and Y, in computing their limit under section
163(j), do not increase any of their section 163(j) items by any of
PRS's section 163(j) items. X and Y each increase their outside basis
in PRS by $30 ($50-$20).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $100 of ATI and $20 of business interest expense
from its sole proprietorship. X's section 163(j) limit is $30 ($100 x
30 percent). Thus, X's $20 of business interest expense is deductible
business interest expense. Y, in computing its limit under section
163(j), has $20 of business interest expense from its sole
proprietorship. Y's section 163(j) limit is $0 ($0 x 30 percent). Thus,
Y's $20 of business interest expense is not allowed as a deduction and
is treated as business interest expense paid or accrued by Y in Year 2.
(2) Example 2--(i) Facts. The facts are the same as in Example 1 in
paragraph (o)(1)(i) of this section. In Year 2, PRS has $200 of ATI, $0
of business interest income, and $30 of business interest expense. PRS
allocates the items comprising its $200 of ATI $100 to X and $100 to Y.
PRS allocates its $30 of business interest expense $15 to X and $15 to
Y. X has $100 of ATI and $20 of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of business interest expense
from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $60 ($200 x 30
percent). Thus, PRS has $100 of excess taxable income, $30 of
deductible business interest expense, and $0 of excess business
interest expense. Such $30 of deductible business interest expense is
includable in PRS's nonseparately stated income or loss, and is not
subject to further limitation under section 163(j) at the partners'
level.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $50 of excess taxable income, $15
of deductible business interest expense, and $0 of excess business
interest expense. As a result, X and Y each increase their ATI by $50.
Because X and Y are each allocated $50 of excess taxable income from
PRS, and excess business interest expense from a partnership is treated
as paid or accrued by a partner to the extent excess taxable income and
excess business interest income are allocated from such partnership to
a partner, X and Y each treat $5 of excess business interest expense
(the carryforward from Year 1) as paid or accrued in Year 2. X and Y
each increase their outside basis in PRS by $85 ($100-$15).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $150 of ATI ($100 from its sole proprietorship,
plus $50 excess taxable income) and $25 of business interest expense
($20 from its sole proprietorship, plus $5 excess business interest
expense treated as paid or accrued in Year 2). X's section 163(j) limit
is $45 ($150 x 30 percent). Thus, X's $25 of business interest expense
is deductible business interest expense. At the end of Year 2, X has $0
of excess business interest expense from PRS ($5 from Year 1, less $5
treated as paid or accrued in Year 2). Y, in computing its limit under
section 163(j), has $50 of ATI ($0 from its sole proprietorship, plus
$50 excess taxable income) and $45 of business interest expense ($20
from its sole proprietorship, plus $20 disallowed business interest
expense from Year 1, plus $5 excess business interest expense treated
as paid or accrued in Year 2). Y's section 163(j) limit is $15 ($50 x
30 percent). Thus, $15 of Y's business interest expense is deductible
business interest expense. The $30 of Y's business interest expense not
allowed as a deduction ($45 business interest expense, less $15 section
163(j) limit) is treated as business interest expense paid or accrued
by Y in Year 3. At the end of Year 2, Y has $0 of excess business
interest expense from PRS ($5 from Year 1, less $5 treated as paid or
accrued in Year 2).
(3) Example 3--(i) Facts. The facts are the same as in Example 1 in
paragraph (o)(1)(i) of this section. In Year 2, PRS has $0 of ATI, $60
of business interest income, and $40 of business interest expense. PRS
allocates its $60 of business interest income $30 to X and $30 to Y.
PRS allocates its $40 of business interest expense $20 to X and $20 to
Y. X has $100 of ATI and $20 of business interest expense from its sole
proprietorship. Y has $0 of ATI and $20 of business interest expense
from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $60 (($0 x 30
percent) + $60). Thus, PRS has $20 of excess business interest income,
$0 of excess taxable income, $40 of deductible business interest
expense, and $0 of excess business interest expense. Such $40 of
deductible business interest expense is includable in PRS's
nonseparately stated income or loss, and is not subject to further
limitation under section 163(j) at the partners' level.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $10 of excess business interest
income, and $20 of deductible business interest expense. As a result, X
and Y each increase their business interest income by $10. Because X
and Y are each allocated $10 of excess business interest income from
PRS, and excess business interest
[[Page 56792]]
expense from a partnership is treated as paid or accrued by a partner
to the extent excess taxable income and excess business interest income
are allocated from such partnership to a partner, X and Y each treat $5
of excess business interest expense (the carryforward from Year 1) as
paid or accrued in Year 2. X and Y each increase their outside basis in
PRS by $10 ($30-$20).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $100 of ATI (from its sole proprietorship), $10 of
business interest income (from the allocation of $10 of excess business
interest income from PRS), and $25 of business interest expense ($20
from its sole proprietorship, plus $5 excess business interest expense
treated as paid or accrued in Year 2). X's section 163(j) limit is $40
(($100 x 30 percent) + $10). Thus, X's $25 of business interest expense
is deductible business interest expense. At the end of Year 2, X has $0
of excess business interest expense from PRS ($5 from Year 1, less $5
treated as paid or accrued in Year 2). Y, in computing its limit under
section 163(j), has $0 of ATI (from its sole proprietorship), $10 of
business interest income, and $45 of business interest expense ($20
from its sole proprietorship, plus $20 disallowed business interest
expense from Year 1, plus $5 excess business interest expense treated
as paid or accrued in Year 2). Y's section 163(j) limit is $10 (($0 x
30 percent) + $10). Thus, $10 of Y's business interest expense is
deductible business interest expense. The $35 of Y's business interest
expense not allowed as a deduction ($45 business interest expense, less
$10 section 163(j) limit) is treated as business interest expense paid
or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess
business interest expense from PRS ($5 from Year 1, less $5 treated as
paid or accrued in Year 2).
(4) Example 4--(i) Facts. The facts are the same as in Example 1 in
paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of ATI,
$60 of business interest income, and $40 of business interest expense.
PRS allocates the items comprising its $100 of ATI $50 to X and $50 to
Y. PRS allocates its $60 of business interest income $30 to X and $30
to Y. PRS allocates its $40 of business interest expense $20 to X and
$20 to Y. X has $100 of ATI and $20 of business interest expense from
its sole proprietorship. Y has $0 of ATI and $20 of business interest
expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $90 (($100 x
30 percent)) + $60). Thus, PRS has $20 of excess business interest
income, $100 of excess taxable income, $40 of deductible business
interest expense, and $0 of excess business interest expense. Such $40
of deductible business interest expense is includable in PRS's
nonseparately stated income or loss, and is not subject to further
limitation under section 163(j) at the partners' level.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $10 of excess business interest
income, $50 of excess taxable income, and $20 of deductible business
interest expense. As a result, X and Y each increase their business
interest income by $10 and ATI by $50. Because X and Y are each
allocated $10 of excess business interest income and $50 of excess
taxable income from PRS, and excess business interest expense from a
partnership is treated as paid or accrued by a partner to the extent
excess taxable income and excess business interest income are allocated
from such partnership to a partner, X and Y each treat $5 of excess
business interest expense (the carryforward from Year 1) as paid or
accrued in Year 2. X and Y each increase their outside basis in PRS by
$60 ($80-$20).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $150 of ATI ($100 from its sole proprietorship,
plus $50 excess taxable income), $10 of business interest income, and
$25 of business interest expense ($20 from its sole proprietorship,
plus $5 excess business interest expense treated as paid or accrued in
Year 2). X's section 163(j) limit is $55 (($150 x 30 percent) + $10).
Thus, $25 of X's business interest expense is deductible business
interest expense. At the end of Year 2, X has $0 of excess business
interest expense from PRS ($5 from Year 1, less $5 treated as paid or
accrued in Year 2). Y, in computing its limit under section 163(j), has
$50 of ATI ($0 from its sole proprietorship, plus $50 excess taxable
income), $10 of business interest income, and $45 of business interest
expense ($20 from its sole proprietorship, plus $20 disallowed business
interest expense from Year 1, plus $5 excess business interest expense
treated as paid or accrued in Year 2). Y's section 163(j) limit is $25
(($50 x 30 percent) + $10). Thus, $25 of Y's business interest expense
is deductible business interest expense. Y's $20 of business interest
expense not allowed as a deduction ($45 business interest expense, less
$25 section 163(j) limit) is treated as business interest expense paid
or accrued by Y in Year 3. At the end of Year 2, Y has $0 of excess
business interest expense from PRS ($5 from Year 1, less $5 treated as
paid or accrued in Year 2).
(5) Example 5--(i) Facts. The facts are the same as in Example 1 in
paragraph (o)(1)(i) of this section. In Year 2, PRS has $100 of ATI,
$11.20 of business interest income, and $40 of business interest
expense. PRS allocates the items comprising its $100 of ATI $50 to X
and $50 to Y. PRS allocates its $11.20 of business interest income
$5.60 to X and $5.60 to Y. PRS allocates its $40 of business interest
expense $20 to X and $20 to Y. X has $100 of ATI and $20 of business
interest expense from its sole proprietorship. Y has $0 of ATI and $20
of business interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $41.20 (($100
x 30 percent) + $11.20). Thus, PRS has $0 of excess business interest
income, $4 of excess taxable income, and $40 of deductible business
interest expense. Such $40 of deductible business interest expense is
includable in PRS's nonseparately stated income or loss, and is not
subject to further limitation under section 163(j) at the partners'
level.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $2 of excess taxable income, $20 of
deductible business interest expense, and $0 of excess business
interest expense. As a result, X and Y each increase their ATI by $2.
Because X and Y are each allocated $2 of excess taxable income from
PRS, and excess business interest expense from a partnership is treated
as paid or accrued by a partner to the extent excess taxable income and
excess business interest income are allocated from such partnership to
a partner, X and Y each treat $2 of excess business interest expense (a
portion of the carryforward from Year 1) as paid or accrued in Year 2.
X and Y each increase their outside basis in PRS by $35.60 ($55.60-
$20).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $102 of ATI ($100 from its sole proprietorship,
plus $2 excess taxable income), $0 of business interest income, and $22
of business interest expense ($20 from its sole proprietorship, plus $2
excess business interest expense treated as paid or accrued). X's
section 163(j) limit is $30.60 ($102 x 30 percent). Thus, X's $22 of
business interest expense is deductible business interest expense. At
the end of Year 2, X has $3 of excess business interest expense from
PRS ($5 from Year 1, less $2 treated as paid or accrued in Year 2).
[[Page 56793]]
Y, in computing its limit under section 163(j), has $2 of ATI ($0 from
its sole proprietorship, plus $2 excess taxable income), $0 of business
interest income, and $42 of business interest expense ($20 from its
sole proprietorship, plus $20 disallowed business interest expense from
Year 1, plus $2 excess business interest expense treated as paid or
accrued in Year 2). Y's section 163(j) limit is $0.60 ($2 x 30
percent). Thus, $0.60 of Y's business interest expense is deductible
business interest expense. Y's $41.40 of business interest expense not
allowed as a deduction ($42 business interest expense, less $0.60
section 163(j) limit) is treated as business interest expense paid or
accrued by Y in Year 3. At the end of Year 2, Y has $3 of excess
business interest expense from PRS ($5 from Year 1, less $2 treated as
paid or accrued in Year 2).
(6) Example 6--(i) Facts. In Year 1, X, Y, and Z formed partnership
PRS. Upon formation, X and Y each contributed $100, and Z contributed
non-excepted and non-depreciable trade or business property with a
basis of $0 and fair market value of $100 (Blackacre). PRS allocates
all items pro rata between its partners. Immediately after the
formation of PRS, Z sold all of its interest in PRS to A for $100
(assume the interest sale is respected for U.S. Federal income tax
purposes). In connection with the interest transfer, PRS made a valid
election under section 754. Therefore, after the interest sale, A had a
$100 positive section 743(b) adjustment in Blackacre. In Year 1, PRS
had $0 of ATI, $15 of business interest expense, and $0 of business
interest income. Pursuant to Sec. 1.163(j)-6(f)(2), PRS allocated each
of the partners $5 of excess business interest expense. In Year 2, PRS
sells Blackacre for $100 which generated $100 of ATI. The sale of
Blackacre was PRS's only item of income in Year 2. In accordance with
section 704(c), PRS allocates all $100 of gain resulting from the sale
of Blackacre to A. Additionally, PRS has $15 of business interest
expense, all of which it allocates to X. A has $50 of ATI and $20 of
business interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30
percent of its ATI, or $30 ($100 x 30 percent). Thus, PRS has $15 of
deductible business interest expense and $50 of excess taxable income.
Such $15 of deductible business interest expense is includable in PRS's
nonseparately stated income or loss, and is not subject to further
limitation under section 163(j) at X's level.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X is allocated $15 of deductible business interest expense and
X's outside basis in PRS is reduced by $15. A is allocated $50 of
excess taxable income and, as a result, A increases its ATI by $50.
Because A is allocated $50 of excess taxable income, and excess
business interest expense from a partnership is treated as paid or
accrued by a partner to the extent excess taxable income and excess
business interest income are allocated from such partnership to a
partner, A treats $5 of excess business interest expense (the
carryforward from Year 1) as paid or accrued in Year 2. PRS's $100 of
gain allocated to A in Year 2 is fully reduced by A's $100 section
743(b) adjustment. Therefore, at the end of Year 2, there is no change
to A's outside basis in PRS.
(iv) Partner-level. A, in computing its limit under section 163(j),
has $0 of ATI ($50 from its sole proprietorship, plus $50 excess
taxable income, less $100 ATI reduction as a result of A's section
743(b) adjustment under Sec. 1.163(j)-6(e)(2)) and $25 of business
interest expense ($20 from its sole proprietorship, plus $5 excess
business interest expense treated as paid or accrued in Year 2). A's
section 163(j) limit is $0 ($0 x 30 percent). Thus, all $25 of A's
business interest expense is not allowed as a deduction and is treated
as business interest expense paid or accrued by A in Year 3.
(7) Example 7--(i) Facts. X and Y are equal partners in partnership
PRS. At the beginning of Year 1, X and Y each have an outside basis in
PRS of $5. In Year 1, PRS has $0 of ATI, $20 of business interest
income, and $40 of business interest expense. PRS allocates its $20 of
business interest income $10 to X and $10 to Y. PRS allocates $40 of
business interest expense $20 to X and $20 to Y. X has $100 of ATI and
$20 of business interest expense from its sole proprietorship. Y has $0
of ATI and $20 of business interest expense from its sole
proprietorship.
(ii) Partnership-level. In Year 1, PRS's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $20 (($0 x 30
percent) + $20). Thus, PRS has $0 of excess business interest income,
$0 of excess taxable income, $20 of deductible business interest
expense, and $20 of excess business interest expense. Such $20 of
deductible business interest expense is includable in nonseparately
stated income or loss of PRS, and not subject to further limitation
under section 163(j) by the partners.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $10 of deductible business interest
expense and $10 of excess business interest expense. After adjusting
each partner's respective basis for business interest income under
section 705(a)(1)(A), pursuant to Sec. 1.163(j)-6(h)(1), X and Y each
take their $10 of deductible business interest expense into account
when reducing their outside basis in PRS before taking the $10 of
excess business interest expense into account. Following each partner's
reduction in outside basis due to the $10 of deductible business
interest expense, each partner has $5 of outside basis remaining in
PRS. Pursuant to Sec. 1.163(j)-6(h)(2), each partner has $5 of excess
business interest expense and $5 of negative section 163(j) expense. In
sum, at the end of Year 1, X and Y each have $5 of excess business
interest expense from PRS which reduces each partner's outside basis to
$0 (and is not treated as paid or accrued by the partners until such
partner is allocated excess taxable income or excess business interest
income from PRS in a succeeding taxable year), and $5 of negative
section 163(j) expense (which is suspended under section 704(d) and not
treated as excess business interest expense of the partners until such
time as the negative section 163(j) expense is no longer subject to a
limitation under section 704(d)).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $100 of ATI (from its sole proprietorship) and $20
of business interest expense (from its sole proprietorship). X's
section 163(j) limit is $30 ($100 x 30 percent). Thus, $20 of X's
business interest expense is deductible business interest expense. Y,
in computing its limit under section 163(j), has $20 of business
interest expense (from its sole proprietorship). Y's section 163(j)
limit is $0 ($0 x 30 percent). Thus, $20 of Y's business interest
expense is not allowed as a deduction in Year 1, and is treated as
business interest expense paid or accrued by Y in Year 2.
(8) Example 8--(i) Facts. The facts are the same as in Example 7 in
paragraph (o)(7)(i) of this section. In Year 2, PRS has $20 of gross
income that is taken into account in determining PRS's ATI (in other
words, properly allocable to a trade or business), $30 of gross
deductions from an investment activity, and $0 of business interest
expense. PRS allocates the items comprising its $20 of ATI $10 to X and
$10 to Y. PRS allocates the items comprising its $30 of gross
deductions $15 to X and $15 to Y. X has $100 of ATI and $20 of business
interest expense from its sole
[[Page 56794]]
proprietorship. Y has $0 of ATI and $20 of business interest expense
from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $6 ($20 x 30
percent). Because PRS has no business interest expense, all $20 of its
ATI is excess taxable income.
(iii) Partner-level allocations. Pursuant to Sec. 1.163(j)-
6(f)(2), X and Y are each allocated $10 of excess taxable income.
Because X and Y are each allocated $10 of excess taxable income from
PRS, X and Y each increase their ATI by $10. Pursuant to Sec. 1.704-
(1)(d)(2), each partner's limitation on losses under section 704(d)
must be allocated to its distributive share of each such loss. Thus,
each partner reduces its adjusted basis of $10 (attributable to the
allocation of items comprising PRS's ATI in Year 2) by $7.50 of gross
deductions from Year 2 ($10 x ($15 of total gross deductions from Year
2/$20 of total losses disallowed)), and $2.50 of excess business
interest expense that was carried over as negative section 163(j)
expense from Year 1 ($10 x ($5 of negative section 163(j) expense
treated as excess business interest expense solely for the purposes of
section 704(d)/$20 of total losses disallowed)). Following the
application of section 704(d), each partner has $7.50 of excess
business interest expense from PRS ($5 excess business interest expense
from Year 1, plus $2.50 of excess business interest expense that was
formerly negative section 163(j) expense carried over from Year 1).
Excess business interest expense from a partnership is treated as paid
or accrued by a partner to the extent excess taxable income and excess
business interest income are allocated from such partnership to the
partner. As a result, X and Y each treat $7.50 of excess business
interest expense as paid or accrued in Year 2.
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $110 of ATI ($100 from its sole proprietorship,
plus $10 excess taxable income) and $27.50 of business interest expense
($20 from its sole proprietorship, plus $7.50 excess business interest
expense treated as paid or accrued in Year 2). X's section 163(j) limit
is $33 ($110 x 30 percent). Thus, $27.50 of X's business interest
expense is deductible business interest expense. At the end of Year 2,
X has $0 of excess business interest expense from PRS ($5 from Year 1,
plus $2.50 treated as excess business interest expense in Year 2, less
$7.50 treated as paid or accrued in Year 2), and $2.50 of negative
section 163(j) expense from PRS. Y, in computing its limit under
section 163(j), has $10 of ATI ($0 from its sole proprietorship, plus
$10 excess taxable income) and $47.50 of business interest expense ($20
from its sole proprietorship, plus $20 disallowed business interest
expense from Year 1, plus $7.50 excess business interest expense
treated as paid or accrued in Year 2). Y's section 163(j) limit is $3
($10 x 30 percent). Thus, $3 of Y's business interest expense is
deductible business interest expense. The $44.50 of Y's business
interest expense not allowed as a deduction ($47.50 business interest
expense, less $3 section 163(j) limit) is treated as business interest
expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $0
of excess business interest expense from PRS ($5 from Year 1, plus
$2.50 treated as excess business interest expense in Year 2, less $7.50
treated as paid or accrued in Year 2), and $2.50 of negative section
163(j) expense from PRS.
(9) Example 9--(i) Facts. X and Y are equal partners in partnership
PRS, and are not members of a consolidated group. At the beginning of
Year 1, X and Y each have $120 of outside basis in PRS. Neither X nor
Y's share of partnership liabilities exceeds the adjusted basis of its
entire interest. In Year 1, X is allocated $20 of excess business
interest expense, which reduces its outside basis from $120 to $100. In
Year 2, X sells 80 percent of its interest in PRS to Z for $160.
Immediately prior to the sale, X's entire PRS interest had a fair
market value of $200 and the transferred portion of the interest had a
fair market value of $160.
(ii) Basis adjustment. Immediately before the sale to Z, X
increases its basis in the portion of the interest sold by 80 percent
of the amount of the excess of the amount of the basis reduction under
paragraph (h)(2) of this section ($20) over the portion of any excess
business interest expense allocated the partner under paragraph (f)(2)
of this section that has previously been treated under paragraph (g) of
this section as business interest expense paid or accrued by X ($0).
Therefore, X's basis in the portion of its interest sold is $96 (($100
x 80%) + ($20 x 80%)), and X's gain is $64 ($160-$96). Following the
sale, X has $20 of outside basis in its remaining partnership interest
and $4 of excess business interest expense.
(10) Example 10--(i) Facts. X and Y are equal partners in
partnership PRS, and are not members of a consolidated group. At the
beginning of Year 1, X and Y each have an outside basis in PRS of $10.
Neither X nor Y's share of partnership liabilities exceeds the adjusted
basis of its entire interest. In Year 1, X is allocated $8 of excess
business interest expense and $12 of loss from PRS. As a result, X has
$4 of excess business interest expense, $4 of negative section 163(j)
expense, $6 of allowable loss, $6 of loss suspended under section
704(d), and $0 of outside basis in PRS at the end of Year 1. In Year 2,
X sells 50 percent of its interest in PRS to Z for $20. Immediately
prior to the sale, X's entire partnership interest had a fair market
value of $40 and the transferred portion of the interest had a fair
market value of $20.
(ii) Basis adjustment. Immediately before the sale to Z, X
increases its basis in the portion of the interest sold by 50 percent
of the amount of the excess of the amount of the basis reduction under
paragraph (h)(2) of this section ($4) over the portion of any excess
business interest expense allocated the partner under paragraph (f)(2)
of this section that has previously been treated under paragraph (g) of
this section as business interest expense paid or accrued by X ($0).
Therefore, X's basis in the portion of its interest sold is $2 (($0 x
50%) + $2), and X's gain is $18 ($20-$2). Following the sale, X has $0
of outside basis in its remaining partnership interest, $2 of excess
business interest expense, $4 of negative section 163(j) expense, and
$6 of loss suspended under section 704(d).
(11) Example 11--(i) Facts. X (a corporation), Y (an individual),
and Z (an individual) are equal partners in partnership PRS. X, Y, and
Z are subject to section 163(j). PRS is not subject to section 163(j)
under section 163(j)(3). In 2021, PRS has $150 of trade or business
income (not taking into account business interest income or business
interest expense), $30 of business interest income, and $45 of business
interest expense. PRS also has $75 of investment income and $60 of
investment interest expense. PRS allocates its items of income, gain,
loss, and deduction equally among its partners. X, Y, and Z each have
$10 of business interest expense from their respective businesses.
(ii) Partnership-level. PRS is not subject to section 163(j) by
reason of section 163(j)(3). As a result, none of PRS's $45 of business
interest expense is subject to the section 163(j) limitation.
(iii) Partner-level allocations. Because PRS is not subject to
section 163(j) by reason of section 163(j)(3), PRS's $45 of business
interest expense does not retain its character as business interest
expense for purposes of section 163(j). As a result, such business
interest expense is not subject to the section 163(j) limitation at the
level of either the partnership or partner. Additionally,
[[Page 56795]]
pursuant to Sec. 1.163(j)-6(m)(1), each partner includes its share of
non-excepted trade or business items of income, gain, loss, and
deduction (including business interest expense and business interest
income) of PRS when calculating its ATI. As a result, each partner
increases its ATI by $45 (one third of $150 + $30-$45). Also, X
increases its ATI by an additional $25 because its items of investment
income and loss from PRS are recharacterized as non-excepted trade or
business income and loss at its level pursuant to Sec. Sec. 1.163(j)-
4(b)(3)(i) and 1.163(j)-10(b)(6). Further, X increases its business
interest expense by its $20 allocation of investment interest expense
from PRS pursuant to Sec. Sec. 1.163(j)-4(b)(3)(i) and 1.163(j)-
10(b)(6).
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $70 of ATI and $30 of business interest expense.
X's section 163(j) limit is $21 ($70 x 30 percent). Thus, X has $21 of
deductible business interest expense. X's $9 of business interest
expense not allowed as a deduction is treated as business interest
expense paid or accrued by X in 2020. Y and Z, in computing their
respective limits under section 163(j), each have $45 of ATI and $10 of
business interest expense. Y and Z each have a section 163(j) limit of
$13.50 ($45-30 percent). Thus, Y and Z each have $10 of deductible
business interest expense.
(12) Example 12--(i) Facts. The facts are the same as in Example 11
in paragraph (o)(11)(i) of this section, except PRS has $200 of
depreciation deductions in addition to its other items of income, gain,
loss, and deduction.
(ii) Partnership-level. Same analysis as Example 11 in paragraph
(o)(11)(ii) of this section.
(iii) Partner-level allocations. Because PRS is not subject to
section 163(j) by reason of section 163(j)(3), PRS's $45 of business
interest expense does not retain its character as business interest
expense for purposes of section 163(j). As a result, such business
interest expense is not subject to the section 163(j) limitation at the
level of either the partnership or partner. Additionally, pursuant to
Sec. 1.163(j)-6(m)(1), each partner includes its share of non-excepted
trade or business items of income, gain, loss, and deduction (including
business interest expense and business interest income) of PRS when
calculating its ATI; however, a net loss allocation of trade or
business items from an exempt entity does not reduce a partner's ATI.
Because each of the partners has a net loss allocation of trade or
business items from PRS, none of the partners adjust their ATI for the
trade or business items of PRS. X, the corporate partner, increases its
ATI by $25 because its items of investment income and loss from PRS are
recharacterized as trade or business income and loss at its level
pursuant to Sec. Sec. 1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6).
Further, X increases its business interest expense by its $20
allocation of investment interest expense from PRS pursuant to
Sec. Sec. 1.163(j)-4(b)(3)(i) and 1.163(j)-10(b)(6).
(iv) Partner-level computations. In computing its limit under
section 163(j), each partner has $0 of ATI and $10 of business interest
expense. Each partner's section 163(j) limit is $0 ($0 x 30 percent).
Thus, each partner's $10 of business interest expense is not allowed as
a deduction and is treated as business interest expense paid or accrued
by the partner in 2020. X, in computing its limit under section 163(j),
has $25 of ATI and $30 of business interest expense. X's section 163(j)
limit is $7.50 ($25 x 30 percent). Thus, X has $7.50 of deductible
business interest expense. X's $22.50 of business interest expense not
allowed as a deduction is treated as business interest expense paid or
accrued by X in 2020. Y and Z, in computing their respective limits
under section 163(j), each have $0 of ATI and $10 of business interest
expense. Thus, Y and Z each have $10 of business interest expense not
allowed as a deduction that is treated as business interest expense
paid or accrued in 2020.
(13) Example 13--(i) Facts. X, Y, and Z are equal partners in
partnership PRS. X, Y, and Z are each individuals subject to section
163(j). PRS is not subject to section 163(j) under section 163(j)(3).
PRS has one excepted and one non-excepted trade or business. In Year 1,
PRS has $200 of income and $10 of business interest expense from its
excepted trade or business, and $60 of business interest income and $30
of business interest expense from its non-excepted trade or business.
PRS allocates its items of income, gain, loss, and deduction equally
among its partners. X, Y, and Z each have $10 of business interest
expense from their respective businesses.
(ii) Partnership-level. PRS is not subject to section 163(j) by
reason of section 163(j)(3). As a result, none of PRS's business
interest expense is subject to the section 163(j) limitation.
(iii) Partner-level allocations. Because PRS's business interest
expense is not subject to the section 163(j) limitation, such business
interest expense is not subject to the section 163(j) limitation at the
level of either the partnership or partner. Additionally, pursuant to
Sec. 1.163(j)-6(m)(1), each partner includes its share of non-excepted
trade or business items of income, gain, loss, and deduction (including
business interest expense and business interest income) of PRS when
calculating its ATI. Therefore, each partner increases its ATI by $10
(each partner's share of $20 of non-excepted income less each partner's
share of $10 of non-excepted loss).
(iv) Partner-level computations. In computing its limit under
section 163(j), each partner has $10 of ATI and $10 of business
interest expense. Each partner's section 163(j) limit is $3 ($10 x 30
percent). Thus, each partner has $3 of deductible business interest
expense. Each partner has $7 of business interest expense not allowed
as a deduction that is treated as business interest expense paid or
accrued by the partner in Year 2.
(14) Example 14--(i) Facts. The facts are the same as in Example 5
in paragraph (o)(5)(i) of this section, except in Year 2 Y is not
subject to section 163(j) under section 163(j)(3).
(ii) Partnership-level. Same analysis as Example 5 in paragraph
(o)(5)(ii) of this section.
(iii) Partner-level allocations. Same analysis as Example 5 in
paragraph (o)(5)(iii) of this section.
(iv) Partner-level computations. For X, same analysis as Example 5
in paragraph (o)(5)(iv) of this section. Y is not subject to section
163(j) under section 163(j)(3). Thus, all $42 of business interest
expense ($20 from its sole proprietorship, plus $20 disallowed business
interest expense from Year 1, plus $2 excess business interest expense
treated as paid or accrued in Year 2) is not subject to limitation
under Sec. 1.163(j)-2(d). At the end of Year 2, Y has $3 of excess
business interest expense from PRS ($5 from Year 1, less $2 treated as
paid or accrued in Year 2).
(15) Example 15--(i) Facts. The facts are the same as in Example 5
in paragraph (o)(5)(i) of this section, except in Year 2 PRS and Y
become not subject to section 163(j) by reason of section 163(j)(3).
(ii) Partnership-level. In Year 2, PRS is not subject to section
163(j) by reason of section 163(j)(3). As a result, none of PRS's $40
of business interest expense is subject to the section 163(j)
limitation at the level of either the partnership or partner.
(iii) Partner-level allocations. Because PRS is not subject to
section 163(j) by reason of section 163(j)(3), PRS's $40 of business
interest expense does not retain its character as business interest
expense for purposes of section 163(j).
[[Page 56796]]
As a result, such business interest expense is not subject to the
section 163(j) limitation at the level of either the partnership or
partner. Additionally, pursuant to Sec. 1.163(j)-6(m)(1), each partner
includes its share of non-excepted trade or business items of income,
gain, loss, and deduction (including business interest expense and
business interest income) of PRS when calculating its ATI. As a result,
X and Y each increase their ATI by $35.60. Further, because PRS is not
subject to section 163(j) by reason of section 163(j)(3), the excess
business interest expense from Year 1 is treated as paid or accrued by
the partners pursuant to Sec. 1.163(j)-6(m)(3). As a result, X and Y
each treat their $5 of excess business interest expense from Year 1 as
paid or accrued in Year 2, and increase their business interest expense
by $5.
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $135.60 of ATI ($100 from its sole proprietorship,
plus $35.60 ATI from PRS) and $25 of business interest expense ($20
from its sole proprietorship, plus $5 of excess business interest
expense treated as paid or accrued in Year 2). X's section 163(j) limit
is $40.68 ($135.60 x 30 percent). Thus, $25 of X's business interest
expense is deductible business interest expense. Y is not subject to
section 163(j) under section 163(j)(3). As a result, Y's business
interest expense is not subject to the section 163(j) limitation. Thus,
all $45 of Y's business interest expense ($20 from its sole
proprietorship, plus $20 disallowed from year 1, plus $5 of excess
business interest expense treated as paid or accrued in Year 2) is not
subject to the section 163(j) limitation.
(16) Example 16--(i) Facts. The facts are the same as in Example 1
in paragraph (o)(1)(i) of this section, except that PRS's only trade or
business is a real property trade or business for which PRS does not
make the election provided for in section 163(j)(7)(B). In Year 2, when
PRS's only trade or business is still its real property trade or
business, PRS makes the election provided for in section 163(j)(7)(B).
Further, in Year 2, PRS has $100 of income and $40 of business interest
expense. PRS allocates its items of income, gain, deduction, and loss
equally between X and Y. X has $100 of ATI and $20 of business interest
expense from its sole proprietorship. Y has $0 of ATI and $20 of
business interest expense from its sole proprietorship.
(ii) Partnership-level. In Year 2, PRS is not subject to section
163(j) because its only trade or business is an excepted trade or
business. As a result, none of PRS's $40 of business interest expense
is subject to the section 163(j) limitation at the level of either the
partnership or partner.
(iii) Partner-level allocations. Because PRS is not subject to
section 163(j), PRS's $40 of business interest expense does not retain
its character as business interest expense for purposes of section
163(j). As a result, such business interest expense is not subject to
the section 163(j) limitation at the partners' level. Pursuant to Sec.
1.163(j)-6(m)(1), the partners do not include their respective $50
shares of income from PRS when calculating their own ATI because such
$50 is excepted trade or business income.
(iv) Partner-level computations. X, in computing its limit under
section 163(j), has $100 of ATI ($100 from its sole proprietorship) and
$20 of business interest expense ($20 from its sole proprietorship).
X's section 163(j) limit is $30 ($100 x 30 percent). Thus, $20 of X's
business interest expense is deductible business interest expense. At
the end of Year 2, X has $5 of excess business interest expense from
PRS ($5 from Year 1). Y, in computing its limit under section 163(j),
has $0 of ATI and $40 of business interest expense ($20 from its sole
proprietorship, plus $20 disallowed business interest expense from Year
1). Y's section 163(j) limit is $0. Thus, Y's $40 of business interest
expense not allowed as a deduction is treated as business interest
expense paid or accrued by Y in Year 3. At the end of Year 2, Y has $5
of excess business interest expense from PRS ($5 from Year 1).
(17) Example 17: Facts. A (an individual) and B (a corporation) own
all of the interests in partnership PRS. At the beginning of Year 1, A
and B each have $100 section 704(b) capital account and $100 of basis
in PRS. In Year 1, PRS has $100 of ATI, $10 of investment interest
income, $20 of business interest income (BII), $60 of business interest
expense (BIE), and $10 of floor plan financing interest expense. PRS's
ATI consists of $100 of gross income and $0 of gross deductions. PRS
allocates its items comprising ATI $100 to A and $0 to B. PRS allocates
its business interest income $10 to A and $10 to B. PRS allocates its
business interest expense $30 to A and $30 to B. PRS allocates all $10
of its investment interest income and all $10 of its floor plan
financing interest expense to B. A has ATI from a sole proprietorship,
unrelated to PRS, in the amount of $300.
(i) First, PRS determines its limitation pursuant to Sec.
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus
its business interest income, or $50 (($100 x 30 percent) + $20). Thus,
PRS has $0 of excess business interest income (EBII), $0 of excess
taxable income, $50 of deductible business interest expense, and $10 of
excess business interest expense. PRS takes its $10 of floor plan
financing into account in determining its nonseparately stated taxable
income or loss.
(ii) Second, PRS determines each partner's allocable share of
section 163(j) items used in its own section 163(j) calculation. B's
$10 of investment interest income is not included in B's allocable
business interest income amount because the $10 of investment interest
income was not taken into account in PRS's section 163(j) calculation.
B's $10 of floor plan financing interest expense is not included in B's
allocable business interest expense. The $300 of ATI from A's sole
proprietorship is not included in A's allocable ATI amount because the
$300 was not taken into account in PRS's section 163(j) calculation.
Table 1 to Paragraph (o)(17)(ii)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................................... $100 $0 $100
Allocable BII................................................... 10 10 20
Allocable BIE................................................... 30 30 60
----------------------------------------------------------------------------------------------------------------
(iii) Third, PRS compares each partner's allocable business
interest income to such partner's allocable business interest expense.
Because each partner's allocable business interest expense exceeds its
allocable business interest income by $20 ($30-$10), each partner has
an allocable business interest income deficit of $20. Thus, the
[[Page 56797]]
total allocable business interest income deficit is $40 ($20 + $20). No
partner has allocable business interest income excess because no
partner has allocable business interest income in excess of its
allocable business interest expense. Thus, the total allocable business
interest income excess is $0.
Table 2 to Paragraph (o)(17)(iii)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
Allocable BII................................................... $10 $10 N/A
Allocable BIE................................................... 30 30 N/A
If allocable BII exceeds allocable BIE, then such amount = 0 0 $0
Allocable BII excess...........................................
If allocable BIE exceeds allocable BII, then such amount = 20 20 40
Allocable BII deficit..........................................
----------------------------------------------------------------------------------------------------------------
(iv) Fourth, PRS determines each partner's final allocable business
interest income excess. Because no partner had any allocable business
interest income excess, each partner has final allocable business
interest income excess of $0.
(v) Fifth, PRS determines each partner's remaining business
interest expense. PRS determines A's remaining business interest
expense by reducing, but not below $0, A's allocable business interest
income deficit ($20) by the product of the total allocable business
interest income excess ($0) and the ratio of A's allocable business
interest income deficit to the total business interest income deficit
($20/$40). Therefore, A's allocable business interest income deficit of
$20 is reduced by $0 ($0 x 50 percent). As a result, A's remaining
business interest expense is $20. PRS determines B's remaining business
interest expense by reducing, but not below $0, B's allocable business
interest income deficit ($20) by the product of the total allocable
business interest income excess ($0) and the ratio of B's allocable
business interest income deficit to the total business interest income
deficit ($20/$40). Therefore, B's allocable business interest income
deficit of $20 is reduced by $0 ($0 x 50 percent). As a result, B's
remaining business interest expense is $20.
Table 3 to Paragraph (o)(17)(v)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit........................................... $20 $20 $40
Less: (Total allocable BII excess) x (Allocable BII deficit/ 0 0 N/A
Total allocable BII deficit)...................................
= Remaining BIE................................................. 20 20 40
----------------------------------------------------------------------------------------------------------------
(vi) Sixth, PRS determines each partner's final allocable ATI. Any
partner with a negative allocable ATI, or an allocable ATI of $0, has a
positive allocable ATI of $0. Therefore, B has a positive allocable ATI
of $0. Because A's allocable ATI is comprised of $100 of income and
gain and $0 of deduction and loss, A has positive allocable ATI of
$100. Thus, the total positive allocable ATI is $100 ($100 + $0). PRS
determines A's final allocable ATI by reducing, but not below $0, A's
positive allocable ATI ($100) by the product of total negative
allocable ATI ($0) and the ratio of A's positive allocable ATI to the
total positive allocable ATI ($100/$100). Therefore, A's positive
allocable ATI is reduced by $0 ($0 x 100 percent). As a result, A's
final allocable ATI is $100. Because B has a positive allocable ATI of
$0, B's final allocable ATI is $0.
Table 4 to Paragraph (o)(17)(vi)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................................... $100 $0 $100
If deduction and loss items comprising allocable ATI exceed 0 0 0
income and gain items comprising allocable ATI, then such
excess amount = Negative allocable ATI.........................
If income and gain items comprising allocable ATI equal or 100 0 100
exceed deduction and loss items comprising allocable ATI, then
such amount = Positive allocable ATI...........................
----------------------------------------------------------------------------------------------------------------
Table 5 to Paragraph (o)(17)(vi)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI.......................................... $100 $0 $100
Less: (Total negative allocable ATI) x (Positive allocable ATI/ 0 0 N/A
Total positive allocable ATI)..................................
= Final allocable ATI........................................... 100 0 100
----------------------------------------------------------------------------------------------------------------
(vii) Seventh, PRS compares each partner's ATI capacity (ATIC)
amount to such partner's remaining business interest expense. A's ATIC
amount is $30 ($100 x 30 percent) and B's ATIC amount is $0 ($0 x 30
percent). Because A's ATIC amount exceeds its remaining business
interest expense by $10 ($30-$20), A has an ATIC excess of $10. B does
not have any ATIC excess. Thus, the total ATIC excess is $10 ($10 +
$0). A does not have any ATIC deficit. Because B's remaining business
interest expense exceeds its ATIC amount by $20 ($20-$0), B has an ATIC
deficit of $20. Thus, the total ATIC deficit is $20 ($0 + $20).
[[Page 56798]]
Table 6 to Paragraph (o)(17)(vii)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 percent)......................... $30 $0 N/A
Remaining BIE................................................... 20 20 N/A
If ATIC exceeds remaining BIE, then such excess = ATIC excess... 10 0 $10
If remaining BIE exceeds ATIC, then such excess = ATIC deficit.. 0 20 20
----------------------------------------------------------------------------------------------------------------
(viii)(A) Eighth, PRS must perform the calculations and make the
necessary adjustments described under paragraph (f)(2)(viii) of this
section if, and only if, PRS has--
(1) An excess business interest expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess amount greater than $0 under paragraph
(f)(2)(vii) of this section.
(B) Because PRS does not meet all three requirements in paragraph
(o)(17)(viii)(A) of this section, PRS does not perform the calculations
or adjustments described in paragraph (f)(2)(viii) of this section. In
sum, the correct amounts to be used in paragraphs (o)(17)(ix) and (x)
of this section are as follows.
Table 7 to Paragraph (o)(17)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................................................... $10 $0 $10
ATIC deficit.................................................... 0 20 20
----------------------------------------------------------------------------------------------------------------
(ix) Ninth, PRS determines each partner's final ATIC excess amount.
Because A has an ATIC excess, PRS must determine A's final ATIC excess
amount. A's final ATIC excess amount is A's ATIC excess ($10), reduced,
but not below $0, by the product of the total ATIC deficit ($20) and
the ratio of A's ATIC excess to the total ATIC excess ($10/$10).
Therefore, A has $0 of final ATIC excess ($10-($20 x 100 percent)).
Table 8 to Paragraph (o)(17)(ix)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................................................... $10 $0 N/A
Less: (Total ATIC deficit) x (ATIC excess/Total ATIC excess).... 20 0 N/A
= Final ATIC excess............................................. 0 0 $0
----------------------------------------------------------------------------------------------------------------
(x) Tenth, PRS determines each partner's final ATIC deficit amount.
Because B has an ATIC deficit, PRS must determine B's final ATIC
deficit amount. B's final ATIC deficit amount is B's ATIC deficit
($20), reduced, but not below $0, by the product of the total ATIC
excess ($10) and the ratio of B's ATIC deficit to the total ATIC
deficit ($20/$20). Therefore, B has $10 of final ATIC deficit ($20-($10
x 100 percent)).
Table 9 to Paragraph (o)(17)(x)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit.................................................... $0 $20 N/A
Less: (Total ATIC excess) x (ATIC deficit/Total ATIC deficit)... 0 10 N/A
= Final ATIC deficit............................................ 0 10 $10
----------------------------------------------------------------------------------------------------------------
(xi) Eleventh, PRS allocates deductible business interest expense
and section 163(j) excess items to the partners. Pursuant to paragraph
(f)(2)(i) of this section, PRS has $10 of excess business interest
expense. PRS allocates the excess business interest expense dollar for
dollar to the partners with final ATIC deficits amounts. Thus, PRS
allocates all $10 of its excess business interest expense to B. A
partner's allocable business interest expense is deductible business
interest expense to the extent it exceeds such partner's share of
excess business interest expense. Therefore, A has deductible business
interest expense of $30 ($30-$0) and B has deductible business interest
expense of $20 ($30-$10). As a result of its allocations from PRS, A
increases its section 704(b) capital account and basis in PRS by $80 to
$180. As a result of its allocations from PRS, B decreases its capital
account and basis in PRS by $20 to $80.
Table 10 to Paragraph (o)(17)(xi)
----------------------------------------------------------------------------------------------------------------
A B Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE.................................................. $30 $20 $50
[[Page 56799]]
EBIE allocated.................................................. 0 10 10
ETI allocated................................................... 0 0 0
EBII allocated.................................................. 0 0 0
----------------------------------------------------------------------------------------------------------------
(18) Example 18: Facts. A, B, and C own all of the interests in
partnership PRS. In Year 1, PRS has $150 of ATI, $10 of business
interest income, and $40 of business interest expense. PRS's ATI
consists of $200 of gross income and $50 of gross deductions. PRS
allocates its items comprising ATI ($50) to A, $200 to B, and $0 to C.
PRS allocates its business interest income $0 to A, $0 to B, and $10 to
C. PRS allocates its business interest expense $30 to A, $10 to B, and
$0 to C.
(i) First, PRS determines its limitation pursuant to Sec.
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus
its business interest income, or $55 (($150 x 30 percent) + $10). Thus,
PRS has $0 of excess business interest income, $50 of excess taxable
income, $40 of deductible business interest expense, and $0 of excess
business interest expense.
(ii) Second, PRS determines each partner's allocable share of
section 163(j) items used in its own section 163(j) calculation.
Table 11 to Paragraph (o)(18)(ii)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................... ($50) $200 $0 $150
Allocable BII................................... 0 0 10 10
Allocable BIE................................... 30 10 0 40
----------------------------------------------------------------------------------------------------------------
(iii) Third, PRS compares each partner's allocable business
interest income to such partner's allocable business interest expense.
Because A's allocable business interest expense exceeds its allocable
business interest income by $30 ($30-$0), A has an allocable business
interest income deficit of $30. Because B's allocable business interest
expense exceeds its allocable business interest income by $10 ($10-$0),
B has an allocable business interest income deficit of $10. C does not
have any allocable business interest income deficit. Thus, the total
allocable business interest income deficit is $40 ($30 + $10 + $0). A
and B do not have any allocable business interest income excess.
Because C's allocable business interest income exceeds its allocable
business interest expense by $10 ($10-$0), C has an allocable business
interest income excess of $10. Thus, the total allocable business
interest income excess is $10 ($0 + $0 + $10).
Table 12 to Paragraph (o)(18)(iii)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable BII................................... $0 $0 $10 N/A
Allocable BIE................................... 30 10 0 N/A
If allocable BII exceeds allocable BIE, then 0 0 10 $10
such amount = Allocable BII excess.............
If allocable BIE exceeds allocable BII, then 30 10 0 40
such amount = Allocable BII deficit............
----------------------------------------------------------------------------------------------------------------
(iv) Fourth, PRS determines each partner's final allocable business
interest income excess. Because A and B do not have any allocable
business interest income excess, each partner has final allocable
business interest income excess of $0. PRS determines C's final
allocable business interest income excess by reducing, but not below
$0, C's allocable business interest income excess ($10) by the product
of the total allocable business interest income deficit ($40) and the
ratio of C's allocable business interest income excess to the total
allocable business interest income excess ($10/$10). Therefore, C's
allocable business interest income excess of $10 is reduced by $10 ($40
x 100 percent). As a result, C's allocable business interest income
excess is $0.
Table 13 to Paragraph (o)(18)(iv)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable BII excess............................ $0 $0 $10 N/A
Less: (Total allocable BII deficit) x (Allocable 0 0 40 N/A
BII excess/Total allocable BII excess).........
= Final Allocable BII Excess.................... 0 0 0 $10
----------------------------------------------------------------------------------------------------------------
(v) Fifth, PRS determines each partner's remaining business
interest expense. PRS determines A's remaining business interest
expense by reducing, but not below $0, A's allocable business interest
income deficit ($30) by the
[[Page 56800]]
product of the total allocable business interest income excess ($10)
and the ratio of A's allocable business interest income deficit to the
total business interest income deficit ($30/$40). Therefore, A's
allocable business interest income deficit of $30 is reduced by $7.50
($10 x 75 percent). As a result, A's remaining business interest
expense is $22.50. PRS determines B's remaining business interest
expense by reducing, but not below $0, B's allocable business interest
income deficit ($10) by the product of the total allocable business
interest income excess ($10) and the ratio of B's allocable business
interest income deficit to the total business interest income deficit
($10/$40). Therefore, B's allocable business interest income deficit of
$10 is reduced by $2.50 ($10 x 25 percent). As a result, B's remaining
business interest expense is $7.50. Because C does not have any
allocable business interest income deficit, C's remaining business
interest expense is $0.
Table 14 to Paragraph (o)(18)(v)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit........................... $30 $10 $0 $40
Less: (Total allocable BII excess) x (Allocable 7.50 2.50 0 N/A
BII deficit/Total allocable BII deficit).......
= Remaining BIE................................. 22.50 7.50 0 N/A
----------------------------------------------------------------------------------------------------------------
(vi) Sixth, PRS determines each partner's final allocable ATI.
Because A's allocable ATI is comprised of $50 of items of deduction and
loss and $0 of income and gain, A has negative allocable ATI of $50. A
is the only partner with negative allocable ATI. Thus, the total
negative allocable ATI amount is $50. Any partner with a negative
allocable ATI, or an allocable ATI of $0, has a positive allocable ATI
of $0. Therefore, A and C have a positive allocable ATI of $0. Because
B's allocable ATI is comprised of $200 of items of income and gain and
$0 of deduction and loss, B has positive allocable ATI of $200. Thus,
the total positive allocable ATI is $200 ($0 + $200 + $0). PRS
determines B's final allocable ATI by reducing, but not below $0, B's
positive allocable ATI ($200) by the product of total negative
allocable ATI ($50) and the ratio of B's positive allocable ATI to the
total positive allocable ATI ($200/$200). Therefore, B's positive
allocable ATI is reduced by $50 ($50 x 100 percent). As a result, B's
final allocable ATI is $150.
Table 15 to Paragraph (o)(18)(vi)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................... ($50) $200 $0 $150
If deduction and loss items comprising allocable 50 0 0 50
ATI exceed income and gain items comprising
allocable ATI, then such excess amount =
Negative allocable ATI.........................
If income and gain items comprising allocable 0 200 0 200
ATI equal or exceed deduction and loss items
comprising allocable ATI, then such amount =
Positive allocable ATI.........................
----------------------------------------------------------------------------------------------------------------
Table 16 to Paragraph (o)(18)(vi)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI.......................... $0 $200 $0 $200
Less: (Total negative allocable ATI) x (Positive 0 50 0 N/A
allocable ATI/Total positive allocable ATI)....
= Final allocable ATI........................... 0 150 0 150
----------------------------------------------------------------------------------------------------------------
(vii) Seventh, PRS compares each partner's ATI capacity (ATIC)
amount to such partner's remaining business interest expense. A's ATIC
amount is $0 ($0 x 30 percent), B's ATIC amount is $45 ($150 x 30
percent), and C's ATIC amount is $0 ($0 x 30 percent). A does not have
any ATIC excess. Because B's ATIC amount exceeds its remaining business
interest expense by $37.50 ($45-$7.50), B has an ATIC excess amount of
$37.50. C does not have any ATIC excess. Thus, the total ATIC excess
amount is $37.50 ($0 + $37.50 + $0). Because A's remaining business
interest expense exceeds its ATIC amount by $22.50 ($22.50-$0), A has
an ATIC deficit of $22.50. B and C do not have any ATIC deficit. Thus,
the total ATIC deficit is $22.50 ($22.50 + $0 + $0).
Table 17 to Paragraph (o)(18)(vii)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 percent)......... $0 $45 $0 N/A
Remaining BIE................................... 22.50 7.50 0 N/A
If ATIC exceeds remaining BIE, then such excess 0 37.50 0 $37.50
= ATIC excess..................................
If remaining BIE exceeds ATIC, then such excess 22.50 0 0 22.50
= ATIC deficit.................................
----------------------------------------------------------------------------------------------------------------
[[Page 56801]]
(viii)(A) Eighth, PRS must perform the calculations and make the
necessary adjustments described under paragraph (f)(2)(viii) of this
section if, and only if, PRS has--
(1) An excess business interest expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess amount greater than $0 under paragraph
(f)(2)(vii) of this section.
(B) Because PRS does not meet all three requirements in paragraph
(o)(18)(viii)(A) of this section, PRS does not perform the calculations
or adjustments described in paragraph (f)(2)(viii) of this section. In
sum, the correct amounts to be used in paragraphs (o)(18)(ix) and (x)
of this section are as follows.
Table 18 to Paragraph (o)(18)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................................... $0 $37.50 $0 $37.50
ATIC deficit.................................... 22.50 0 0 22.50
----------------------------------------------------------------------------------------------------------------
(ix) Ninth, PRS determines each partner's final ATIC excess amount.
Because B has ATIC excess, PRS must determine B's final ATIC excess
amount. B's final ATIC excess amount is B's ATIC excess ($37.50),
reduced, but not below $0, by the product of the total ATIC deficit
($22.50) and the ratio of B's ATIC excess to the total ATIC excess
($37.50/$37.50). Therefore, B has $15 of final ATIC excess ($37.50-
($22.50 x 100 percent)).
Table 19 to Paragraph (o)(18)(ix)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................................... $0 $37.50 $0 N/A
Less: (Total ATIC deficit) x (ATIC excess/Total 0 22.50 0 N/A
ATIC excess)...................................
= Final ATIC excess............................. 0 15 0 $15
----------------------------------------------------------------------------------------------------------------
(x) Tenth, PRS determines each partner's final ATIC deficit amount.
Because A has an ATIC deficit, PRS must determine A's final ATIC
deficit amount. A's final ATIC deficit amount is A's ATIC deficit
($22.50), reduced, but not below $0, by the product of the total ATIC
excess ($37.50) and the ratio of A's ATIC deficit to the total ATIC
deficit ($22.50/$22.50). Therefore, A has $0 of final ATIC deficit
($22.50-($37.50 x 100 percent)).
Table 20 to Paragraph (o)(18)(x)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit.................................... $22.50 $0 $0 N/A
Less: (Total ATIC excess) x (ATIC deficit/Total 37.50 0 0 N/A
ATIC deficit)..................................
= Final ATIC deficit............................ 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(xi) Eleventh, PRS allocates deductible business interest expense
and section 163(j) excess items to the partners. Pursuant to paragraph
(f)(2)(i) of this section, PRS has $50 of excess taxable income and $40
of deductible business interest expense. After grossing up each
partner's final ATIC excess amounts by ten-thirds, excess taxable
income is allocated dollar for dollar to partners with final ATIC
excess amounts. Thus, PRS allocates its excess taxable income $50 to B.
A partner's allocable business interest expense is deductible business
interest expense to the extent it exceeds such partner's share of
excess business interest expense. Therefore, A has deductible business
interest expense of $30 ($30-$0), B has deductible business interest
expense of $10 ($10-$0), and C has deductible business interest expense
of $0 ($0-$0).
Table 21 to Paragraph (o)(18)(xi)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE.................................. $30 $10 $0 $40
EBIE allocated.................................. 0 0 0 0
ETI allocated................................... 0 50 0 50
EBII allocated.................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(19) Example 19: Facts. A, B, and C own all of the interests in
partnership PRS. In Year 1, PRS has $100 of ATI, $0 of business
interest income, and $50 of business interest expense. PRS's ATI
consists of $200 of gross income and $100 of gross deductions. PRS
allocates its items comprising ATI $100 to A, $100 to B, and ($100) to
C. PRS allocates its business interest expense $0 to A, $25 to B, and
$25 to C.
(i) First, PRS determines its limitation pursuant to Sec.
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus
its business interest income, or $30 ($100 x 30 percent). Thus, PRS has
$30 of deductible business interest expense
[[Page 56802]]
and $20 of excess business interest expense.
(ii) Second, PRS determines each partner's allocable share of
section 163(j) items used in its own section 163(j) calculation.
Table 22 to Paragraph (o)(19)(ii)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................... $100 $100 ($100) $100
Allocable BII................................... 0 0 0 0
Allocable BIE................................... 0 25 25 50
----------------------------------------------------------------------------------------------------------------
(iii) Third, PRS compares each partner's allocable business
interest income to such partner's allocable business interest expense.
No partner has allocable business interest income. Consequently, each
partner's allocable business interest income deficit is equal to such
partner's allocable business interest expense. Thus, A's allocable
business interest income deficit is $0, B's allocable business interest
income deficit is $25, and C's allocable business interest income
deficit is $25. The total allocable business interest income deficit is
$50 ($0 + $25 + $25). No partner has allocable business interest income
excess because no partner has allocable business interest income in
excess of its allocable business interest expense. Thus, the total
allocable business interest income excess is $0.
Table 23 to Paragraph (o)(19)(iii)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable BII................................... $0 $0 $0 N/A
Allocable BIE................................... 0 25 25 N/A
If allocable BII exceeds allocable BIE, then 0 0 0 $0
such amount = Allocable BII excess.............
If allocable BIE exceeds allocable BII, then 0 25 25 50
such amount = Allocable BII deficit............
----------------------------------------------------------------------------------------------------------------
(iv) Fourth, PRS determines each partner's final allocable business
interest income excess. Because no partner had any allocable business
interest income excess, each partner has final allocable business
interest income excess of $0.
(v) Fifth, PRS determines each partner's remaining business
interest expense. Because no partner has any allocable business
interest income excess, each partner's remaining business interest
expense equals its allocable business interest income deficit. Thus,
A's remaining business interest expense is $0, B's remaining business
interest expense is $25, and C's remaining business interest expense is
$25.
Table 24 to Paragraph (o)(19)(v)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit........................... $0 $25 $25 $50
Less: (Total allocable BII excess) x (Allocable 0 0 0 N/A
BII deficit/Total allocable BII deficit).......
= Remaining BIE................................. 0 25 25 N/A
----------------------------------------------------------------------------------------------------------------
(vi) Sixth, PRS determines each partner's final allocable ATI.
Because C's allocable ATI is comprised of $100 of items of deduction
and loss and $0 of income and gain, C has negative allocable ATI of
$100. C is the only partner with negative allocable ATI. Thus, the
total negative allocable ATI amount is $100. Any partner with a
negative allocable ATI, or an allocable ATI of $0, has a positive
allocable ATI of $0. Therefore, C has a positive allocable ATI of $0.
Because A's allocable ATI is comprised of $100 of items of income and
gain and $0 of deduction and loss, A has positive allocable ATI of
$100. Because B's allocable ATI is comprised of $100 of items of income
and gain and $0 of deduction and loss, B has positive allocable ATI of
$100. Thus, the total positive allocable ATI is $200 ($100 + $100 +
$0). PRS determines A's final allocable ATI by reducing, but not below
$0, A's positive allocable ATI ($100) by the product of total negative
allocable ATI ($100) and the ratio of A's positive allocable ATI to the
total positive allocable ATI ($100/$200). Therefore, A's positive
allocable ATI is reduced by $50 ($100 x 50 percent). As a result, A's
final allocable ATI is $50. PRS determines B's final allocable ATI by
reducing, but not below $0, B's positive allocable ATI ($100) by the
product of total negative allocable ATI ($100) and the ratio of B's
positive allocable ATI to the total positive allocable ATI ($100/$200).
Therefore, B's positive allocable ATI is reduced by $50 ($100 x 50
percent). As a result, B's final allocable ATI is $50. Because C has a
positive allocable ATI of $0, C's final allocable ATI is $0.
[[Page 56803]]
Table 25 to Paragraph (o)(19)(vi)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................... $100 $100 ($100) $100
If deduction and loss items comprising allocable 0 0 100 100
ATI exceed income and gain items comprising
allocable ATI, then such excess amount =
Negative allocable ATI.........................
If income and gain items comprising allocable 100 100 0 200
ATI equal or exceed deduction and loss items
comprising allocable ATI, then such amount =
Positive allocable ATI.........................
----------------------------------------------------------------------------------------------------------------
Table 26 to Paragraph (o)(19)(vi)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI.......................... $100 $100 $0 $200
Less: (Total negative allocable ATI) x (Positive 50 50 0 N/A
allocable ATI/Total positive allocable ATI)....
= Final allocable ATI........................... 50 50 0 100
----------------------------------------------------------------------------------------------------------------
(vii) Seventh, PRS compares each partner's ATI capacity (ATIC)
amount to such partner's remaining business interest expense. A's ATIC
amount is $15 ($50 x 30 percent), B's ATIC amount is $15 ($50 x 30
percent), and C's ATIC amount is $0 ($0 x 30 percent). Because A's ATIC
amount exceeds its remaining business interest expense by $15 ($15-$0),
A has an ATIC excess of $15. B and C do not have any ATIC excess. Thus,
the total ATIC excess is $15 ($15 + $0 + $0). A does not have any ATIC
deficit. Because B's remaining business interest expense exceeds its
ATIC amount by $10 ($25-$15), B has an ATIC deficit of $10. Because C's
remaining business interest expense exceeds its ATIC amount by $25
($25-$0), C has an ATIC deficit of $25. Thus, the total ATIC deficit is
$35 ($0 + $10 + $25).
Table 27 to Paragraph (o)(19)(vii)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 percent)......... $15 $15 $0 N/A
Remaining BIE................................... 0 25 25 N/A
If ATIC exceeds remaining BIE, then such excess 15 0 0 $15
= ATIC excess..................................
If remaining BIE exceeds ATIC, then such excess 0 10 25 35
= ATIC deficit.................................
----------------------------------------------------------------------------------------------------------------
(viii)(A) Eighth, PRS must perform the calculations and make the
necessary adjustments described under paragraph (f)(2)(viii) of this
section if, and only if, PRS has--
(1) An excess business interest expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess greater than $0 under paragraph (f)(2)(vii)
of this section. Because PRS satisfies each of these three
requirements, PRS must perform the calculations and make the necessary
adjustments described under paragraphs (f)(2)(viii)(B) and (C) or (D)
of this section.
(B) PRS must determine each partner's priority amount and usable
priority amount. Only partners with an ATIC deficit under paragraph
(f)(2)(vii) of this section can have a priority amount greater than $0.
Thus, only partners B and C can have a priority amount greater than $0.
PRS determines a partner's priority amount as 30 percent of the amount
by which such partner's allocable positive ATI exceeds its final
allocable ATI. Therefore, A's priority amount is $0, B's priority
amount is $15 (($100-$50) x 30 percent), and C's priority amount is $0
(($0-$0) x 30 percent). Thus, the total priority amount is $15 ($0 +
$15 + $0). Next, PRS must determine each partner's usable priority
amount. Each partner's usable priority amount is the lesser of such
partner's priority amount or ATIC deficit. Thus, A has a usable
priority amount of $0, B has a usable priority amount of $10, and C has
a usable priority amount of $0. As a result, the total usable priority
amount is $10 ($0 + $10 + $0). Because the total ATIC excess under
paragraph (f)(2)(vii) of this section ($15) is greater than the total
usable priority amount ($10), PRS must perform the adjustments
described in paragraph (f)(2)(viii)(C) of this section.
Table 28 to Paragraph (o)(19)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI--Final allocable ATI)... $0 $50 $0 N/A
Multiplied by 30 percent........................ 30% 30% 30% N/A
= Priority amount............................... $0 $15 $0 $15
----------------------------------------------------------------------------------------------------------------
[[Page 56804]]
Table 29 to Paragraph (o)(19)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Priority amount................................. $0 $15 $0 N/A
ATIC deficit.................................... 0 10 25 N/A
Lesser of priority amount or ATIC deficit = 0 10 0 $10
Usable priority amount.........................
----------------------------------------------------------------------------------------------------------------
(C) For purposes of paragraph (f)(2)(ix) of this section, each
partner's final ATIC excess is $0. For purposes of paragraph (f)(2)(x)
of this section, the following terms have the following meanings. Each
partner's ATIC deficit is such partner's ATIC deficit as determined
pursuant to paragraph (f)(2)(vii) of this section reduced by such
partner's usable priority amount. Thus, A's ATIC deficit is $0 ($0-$0),
B's ATIC deficit is $0 ($10-$10), and C's ATIC deficit is $25 ($25-$0).
The total ATIC deficit is the total ATIC deficit determined pursuant to
paragraph (f)(2)(vii) ($35) reduced by the total usable priority amount
($10). Thus, the total ATIC deficit is $25 ($35-$10). The total ATIC
excess is the total ATIC excess determined pursuant to paragraph
(f)(2)(vii) of this section ($15) reduced by the total usable priority
amount ($10). Thus, the total ATIC excess is $5 ($15-$5).
Table 30 to Paragraph (o)(19)(viii)(C)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit.................................... $0 $10 $25 N/A
Less: Usable priority amount.................... 0 10 0 N/A
= ATIC deficit for purposes of paragraph 0 0 25 $25
(f)(2)(x) of this section......................
----------------------------------------------------------------------------------------------------------------
(D)(1) In light of the fact that the total ATIC excess was greater
than the total usable priority amount under paragraph (f)(2)(viii)(B)
of this section, paragraph (f)(2)(viii)(D) of this section does not
apply.
(2) In sum, the correct amounts to be used in paragraphs
(o)(19)(ix) and (x) of this section are as follows.
Table 31 to Paragraph (o)(19)(viii)(D)(2)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................................... $5 $0 $0 $5
ATIC deficit.................................... 0 0 25 25
----------------------------------------------------------------------------------------------------------------
(ix) Ninth, PRS determines each partner's final ATIC excess amount.
Pursuant to paragraph (f)(2)(viii)(C) of this section, each partner's
final ATIC excess amount is $0.
(x) Tenth, PRS determines each partner's final ATIC deficit amount.
Because C has an ATIC deficit, PRS must determine C's final ATIC
deficit amount. C's final ATIC deficit amount is C's ATIC deficit
($25), reduced, but not below $0, by the product of the total ATIC
excess ($5) and the ratio of C's ATIC deficit to the total ATIC deficit
($25/$25). Therefore, C has $20 of final ATIC deficit ($25-($5 x 100
percent)).
Table 32 to Paragraph (o)(19)(x)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit.................................... $0 $0 $25 N/A
Less: (Total ATIC excess) x (ATIC deficit/Total 0 0 5 N/A
ATIC deficit)..................................
= Final ATIC deficit............................ 0 0 20 $20
----------------------------------------------------------------------------------------------------------------
(xi) Eleventh, PRS allocates deductible business interest expense
and section 163(j) excess items to the partners. Pursuant to paragraph
(f)(2)(i) of this section, PRS has $20 of excess business interest
expense. PRS allocates the excess business interest expense dollar for
dollar to the partners with final ATIC deficits. Thus, PRS allocates
its excess business interest expense $20 to C. A partner's allocable
business interest expense is deductible business interest expense to
the extent it exceeds such partner's share of excess business interest
expense. Therefore, A has deductible business interest expense of $0
($0-$0), B has deductible business interest expense of $25 ($25-$0),
and C has deductible business interest expense of $5 ($25-$20).
Table 33 to Paragraph (o)(19)(xi)
----------------------------------------------------------------------------------------------------------------
A B C Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE.................................. $0 $25 $5 $30
EBIE allocated.................................. 0 0 20 20
ETI allocated................................... 0 0 0 0
[[Page 56805]]
EBII allocated.................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(20) Example 20: Facts. A, B, C, and D own all of the interests in
partnership PRS. In Year 1, PRS has $200 of ATI, $0 of business
interest income, and $140 of business interest expense. PRS's ATI
consists of $600 of gross income and $400 of gross deductions. PRS
allocates its items comprising ATI $100 to A, $100 to B, $400 to C, and
($400) to D. PRS allocates its business interest expense $0 to A, $40
to B, $60 to C, and $40 to D.
(i) First, PRS determines its limitation pursuant to Sec.
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus
its business interest income, or $60 ($200 x 30 percent). Thus, PRS has
$60 of deductible business interest expense and $80 of excess business
interest expense.
(ii) Second, PRS determines each partner's allocable share of
section 163(j) items used in its own section 163(j) calculation.
Table 34 to Paragraph (o)(20)(ii)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................... $100 $100 $400 ($400) $200
Allocable BII................... 0 0 0 0 0
Allocable BIE................... 0 40 60 40 140
----------------------------------------------------------------------------------------------------------------
(iii) Third, PRS compares each partner's allocable business
interest income to such partner's allocable business interest expense.
No partner has allocable business interest income. Consequently, each
partner's allocable business interest income deficit is equal to such
partner's allocable business interest expense. Thus, A's allocable
business interest income deficit is $0, B's allocable business interest
income deficit is $40, C's allocable business interest income deficit
is $60, and D's allocable business interest income deficit is $40. The
total allocable business interest income deficit is $140 ($0 + $40 +
$60 + $40). No partner has allocable business interest income excess
because no partner has allocable business interest income in excess of
its allocable business interest expense. Thus, the total allocable
business interest income excess is $0.
Table 35 to Paragraph (o)(20)(iii)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable BII................... $0 $0 $0 $0 N/A
Allocable BIE................... 0 40 60 40 N/A
If allocable BII exceeds 0 0 0 0 $0
allocable BIE, then such amount
= Allocable BII excess.........
If allocable BIE exceeds 0 40 60 40 140
allocable BII, then such amount
= Allocable BII deficit........
----------------------------------------------------------------------------------------------------------------
(iv) Fourth, PRS determines each partner's final allocable business
interest income excess. Because no partner has any allocable business
interest income excess, each partner has final allocable business
interest income excess of $0.
(v) Fifth, PRS determines each partner's remaining business
interest expense. Because no partner has any allocable business
interest income excess, each partner's remaining business interest
expense equals its allocable business interest income deficit. Thus,
A's remaining business interest expense is $0, B's remaining business
interest expense is $40, C's remaining business interest expense is
$60, and D's remaining business interest expense is $40.
Table 36 to Paragraph (o)(20)(v)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit........... $0 $40 $60 $40 $140
Less: (Total allocable BII 0 0 0 0 N/A
excess) x (Allocable BII
deficit/Total allocable BII
deficit).......................
= Remaining BIE................. 0 40 60 40 N/A
----------------------------------------------------------------------------------------------------------------
(vi) Sixth, PRS determines each partner's final allocable ATI.
Because D's allocable ATI is comprised of $400 of items of deduction
and loss and $0 of income and gain, D has negative allocable ATI of
$400. D is the only partner with negative allocable ATI. Thus, the
total negative allocable ATI amount is $400. Any partner with a
negative allocable ATI, or an allocable ATI of $0, has a positive
allocable ATI of $0. Therefore, D has a positive allocable ATI of $0.
PRS determines A's final allocable ATI by reducing, but not below $0,
A's positive allocable ATI ($100) by the product of total negative
allocable ATI ($400) and the ratio of A's positive allocable ATI to the
total
[[Page 56806]]
positive allocable ATI ($100/$600). Therefore, A's positive allocable
ATI is reduced by $66.67 ($400 x 16.67 percent). As a result, A's final
allocable ATI is $33.33. PRS determines B's final allocable ATI by
reducing, but not below $0, B's positive allocable ATI ($100) by the
product of total negative allocable ATI ($400) and the ratio of B's
positive allocable ATI to the total positive allocable ATI ($100/$600).
Therefore, B's positive allocable ATI is reduced by $66.67 ($400 x
16.67 percent). As a result, B's final allocable ATI is $33.33. PRS
determines C's final allocable ATI by reducing, but not below $0, C's
positive allocable ATI ($400) by the product of total negative
allocable ATI ($400) and the ratio of C's positive allocable ATI to the
total positive allocable ATI ($400/$600). Therefore, C's positive
allocable ATI is reduced by $266.67 ($400 x 66.67 percent). As a
result, C's final allocable ATI is $133.33. Because D has a positive
allocable ATI of $0, D's final allocable ATI is $0.
Table 37 to Paragraph (o)(20)(vi)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................... $100 $100 $400 ($400) $200
If deduction and loss items 0 0 0 400 400
comprising allocable ATI exceed
income and gain items
comprising allocable ATI, then
such excess amount = Negative
allocable ATI..................
If income and gain items 100 100 400 0 600
comprising allocable ATI equal
or exceed deduction and loss
items comprising allocable ATI,
then such amount = Positive
allocable ATI..................
----------------------------------------------------------------------------------------------------------------
Table 38 to Paragraph (o)(20)(vi)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI.......... $100 $100 $400 $0 $600
Less: (Total negative allocable 66.67 66.67 266.67 0 N/A
ATI) x (Positive allocable ATI/
Total positive allocable ATI)..
= Final allocable ATI........... 33.33 33.33 133.33 0 200
----------------------------------------------------------------------------------------------------------------
(vii) Seventh, PRS compares each partner's ATI capacity (ATIC)
amount to such partner's remaining business interest expense. A's ATIC
amount is $10 ($33.33 x 30 percent), B's ATIC amount is $10 ($33.33 x
30 percent), C's ATIC amount is $40 ($133.33 x 30 percent), and D's
ATIC amount is $0 ($0 x 30 percent). Because A's ATIC amount exceeds
its remaining business interest expense by $10 ($10-$0), A has an ATIC
excess of $10. B, C, and D do not have any ATIC excess. Thus, the total
ATIC excess is $10 ($10 + $0 + $0 + $0). A does not have any ATIC
deficit. Because B's remaining business interest expense exceeds its
ATIC amount by $30 ($40-$10), B has an ATIC deficit of $30. Because C's
remaining business interest expense exceeds its ATIC amount by $20
($60-$40), C has an ATIC deficit of $20. Because D's remaining business
interest expense exceeds its ATIC amount by $40 ($40-$0), D has an ATIC
deficit of $40. Thus, the total ATIC deficit is $90 ($0 + $30 + $20 +
$40).
Table 39 to Paragraph (o)(20)(vii)
----------------------------------------------------------------------------------------------------------------
_ A B C D Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 $10 $10 $40 $0 N/A
percent).......................
Remaining BIE................... 0 40 60 40 N/A
If ATIC exceeds remaining BIE, 10 0 0 0 $10
then such excess = ATIC excess.
If remaining BIE exceeds ATIC, 0 30 20 40 90
then such excess = ATIC deficit
----------------------------------------------------------------------------------------------------------------
(viii)(A) Eighth, PRS must perform the calculations and make the
necessary adjustments described under paragraph (f)(2)(viii) of this
section if, and only if, PRS has (1) an excess business interest
expense greater than $0 under paragraph (f)(2)(i) of this section, (2)
a total negative allocable ATI greater than $0 under paragraph
(f)(2)(vi) of this section, and (3) a total ATIC excess amount greater
than $0 under paragraph (f)(2)(vii) of this section. Because PRS
satisfies each of these three requirements, PRS must perform the
calculations and make the necessary adjustments described under
paragraphs (f)(2)(viii)(B) and (C) or paragraph (f)(2)(viii)(D) of this
section.
(B) PRS must determine each partner's priority amount and usable
priority amount. Only partners with an ATIC deficit under paragraph
(f)(2)(vii) of this section can have a priority amount greater than $0.
Thus, only partners B, C, and D can have a priority amount greater than
$0. PRS determines a partner's priority amount as 30 percent of the
amount by which such partner's allocable positive ATI exceeds its final
allocable ATI. Therefore, B's priority amount is $20 (($100-$33.33) x
30 percent), C's priority amount is $80 (($400-$133.33) x 30 percent),
and D's priority amount is $0 (($0-$0) x 30 percent). Thus, the total
priority amount is $100 ($0 + $20 + $80 + $0). Next, PRS must determine
each partner's usable priority amount. Each partner's usable priority
amount is the lesser of such partner's priority amount or ATIC deficit.
Thus, A has a usable priority amount of $0, B has a usable priority
amount of $20, C has a usable priority amount of $20, and D has a
usable priority amount of $0. As a result, the total usable priority
amount is $40 ($0 + $20 + $20 + $0). Because the total usable priority
amount ($40) is greater
[[Page 56807]]
than the total ATIC excess under paragraph (f)(2)(vii) of this section
($10), PRS must perform the adjustments described in paragraph
(f)(2)(viii)(D) of this section.
Table 40 to Paragraph (o)(20)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI--Final $0 $66.67 $266.67 $0 N/A
allocable ATI).................
Multiplied by 30 percent........ 30% 30% 30% 30% N/A
= Priority amount............... 0 20 80 0 $100
----------------------------------------------------------------------------------------------------------------
Table 41 to Paragraph (o)(20)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Priority amount................. $0 $20 $80 $0 N/A
ATIC deficit.................... 0 30 20 40 N/A
Lesser of priority amount or 0 20 20 0 $40
ATIC deficit = Usable priority
amount.........................
----------------------------------------------------------------------------------------------------------------
(C) In light of the fact that the total usable priority amount is
greater than the total ATIC excess under paragraph (f)(2)(viii)(B) of
this section, paragraph (f)(2)(viii)(C) of this section does not apply.
(D)(1) Because B and C are the only partners with priority amounts
greater than $0, B and C are priority partners, while A and D are non-
priority partners. For purposes of paragraph (f)(2)(ix) of this
section, each partner's final ATIC excess amount is $0. For purposes of
paragraph (f)(2)(x) of this section, each non-priority partner's final
ATIC deficit amount is such partner's ATIC deficit determined pursuant
to paragraph (f)(2)(vii) of this section. Therefore, A has a final ATIC
deficit of $0 and D has a final ATIC deficit of $40. Additionally, for
purposes of paragraph (f)(2)(x) of this section, PRS must determine
each priority partner's step eight excess share. A priority partner's
step eight excess share is the product of the total ATIC excess and the
ratio of the partner's priority amount to the total priority amount.
Thus, B's step eight excess share is $2 ($10 x ($20/$100)) and C's step
eight excess share is $8 ($10 x ($80/$100)). To the extent a priority
partner's step eight excess share exceeds its ATIC deficit, the excess
will be the partner's ATIC excess for purposes of paragraph (f)(2)(x)
of this section. Thus, B and C each have an ATIC excess of $0,
resulting in a total ATIC excess is $0. To the extent a priority
partner's ATIC deficit exceeds its step eight excess share, the excess
will be the partner's ATIC deficit for purposes of paragraph (f)(2)(x)
of this section. Because B's ATIC deficit ($30) exceeds its step eight
excess share ($2), B's ATIC deficit for purposes of paragraph (f)(2)(x)
of this section is $28 ($30-$2). Because C's ATIC deficit ($20) exceeds
its step eight excess share ($8), C's ATIC deficit for purposes of
paragraph (f)(2)(x) of this section is $12 ($20-$8). Thus, the total
ATIC deficit is $40 ($28 + $12).
Table 42 to Paragraph (o)(20)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Non-priority partners ATIC $0 N/A N/A $40 N/A
deficit in paragraph
(f)(2)(vii) = Final ATIC
deficit for purposes of
paragraph (f)(2)(x) of this
section........................
----------------------------------------------------------------------------------------------------------------
Table 43 to Paragraph (o)(20)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Priority partners step eight N/A $2 $8 N/A N/A
excess share = (Total ATIC
excess) x (Priority/Total
priority)......................
ATIC deficit.................... N/A 30 20 N/A N/A
If step eight excess share N/A 0 0 N/A 0
exceeds ATIC deficit, then such
excess = ATIC excess for
purposes of paragraph (f)(2)(x)
of this section................
If ATIC deficit exceeds step N/A 28 12 N/A 40
eight excess share, then such
excess = ATIC deficit for
purposes of paragraph (f)(2)(x)
of this section................
----------------------------------------------------------------------------------------------------------------
(2) In sum, the correct amounts to be used in paragraphs
(o)(20)(ix) and (x) of this section are as follows.
[[Page 56808]]
Table 44 to Paragraph (o)(20)(viii)(D)(2)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................... $0 $0 $0 $0 $0
ATIC deficit.................... 0 28 12 0 40
Non-priority partner final ATIC 0 0 0 0 N/A
deficit........................
----------------------------------------------------------------------------------------------------------------
(ix) Ninth, PRS determines each partner's final ATIC excess amount.
Pursuant to paragraph (f)(2)(viii)(D) of this section, each priority
and non-priority partner's final ATIC excess amount is $0.
(x) Tenth, PRS determines each partner's final ATIC deficit amount.
Because B has an ATIC deficit, PRS must determine B's final ATIC
deficit amount. B's final ATIC deficit amount is B's ATIC deficit
($28), reduced, but not below $0, by the product of the total ATIC
excess ($0) and the ratio of B's ATIC deficit to the total ATIC deficit
($28/$40). Therefore, B has $28 of final ATIC deficit ($28-($0 x 70
percent)). Because C has an ATIC deficit, PRS must determine C's final
ATIC deficit amount. C's final ATIC deficit amount is C's ATIC deficit
($12), reduced, but not below $0, by the product of the total ATIC
excess ($0) and the ratio of C's ATIC deficit to the total ATIC deficit
($12/$40). Therefore, C has $12 of final ATIC deficit ($12-($0 x 30
percent)). Pursuant to paragraph (f)(2)(viii)(D) of this section, D's
final ATIC deficit amount is $40.
Table 45 to Paragraph (o)(20)(x)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit.................... N/A $28 $12 N/A N/A
Less: (Total ATIC excess) x N/A 0 0 N/A N/A
(ATIC deficit/Total ATIC
deficit).......................
= Final ATIC deficit............ $0 28 12 $40 $80
----------------------------------------------------------------------------------------------------------------
(xi) Eleventh, PRS allocates deductible business interest expense
and section 163(j) excess items to the partners. Pursuant to paragraph
(f)(2)(i) of this section, PRS has $80 of excess business interest
expense. PRS allocates the excess business interest expense dollar for
dollar to the partners with final ATIC deficits. Thus, PRS allocates
its excess business interest expense $28 to B, $12 to C, and $40 to D.
A partner's allocable business interest expense is deductible business
interest expense to the extent it exceeds such partner's share of
excess business interest expense. Therefore, A has deductible business
interest expense of $0 ($0-$0), B has deductible business interest
expense of $12 ($40-$28), C has deductible business interest expense of
$48 ($60-$12), and D has deductible business interest expense of $0
($40-$40).
Table 46 to Paragraph (o)(20)(xi)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE.................. $0 $12 $48 $0 $60
EBIE allocated.................. 0 28 12 40 80
ETI allocated................... 0 0 0 0 0
EBII allocated.................. 0 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(21) Example 21: Facts. A, B, C, and D own all of the interests in
partnership PRS. In Year 1, PRS has $200 of ATI, $0 of business
interest income, and $150 of business interest expense. PRS's ATI
consists of $500 of gross income and $300 of gross deductions. PRS
allocates its items comprising ATI $50 to A, $50 to B, $400 to C, and
($300) to D. PRS allocates its business interest expense $0 to A, $50
to B, $50 to C, and $50 to D.
(i) First, PRS determines its limitation pursuant to Sec.
1.163(j)-2. PRS's section 163(j) limit is 30 percent of its ATI plus
its business interest income, or $60 ($200 x 30 percent). Thus, PRS has
$60 of deductible business interest expense, and $90 of excess business
interest expense.
(ii) Second, PRS determines each partner's allocable share of
section 163(j) items used in its own section 163(j) calculation.
Table 47 to Paragraph (o)(21)(ii)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................... $50 $50 $400 ($300) $200
Allocable BII................... 0 0 0 0 0
Allocable BIE................... 0 50 50 50 150
----------------------------------------------------------------------------------------------------------------
(iii) Third, PRS compares each partner's allocable business
interest income to such partner's allocable business interest expense.
No partner has allocable business interest income. Consequently, each
partner's allocable business interest income deficit is equal to such
partner's allocable business interest expense. Thus, A's allocable
[[Page 56809]]
business interest income deficit is $0, B's allocable business interest
income deficit is $50, C's allocable business interest income deficit
is $50, and D's allocable business interest income deficit is $50. The
total allocable business interest income deficit is $150 ($0 + $50 +
$50 + $50). No partner has allocable business interest income excess
because no partner has allocable business interest income in excess of
its allocable business interest expense. Thus, the total allocable
business interest income excess is $0.
Table 48 to Paragraph (o)(21)(iii)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable BII................... $0 $0 $0 $0 N/A
Allocable BIE................... 0 50 50 50 N/A
If allocable BII exceeds 0 0 0 0 0
allocable BIE, then such amount
= Allocable BII excess.........
If allocable BIE exceeds 0 50 50 50 150
allocable BII, then such amount
= Allocable BII deficit........
----------------------------------------------------------------------------------------------------------------
(iv) Fourth, PRS determines each partner's final allocable business
interest income excess. Because no partner has any allocable business
interest income excess, each partner has final allocable business
interest income excess of $0.
(v) Fifth, PRS determines each partner's remaining business
interest expense. Because no partner has any allocable business
interest income excess, each partner's remaining business interest
expense equals its allocable business interest income deficit. Thus,
A's remaining business interest expense is $0, B's remaining business
interest expense is $50, C's remaining business interest expense is
$50, and D's remaining business interest expense is $50.
Table 49 to Paragraph (o)(21)(v)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable BII deficit........... $0 $50 $50 $50 $150
Less: (Total allocable BII 0 0 0 0 N/A
excess) x (Allocable BII
deficit/Total allocable BII
deficit).......................
= Remaining BIE................. 0 50 50 50 N/A
----------------------------------------------------------------------------------------------------------------
(vi) Sixth, PRS determines each partner's final allocable ATI.
Because D's allocable ATI is comprised of $300 of items of deduction
and loss and $0 of income and gain, D has negative allocable ATI of
$300. D is the only partner with negative allocable ATI. Thus, the
total negative allocable ATI amount is $300. Any partner with a
negative allocable ATI, or an allocable ATI of $0, has a positive
allocable ATI of $0. Therefore, D has a positive allocable ATI of $0.
PRS determines A's final allocable ATI by reducing, but not below $0,
A's positive allocable ATI ($50) by the product of total negative
allocable ATI ($300) and the ratio of A's positive allocable ATI to the
total positive allocable ATI ($50/$500). Therefore, A's positive
allocable ATI is reduced by $30 ($300 x 10 percent). As a result, A's
final allocable ATI is $20. PRS determines B's final allocable ATI by
reducing, but not below $0, B's positive allocable ATI ($50) by the
product of total negative allocable ATI ($300) and the ratio of B's
positive allocable ATI to the total positive allocable ATI ($50/$500).
Therefore, B's positive allocable ATI is reduced by $30 ($300 x 10
percent). As a result, B's final allocable ATI is $20. PRS determines
C's final allocable ATI by reducing, but not below $0, C's positive
allocable ATI ($400) by the product of total negative allocable ATI
($300) and the ratio of C's positive allocable ATI to the total
positive allocable ATI ($400/$500). Therefore, C's positive allocable
ATI is reduced by $240 ($300 x 80 percent). As a result, C's final
allocable ATI is $160. Because D has a positive allocable ATI of $0,
D's final allocable ATI is $0.
Table 50 to Paragraph (o)(21)(vi)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................... $50 $50 $400 ($300) $200
If deduction and loss items 0 0 0 300 300
comprising allocable ATI exceed
income and gain items
comprising allocable ATI, then
such excess amount = Negative
allocable ATI..................
If income and gain items 50 50 400 0 500
comprising allocable ATI equal
or exceed deduction and loss
items comprising allocable ATI,
then such amount = Positive
allocable ATI..................
----------------------------------------------------------------------------------------------------------------
Table 51 to Paragraph (o)(21)(vi)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Positive allocable ATI.......... $50 $50 $400 $0 $500
[[Page 56810]]
Less: (Total negative allocable 30 30 240 0 N/A
ATI) x (Positive allocable ATI/
Total positive allocable ATI)..
= Final allocable ATI........... 20 20 160 0 200
----------------------------------------------------------------------------------------------------------------
(vii) Seventh, PRS compares each partner's ATI capacity (ATIC)
amount to such partner's remaining business interest expense. A's ATIC
amount is $6 ($20 x 30 percent), B's ATIC amount is $6 ($20 x 30
percent), C's ATIC amount is $48 ($160 x 30 percent), and D's ATIC
amount is $0 ($0 x 30 percent). Because A's ATIC amount exceeds its
remaining business interest expense by $6 ($6-$0), A has an ATIC excess
of $6. B, C, and D do not have any ATIC excess. Thus, the total ATIC
excess amount is $6 ($6 + $0 + $0 + $0). A does not have any ATIC
deficit. Because B's remaining business interest expense exceeds its
ATIC amount by $44 ($50-$6), B has an ATIC deficit of $44. Because C's
remaining business interest expense exceeds its ATIC amount by $2 ($50-
$48), C has an ATIC deficit of $2. Because D's remaining business
interest expense exceeds its ATIC amount by $50 ($50-$0), D has an ATIC
deficit of $50. Thus, the total ATIC deficit is $96 ($0 + $44 + $2 +
$50).
Table 52 to Paragraph (o)(21)(vii)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
ATIC (Final allocable ATI x 30 $6 $6 $48 $0 N/A
percent).......................
Remaining BIE................... 0 50 50 50 N/A
If ATIC exceeds remaining BIE, 6 0 0 0 $6
then such excess = ATIC excess.
If remaining BIE exceeds ATIC, 0 44 2 50 96
then such excess = ATIC deficit
----------------------------------------------------------------------------------------------------------------
(viii)(A) Eighth, PRS must perform the calculations and make the
necessary adjustments described under paragraph (f)(2)(viii) of this
section if, and only if, PRS has--
(1) An excess business interest expense greater than $0 under
paragraph (f)(2)(i) of this section;
(2) A total negative allocable ATI greater than $0 under paragraph
(f)(2)(vi) of this section; and
(3) A total ATIC excess amount greater than $0 under paragraph
(f)(2)(vii) of this section. Because PRS satisfies each of these three
requirements, PRS must perform the calculations and make the necessary
adjustments described under paragraph (f)(2)(viii) of this section.
(B) PRS must determine each partner's priority amount and usable
priority amount. Only partners with an ATIC deficit under paragraph
(f)(2)(vii) of this section of this section can have a priority amount
greater than $0. Thus, only partners B, C, and D can have a priority
amount greater than $0. PRS determines a partner's priority amount as
30 percent of the amount by which such partner's allocable positive ATI
exceeds its final allocable ATI. Therefore, B's priority amount is $9
(($50-$20) x 30 percent), C's priority amount is $72 (($400-$160) x 30
percent), and D's priority amount is $0 (($0-$0) x 30 percent). Thus,
the total priority amount is $81 ($0 + $9 + $72 + $0). Next, PRS must
determine each partner's usable priority amount. Each partner's usable
priority amount is the lesser of such partner's priority amount or ATIC
deficit. Thus, B has a usable priority amount of $9, C has a usable
priority amount of $2, and D has a usable priority amount of $0. As a
result, the total usable priority amount is $11 ($0 + $9 + $2 + $0).
Because the total usable priority amount ($11) is greater than the
total ATIC excess ($6) under paragraph (f)(2)(vii) of this section, PRS
must perform the adjustments described in paragraph (f)(2)(viii)(D) of
this section.
Table 53 to Paragraph (o)(21)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
(Positive allocable ATI-Final $0 $30 $240 $0 N/A
allocable ATI).................
Multiplied by 30 percent........ 30% 30% 30% 30% N/A
= Priority amount............... $0 $9 $72 $0 $81
----------------------------------------------------------------------------------------------------------------
Table 54 to Paragraph (o)(21)(viii)(B)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Priority amount................. $0 $9 $72 $0 N/A
ATIC deficit.................... 0 44 2 50 N/A
Lesser of priority amount or 0 9 2 0 $11
ATIC deficit = Usable priority
amount.........................
----------------------------------------------------------------------------------------------------------------
[[Page 56811]]
(C) In light of the fact that the total usable priority amount is
greater than the total ATIC excess under paragraph (f)(2)(viii)(B) of
this section, paragraph (f)(2)(viii)(C) of this section does not apply.
(D)(1) Because B and C are the only partners with priority amounts
greater than $0, B and C are priority partners, while A and D are non-
priority partners. For purposes of paragraph (f)(2)(ix) of this
section, each partner's final ATIC excess amount is $0. For purposes of
paragraph (f)(2)(x) of this section, each non-priority partner's final
ATIC deficit amount is such partner's ATIC deficit determined pursuant
to paragraph (f)(2)(vii) of this section. Therefore, A has a final ATIC
deficit of $0 and D has a final ATIC deficit of $50. Additionally, for
purposes of paragraph (f)(2)(x) of this section, PRS must determine
each priority partner's step eight excess share. A priority partner's
step eight excess share is the product of the total ATIC excess and the
ratio of the partner's priority amount to the total priority amount.
Thus, B's step eight excess share is $0.67 ($6 x ($9/$81)) and C's step
eight excess share is $5.33 ($6 x ($72/$81)). To the extent a priority
partner's step eight excess share exceeds its ATIC deficit, the excess
will be the partner's ATIC excess for purposes of paragraph (f)(2)(x)
of this section. B's step eight excess share does not exceed its ATIC
deficit. Because C's step eight excess share ($5.33) exceeds its ATIC
deficit ($2), C's ATIC excess for purposes of paragraph (f)(2)(x) of
this section is $3.33 ($5.33-$2). Thus, the total ATIC excess for
purposes of paragraph (f)(2)(x) of this section is $3.33 ($0 + $3.33).
To the extent a priority partner's ATIC deficit exceeds its step eight
excess share, the excess will be the partner's ATIC deficit for
purposes of paragraph (f)(2)(x) of this section. Because B's ATIC
deficit ($44) exceeds its step eight excess share ($0.67), B's ATIC
deficit for purposes of paragraph (f)(2)(x) of this section is $43.33
($44-$0.67). C's ATIC deficit does not exceed its step eight excess
share. Thus, the total ATIC deficit for purposes of paragraph (f)(2)(x)
of this section is $43.33 ($43.33 + $0).
Table 55 to Paragraph (o)(21)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Non-priority partners ATIC $0 N/A N/A $50 N/A
deficit in paragraph
(f)(2)(vii) = Final ATIC
deficit for purposes of
paragraph (f)(2)(x) of this
section........................
----------------------------------------------------------------------------------------------------------------
Table 56 to Paragraph (o)(21)(viii)(D)(1)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Priority partners step eight N/A $0.67 $5.33 N/A N/A
excess share = (Total ATIC
excess) x (Priority/Total
priority)......................
ATIC deficit.................... N/A 44 2 N/A N/A
If step eight excess share N/A 0 3.33 N/A $3.33
exceeds ATIC deficit, then such
excess = ATIC excess for
purposes of paragraph (f)(2)(x)
of this section................
If ATIC deficit exceeds step N/A 43.33 0 N/A 43.33
eight excess share, then such
excess = ATIC deficit for
purposes of paragraph (f)(2)(x)
of this section................
----------------------------------------------------------------------------------------------------------------
(2) In sum, the correct amounts to be used in paragraphs
(o)(21)(ix) and (x) of this section are as follows.
Table 57 to Paragraph (o)(21)(viii)(D)(2)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
ATIC excess..................... $0 $0 $3.33 $0 $3.33
ATIC deficit.................... 0 43.33 0 0 43.33
Non-priority partner final ATIC 0 0 0 50 N/A
deficit........................
----------------------------------------------------------------------------------------------------------------
(ix) Ninth, PRS determines each partner's final ATIC excess amount.
Pursuant to paragraph (f)(2)(viii)(D) of this section, each priority
and non-priority partner's final ATIC excess amount is $0.
(x) Tenth, PRS determines each partner's final ATIC deficit amount.
Because B has an ATIC deficit, PRS must determine B's final ATIC
deficit amount. B's final ATIC deficit amount is B's ATIC deficit
($43.33), reduced, but not below $0, by the product of the total ATIC
excess ($3.33) and the ratio of B's ATIC deficit to the total ATIC
deficit ($43.33/$43.33). Therefore, B has $40 of final ATIC deficit
($43.33-($3.33 x 100 percent)). Pursuant to paragraph (f)(2)(viii)(D)
of this section, D's final ATIC deficit amount is $40.
Table 58 to Paragraph (o)(21)(x)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
ATIC deficit.................... $0 $43.33 $0 N/A N/A
[[Page 56812]]
Less: (Total ATIC excess) x 0 3.33 0 N/A N/A
(ATIC deficit/Total ATIC
deficit).......................
= Final ATIC deficit............ 0 40 0 $50 $90
----------------------------------------------------------------------------------------------------------------
(xi) Eleventh, PRS allocates deductible business interest expense
and section 163(j) excess items to the partners. Pursuant to paragraph
(f)(2)(i) of this section, PRS has $90 of excess business interest
expense. PRS allocates the excess business interest expense dollar for
dollar to the partners with final ATIC deficits. Thus, PRS allocates
its excess business interest expense $40 to B and $50 to D. A partner's
allocable business interest expense is deductible business interest
expense to the extent it exceeds such partner's share of excess
business interest expense. Therefore, A has deductible business
interest expense of $0 ($0-$0), B has deductible business interest
expense of $10 ($50-$40), C has deductible business interest expense of
$50 ($50-$0), and D has deductible business interest expense of $0
($50-$50).
Table 59 to Paragraph (o)(21)(xi)
----------------------------------------------------------------------------------------------------------------
A B C D Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE.................. $0 $10 $50 $0 $60
EBIE allocated.................. 0 40 0 50 90
ETI allocated................... 0 0 0 0 0
EBII allocated.................. 0 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(22) Example 22--(i) Facts. A and B are equal shareholders in X, a
subchapter S corporation. In Year 1, X has $100 of ATI and $40 of
business interest expense. A has $100 of ATI and $20 of business
interest expense from its sole proprietorship. B has $0 of ATI and $20
of business interest expense from its sole proprietorship.
(ii) S corporation-level. In Year 1, X's section 163(j) limit is 30
percent of its ATI, or $30 ($100 x 30 percent). Thus, X has $30 of
deductible business interest expense and $10 of disallowed business
interest expense. Such $30 of deductible business interest expense is
includable in X's nonseparately stated income or loss, and is not
subject to further limitation under section 163(j). X carries forward
the $10 of disallowed business interest expense to Year 2 as a
disallowed business interest expense carryforward under Sec. 1.163(j)-
2(c). X may not currently deduct all $40 of its business interest
expense in Year 1. X only reduces its accumulated adjustments account
in Year 1 by the $30 of deductible business interest expense in Year 1
under Sec. 1.163(j)-6(l)(7).
(iii) Shareholder allocations. A and B are each allocated $35 of
nonseparately stated taxable income ($50 items of income or gain, less
$15 of deductible business interest expense) from X. A and B do not
reduce their basis in X by the $10 of disallowed business interest
expense.
(iv) Shareholder-level computations. A, in computing its limit
under section 163(j), has $100 of ATI and $20 of business interest
expense from its sole proprietorship. A's section 163(j) limit is $30
($100 x 30 percent). Thus, A's $20 of business interest expense is
deductible business interest expense. B, in computing its limit under
section 163(j), has $20 of business interest expense from its sole
proprietorship. B's section 163(j) limit is $0 ($0 x 30 percent). Thus,
B's $20 of business interest expense is not allowed as a deduction and
is treated as business interest expense paid or accrued by B in Year 2.
(23) Example 23--(i) Facts. The facts are the same as in Example 22
in paragraph (o)(22)(i) of this section. In Year 2, X has $233.33 of
ATI, $0 of business interest income, and $30 of business interest
expense. A has $100 of ATI and $20 of business interest expense from
its sole proprietorship. B has $0 of ATI and $20 of business interest
expense from its sole proprietorship.
(ii) S corporation-level. In Year 2, X's section 163(j) limit is 30
percent of its ATI plus its business interest income, or $70 ($233.33 x
30 percent). Because X's section 163(j) limit exceeds X's $40 of
business interest expense ($30 from Year 2, plus the $10 disallowed
business interest expense carryforwards from Year 1), X may deduct all
$40 of business interest expense in Year 2. Such $40 of deductible
business interest expense is includable in X's nonseparately stated
income or loss, and is not subject to further limitation under section
163(j). Pursuant to Sec. 1.163(j)-6(l)(7), X must reduce its
accumulated adjustments account by $40. Additionally, X has $100 of
excess taxable income under Sec. 1.163(j)-1(b)(17).
(iii) Shareholder allocations. A and B are each allocated $96.67 of
nonseparately stated taxable income ($116.67 items of income or gain,
less $20 of deductible business interest expense) from X. Additionally,
A and B are each allocated $50 of excess taxable income under Sec.
1.163(j)-6(l)(4). As a result, A and B each increase their ATI by $50.
(iv) Shareholder-level computations. A, in computing its limit
under section 163(j), has $150 of ATI ($100 from its sole
proprietorship, plus $50 excess taxable income) and $20 of business
interest expense (from its sole proprietorship). A's section 163(j)
limit is $45 ($150 x 30 percent). Thus, A's $20 of business interest
expense is deductible business interest expense. B, in computing its
limit under section 163(j), has $50 of ATI ($0 from its sole
proprietorship, plus $50 excess taxable income) and $40 of business
interest expense ($20 from its sole proprietorship, plus $20 disallowed
business interest expense from its sole proprietorship in Year 1). B's
section 163(j) limit is $15 ($50 x 30 percent). Thus, $15 of B's
business interest expense is deductible business interest expense. The
$25 of B's business interest expense not allowed as a deduction ($40
business interest expense, less $15 section 163(j) limit) is treated as
business interest expense paid or accrued by B in Year 3.
[[Page 56813]]
(p) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
Sec. 1.163(j)-7 Application of the section 163(j) limitation to
foreign corporations and United States shareholders.
(a) Overview. This section provides rules for the application of
section 163(j) to relevant foreign corporations with shareholders that
are United States persons. Paragraph (b) of this section describes the
general rule regarding the application of section 163(j) to relevant
foreign corporations. Paragraphs (c) through (f) of this section are
reserved. Paragraph (g) of this section provides rules concerning the
computation of ATI of a relevant foreign corporation. Paragraphs (h)
through (k) of this section are reserved.
(b) General rule regarding the application of section 163(j) to
relevant foreign corporations. Except as otherwise provided in this
section, section 163(j) and the section 163(j) regulations apply to
determine the deductibility of a relevant foreign corporation's
business interest expense for purposes of computing its taxable income
for U.S. income tax purposes (if any) in the same manner as those
provisions apply to determine the deductibility of a domestic C
corporation's business interest expense for purposes of computing its
taxable income. See also Sec. 1.952-2. If a relevant foreign
corporation is a direct or indirect partner in a partnership, see Sec.
1.163(j)-6 (concerning the application of section 163(j) to
partnerships).
(c)-(f) [Reserved]
(g) Rules concerning the computation of adjusted taxable income of
a relevant foreign corporation--(1) Tentative taxable income. For
purposes of computing the tentative taxable income of a relevant
foreign corporation for a taxable year, the relevant foreign
corporation's gross income and allowable deductions are determined
under the principles of Sec. 1.952-2 or under the rules of section 882
for determining income that is, or deductions that are allocable to,
effectively connected income, as applicable.
(2) Treatment of certain dividends. For purposes of computing the
ATI of a relevant foreign corporation for a taxable year, any dividend
included in gross income that is received from a related person, within
the meaning of section 954(d)(3), with respect to the distributee is
subtracted from tentative taxable income.
(h)-(l) [Reserved]
(m) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
Sec. 1.163(j)-8. [Reserved]
Sec. 1.163(j)-9 Elections for excepted trades or businesses; safe
harbor for certain REITs.
(a) Overview. The limitation in section 163(j) applies to business
interest, which is defined under section 163(j)(5) as interest properly
allocable to a trade or business. The term trade or business does not
include any electing real property trade or business or any electing
farming business. See section 163(j)(7). This section provides the
rules and procedures for taxpayers to follow in making an election
under section 163(j)(7)(B) for a trade or business to be an electing
real property trade or business and an election under section
163(j)(7)(C) for a trade or business to be an electing farming
business.
(b) Availability of election--(1) In general. An election under
section 163(j)(7)(B) for a real property trade or business to be an
electing real property trade or business is available to any trade or
business that is described in Sec. 1.163(j)-1(b)(14)(i), (ii), or
(iii), and an election under section 163(j)(7)(C) for a farming
business to be an electing farming business is available to any trade
or business that is described in Sec. 1.163(j)-1(b)(13)(i), (ii), or
(iii).
(2) Special rules--(i) Exempt small businesses. An election
described in paragraph (b)(1) of this section is available regardless
of whether the real property trade or business or farming business
making the election also meets the requirements of the small business
exemption in section 163(j)(3) and Sec. 1.163(j)-2(d). See paragraph
(c)(2) of this section for the effect of the election relating to
depreciation.
(ii) Section 162 trade or business not required for electing real
property trade or business. An election described in paragraph (b)(1)
of this section to be an electing real property trade or business is
available regardless of whether the trade or business with respect to
which the election is made is a trade or business under section 162.
For example, a taxpayer engaged in activities described in section
469(c)(7)(C) and Sec. 1.469-9(b)(2), as required in Sec. 1.163(j)-
1(b)(14)(i), may make an election for a trade or business to be an
electing real property trade or business, regardless of whether its
activities rise to the level of a section 162 trade or business.
(c) Scope and effect of election--(1) In general. An election under
this section is made with respect to each eligible trade or business of
the taxpayer and applies only to such trade or business for which the
election is made. An election under this section applies to the taxable
year in which the election is made and to all subsequent taxable years.
See paragraph (e) of this section for terminations of elections.
(2) Irrevocability. An election under this section is irrevocable.
(3) Depreciation. Taxpayers making an election under this section
are required to use the alternative depreciation system for certain
types of property under section 163(j)(11) and cannot claim the
additional first-year depreciation deduction under section 168(k) for
those types of property.
(d) Time and manner of making election--(1) In general. Subject to
paragraph (f) of this section, a taxpayer makes an election under this
section by attaching an election statement to the taxpayer's timely
filed original Federal income tax return, including extensions. A
taxpayer may make elections for multiple trades or businesses on a
single election statement.
(2) Election statement contents. The election statement should be
titled ``Section 1.163(j)-9 Election'' and must contain the following
information for each trade or business:
[[Page 56814]]
(i) The taxpayer's name;
(ii) The taxpayer's address;
(iii) The taxpayer's social security number (SSN) or employer
identification number (EIN);
(iv) A description of the taxpayer's electing trade or business
sufficient to demonstrate qualification for an election under this
section, including the principal business activity code; and
(v) A statement that the taxpayer is making an election under
section 163(j)(7)(B) or (C), as applicable.
(3) Consolidated group's trade or business. For a consolidated
group's trade or business, the election under this section is made by
the agent for the group, as defined in Sec. 1.1502-77, on behalf of
itself and members of the consolidated group. Only the name and
taxpayer identification number (TIN) of the agent for the group, as
defined in Sec. 1.1502-77, must be provided on the election statement.
(4) Partnership's trade or business. An election for a partnership
must be made on the partnership's return for a trade or business that
the partnership conducts. An election by a partnership does not apply
to a trade or business conducted by a partner outside the partnership.
(e) Termination of election--(1) In general. An election under this
section automatically terminates if a taxpayer ceases to engage in the
electing trade or business. A taxpayer is considered to cease to engage
in an electing trade or business if the taxpayer sells or transfers
substantially all of the assets of the electing trade or business to an
acquirer that is not a related party in a taxable asset transfer. A
taxpayer is also considered to cease to engage in an electing trade or
business if the taxpayer terminates its existence for Federal income
tax purposes or ceases operation of the electing trade or business,
except to the extent that such termination or cessation results in the
sale or transfer of substantially all of the assets of the electing
trade or business to an acquirer that is a related party, or in a
transaction that is not a taxable asset transfer.
(2) Taxable asset transfer defined. For purposes of this paragraph
(e), the term taxable asset transfer means a transfer in which the
acquirer's basis or adjusted basis in the assets is not determined,
directly or indirectly, in whole or in part, by reference to the
transferor's basis in the assets.
(3) Related party defined. For purposes of this paragraph (e), the
term related party means any person who bears a relationship to the
taxpayer which is described in section 267(b) or 707(b)(1).
(4) Anti-abuse rule. If, within 60 months of a sale or transfer of
assets described in paragraph (e)(1) of this section, the taxpayer or a
related party reacquires substantially all of the assets that were used
in the taxpayer's prior electing trade or business, or substantially
similar assets, and resumes conducting such prior electing trade or
business, the taxpayer's previously terminated election under this
section is reinstated and is effective on the date the prior electing
trade or business is reacquired.
(f) Additional guidance. The rules and procedures regarding the
time and manner of making an election under this section and the
election statement contents in paragraph (d) of this section may be
modified through other guidance (see Sec. Sec. 601.601(d) and 601.602
of this chapter). Additional situations in which an election may
terminate under paragraph (e) of this section may be provided through
guidance published in the Federal Register or in the Internal Revenue
Bulletin (see Sec. 601.601(d) of this chapter).
(g) Examples. The examples in this paragraph (g) illustrate the
application of this section. Unless otherwise indicated, X and Y are
domestic C corporations; D and E are U.S. resident individuals not
subject to any foreign income tax; and the exemption for certain small
businesses in Sec. 1.163(j)-2(d) does not apply.
(1) Example 1: Scope of election--(i) Facts. For the taxable year
ending December 31, 2021, D, a sole proprietor, owned and operated a
dairy farm and an orchard as separate farming businesses described in
section 263A(e)(4). D filed an original Federal income tax return for
the 2021 taxable year on August 1, 2022, and included with the return
an election statement meeting the requirements of paragraph (d)(2) of
this section. The election statement identified D's dairy farm business
as an electing trade or business under this section. On March 1, 2023,
D sold some but not all or substantially all of the assets from D's
dairy farm business to D's neighbor, E, who is unrelated to D. After
the sale, D continued to operate the dairy farm trade or business.
(ii) Analysis. D's election under this section was properly made
and is effective for the 2021 taxable year and subsequent years. D's
dairy farm business is an excepted trade or business because D made the
election with D's timely filed Federal income tax return. D's orchard
business is a non-excepted trade or business, because D did not make an
election for the orchard business to be an excepted trade or business.
The sale of some but not all or substantially all of the assets from
D's dairy farm business does not affect D's election under this
section.
(2) Example 2: Availability of election--(i) Facts. E, an
individual, operates a dairy business that is a farming business under
section 263A and also owns real property that is not part of E's dairy
business that E leases to an unrelated party through a triple net
lease. E's average gross receipts, excluding inherently personal
amounts, for the three years prior to 2021 are approximately $25
million, but E is unsure of the exact amount.
(ii) Analysis. Under paragraph (b)(2)(i) of this section, E may
make an election under this section for the dairy business to be an
electing farming business, even though E is unsure whether the small
business exemption of Sec. 1.163(j)-2(d) applies. Additionally, under
paragraph (b)(2)(ii) of this section, assuming the requirements of
section 163(j)(7)(C) and this section are otherwise satisfied, E may
make an election under this section for its triple net lease property
to be an electing real property trade or business, even though E may
not be engaged in a trade or business under section 162 with respect to
the real property.
(3) Example 3: Cessation of entire trade or business--(i) Facts. X
has a real property trade or business for which X made an election
under this section by attaching an election statement to A's 2021
Federal income tax return. On March 1, 2022, X sold all of the assets
used in its real property trade or business to Y, an unrelated party,
and ceased to engage in the electing trade or business. On June 1,
2027, X started a new real property trade or business that was
substantially similar to X's prior electing trade or business.
(ii) Analysis. X's election under this section terminated on March
1, 2022, under paragraph (e)(1) of this section. X may choose whether
to make an election under this section for X's new real property trade
or business that A started in 2027.
(4) Example 4: Anti-abuse rule--(i) Facts. The facts are the same
as in Example 3 in paragraph (g)(3)(i) of this section, except that X
re-started its previous real property trade or business on February 1,
2023, when X reacquired substantially all of the assets that X had sold
on March 1, 2022.
(ii) Analysis. X's election under this section terminated on March,
1, 2022, under paragraph (e)(1) of this section. On February 1, 2023,
X's election was reinstated under paragraph (e)(4) of this section. X's
new real property trade or business is treated as a resumption of X's
prior electing trade or business and is therefore treated as an
electing real property trade or business.
[[Page 56815]]
(5) Example 5: Trade or business continuing after acquisition--(i)
Facts. X has a farming business for which X made an election under this
section by attaching an election statement to X's timely filed 2021
Federal income tax return. Y, unrelated to X, also has a farming
business, but Y has not made an election under this section. On July 1,
2022, X transferred all of its assets to Y in a transaction described
in section 368(a)(1)(D). After the transfer, Y continues to operate the
farming trade or business acquired from X.
(ii) Analysis. Under paragraph (e)(1) of this section, Y is subject
to X's election under this section for the trade or business that uses
X's assets because the sale or transfer was not in a taxable
transaction. Y cannot revoke X's election, but X's election has no
effect on Y's existing farming business for which Y has not made an
election under this section.
(6) Example 6: Trade or business merged after acquisition--(i)
Facts. The facts are the same as in Example 5 in paragraph (g)(5)(i) of
this section, except that Y uses the assets acquired from X in a trade
or business that is neither a farming business (as defined in section
263A(e)(4) or Sec. 1.263A-4(a)(4)) nor a trade or business of a
specified agricultural or horticultural cooperative (as defined in
section 199A(g)(4)).
(ii) Analysis. Y is not subject to X's election for Y's farming
business because the farming trade or business ceased to exist after
the acquisition.
(h) Safe harbor for REITs--(1) In general. If a REIT holds real
property, as defined in Sec. 1.856-10, interests in one or more
partnerships directly or indirectly holding real property (through
interests in other partnerships or shares in other REITs), as defined
in Sec. 1.856-10, or shares in one or more other REITs directly or
indirectly holding real property (through interests in partnerships or
shares in other REITs), as defined in Sec. 1.856-10, the REIT is
eligible to make the election described in paragraph (b)(1) of this
section to be an electing real property trade or business for purposes
of sections 163(j)(7)(B) and 168(g)(1)(F) for all or part of its
assets. The portion of the REIT's assets eligible for this election is
determined under paragraph (h)(2) or (3) of this section.
(2) REITs that do not significantly invest in real property
financing assets. If a REIT makes the election under paragraph (h)(1)
of this section and the value of the REIT's real property financing
assets, as defined in paragraphs (h)(5) and (6) of this section, at the
close of the taxable year is 10 percent or less of the value of the
REIT's total assets at the close of the taxable year, as determined
under section 856(c)(4)(A), then all of the REIT's assets are treated
as assets of an excepted trade or business.
(3) REITs that significantly invest in real property financing
assets. If a REIT makes the election under paragraph (h)(1) of this
section and the value of the REIT's real property financing assets, as
defined in paragraphs (h)(5) and (6) of this section, at the close of
the taxable year is more than 10 percent of the value of the REIT's
total assets at the close of the taxable year, as determined under
section 856(c)(4)(A), then for the allocation of interest expense,
interest income, and other items of expense and gross income to
excepted and non-excepted trades or businesses, the REIT must apply the
rules set forth in Sec. 1.163(j)-10 as modified by paragraph (h)(4) of
this section.
(4) REIT real property assets, interests in partnerships, and
shares in other REITs--(i) Real property assets. Assets held by a REIT
described in paragraph (h)(3) of this section that meet the definition
of real property under Sec. 1.856-10 are treated as assets of an
excepted trade or business.
(ii) Partnership interests. If a REIT described in paragraph (h)(3)
of this section holds an interest in a partnership, in applying the
partnership look-through rule described in Sec. 1.163(j)-
10(c)(5)(ii)(A)(2), the REIT treats assets of the partnership that meet
the definition of real property under Sec. 1.856-10 as assets of an
excepted trade or business. This application of the definition of real
property under Sec. 1.856-10 does not affect the characterization of
the partnership's assets at the partnership level or for any non-REIT
partner. However, no portion of the adjusted basis of the REIT's
interest in the partnership is allocated to a non-excepted trade or
business if the partnership makes an election under paragraph (h)(7) of
this section and if all of the partnership's assets are treated as
assets of an excepted trade or business under paragraph (h)(2) of this
section.
(iii) Shares in other REITs--(A) In general. If a REIT (shareholder
REIT) described in paragraph (h)(3) of this section holds an interest
in another REIT, then for purposes of applying the allocation rules in
Sec. 1.163(j)-10, the partnership look-through rule described in Sec.
1.163(j)-10(c)(5)(ii)(A)(2), as modified by paragraph (h)(4)(ii) of
this section, applies to the assets of the other REIT (as if the other
REIT were a partnership) in determining the portion of shareholder
REIT's adjusted basis in the shares of the other REIT that is allocable
to an excepted or non-excepted trade or business of shareholder REIT.
However, no portion of the adjusted basis of shareholder REIT's shares
in the other REIT is allocated to a non-excepted trade or business if
all of the other REIT's assets are treated as assets of an excepted
trade or business under paragraph (h)(2) of this section.
(B) Information necessary. If shareholder REIT does not receive,
either directly from the other REIT or indirectly through the analysis
of an applicable financial statement (within the meaning of section
451(b)(3)) of the other REIT, the information necessary to determine
whether and to what extent the assets of the other REIT are investments
in real property financing assets, then shareholder REIT's shares in
the other REIT are treated as assets of a non-excepted trade or
business under Sec. 1.163(j)-10(c).
(iv) Tiered entities. In applying Sec. 1.163(j)-10(c)(5)(ii)(E),
the rules in paragraphs (h)(4)(ii) and (h)(4)(iii)(A) and (B) of this
section apply to any partnerships and other REITs within the tier.
(5) Value of shares in other REITs--(i) In general. If a REIT
(shareholder REIT) holds shares in another REIT, then solely for
purposes of applying the value tests under paragraphs (h)(2) and (3) of
this section, the value of shareholder REIT's real property financing
assets includes the portion of the value of shareholder REIT's shares
in the other REIT that is attributable to the other REIT's investments
in real property financing assets. However, no portion of the value of
shareholder REIT's shares in the other REIT is included in the value of
shareholder REIT's real property financing assets if all of the other
REIT's assets are treated as assets of an excepted trade or business
under paragraph (h)(2) of this section.
(ii) Information necessary. If shareholder REIT does not receive,
either directly from the other REIT or indirectly through the analysis
of an applicable financial statement (within the meaning of section
451(b)(3)) of the other REIT, the information necessary to determine
whether and to what extent the assets of the other REIT are investments
in real property financing assets, then shareholder REIT's shares in
the other REIT are treated as real property financing assets for
purposes of paragraphs (h)(2) and (3) of this section.
(iii) Tiered REITs. The rules in paragraphs (h)(5)(i) and (ii) of
this section apply successively to the extent that the other REIT, and
any other REIT in the tier, holds shares in another REIT.
[[Page 56816]]
(6) Real property financing assets. For purposes of this paragraph
(h), real property financing assets include interests, including
participation interests, in the following: Mortgages, deeds of trust,
and installment land contracts; mortgage pass-through certificates
guaranteed by Government National Mortgage Association (GNMA), Federal
National Mortgage Association (FNMA), Federal Home Loan Mortgage
Corporation (FHLMC), or Canada Mortgage and Housing Corporation (CMHC);
REMIC regular interests; other interests in investment trusts
classified as trusts under Sec. 301.7701-4(c) of this chapter that
represent undivided beneficial ownership in a pool of obligations
principally secured by interests in real property and related assets
that would be permitted investments if the investment trust were a
REMIC; obligations secured by manufactured housing treated as single
family residences under section 25(e)(10), without regard to the
treatment of the obligations or the properties under state law; and
debt instruments issued by publicly offered REITs.
(7) Application of safe harbor for partnerships controlled by
REITs. A partnership is eligible to make the election under paragraph
(h)(1) of this section if one or more REITs own directly or indirectly
at least 50 percent of the partnership's capital and profits, the
partnership meets the requirements of section 856(c)(2), (3), and (4)
as if the partnership were a REIT, and the partnership satisfies the
requirements described in paragraph (h)(1) of this section as if the
partnership were a REIT. The portion of the partnership's assets
eligible for this election is determined under paragraph (h)(2) or (3)
of this section, treating the partnership as if it were a REIT.
(8) REITs or partnerships controlled by REITs that do not apply the
safe harbor. A REIT or a partnership that is eligible but chooses not
to apply the safe harbor provisions of paragraph (h)(1) or (7) of this
section, respectively, may still elect, under paragraph (b)(1) of this
section, for one or more of its trades or businesses to be an electing
real property trade or business, provided that such trade or business
is otherwise eligible to elect under paragraph (b)(1) of this section.
A REIT or partnership that makes the election under paragraph (b)(1) of
this section without utilizing the safe harbor provisions of paragraph
(h) of this section may not rely on any portion of paragraphs (h)(1)
through (7) of this section.
(i) [Reserved]
(j) Special anti-abuse rule for certain real property trades or
businesses--(1) In general. Except as provided in paragraph (j)(2) of
this section, a trade or business (lessor) does not constitute a trade
or business eligible for an election described in paragraph (b)(1) of
this section to be an electing real property trade or business if at
least 80 percent, determined by fair market rental value, of the real
property used in the business is leased to a trade or business (lessee)
under common control with the lessor, regardless of whether the
arrangement is pursuant to a written lease or pursuant to a service
contract or another agreement that is not denominated as a lease. For
purposes of this paragraph (j), fair market rental value is the amount
of rent that a prospective lessee that is unrelated to the lessor would
be willing to pay for a rental interest in real property, taking into
account the geographic location, size, and type of the real property.
For purposes of this paragraph (j), two trades or businesses are under
common control if 50 percent of the direct and indirect ownership of
both businesses are held by related parties within the meaning of
sections 267(b) and 707(b).
(2) Exceptions--(i) De minimis exception. The limitation in
paragraph (j)(1) of this section does not apply, and the lessor is
eligible to make an election under paragraph (b)(1) of this section, if
the lessor leases, regardless of whether the arrangement is pursuant to
a written lease or pursuant to a service contract or another agreement
that is not denominated as a lease, at least 90 percent of the lessor's
real property, determined by fair market rental value, to one or more
of the following:
(A) A party not under common control with the lessor or lessee;
(B) A party under common control with the lessor or lessee that has
made an election described in paragraph (b)(1) of this section for a
trade or business to be an electing real property trade or business or
electing farming business, but only to the extent that the real
property is used as part of its electing real property trade or
business or electing farming business; or
(C) A party under common control with the lessor or lessee that is
an excepted regulated utility trade or business, but only to the extent
that the real property is used as part of its excepted regulated
utility trade or business.
(ii) Look-through exception. If the de minimis exception in
paragraph (j)(2)(i) of this section does not apply because less than 90
percent of the lessor's real property is leased to parties described in
paragraphs (j)(2)(i)(A), (B), and (C), the lessor is eligible to make
the election under paragraph (b)(1) of this section to the extent that
the lessor leases the real property to parties described in paragraph
(j)(2)(A), (B), or (C), and to the extent that the lessee subleases (or
lessees ultimately sublease) the real property to:
(A) A party not under common control with the lessor or lessee;
(B) A party under common control with the lessor or lessee that has
made an election described in paragraph (b)(1) of this section for a
trade or business to be an electing real property trade or business or
electing farming business to the extent that the real property is used
as part of its electing real property trade or business or electing
farming business; or
(C) A party under common control with the lessor or lessee that is
an excepted regulated utility trade or business to the extent that the
real property is used as part of its excepted regulated utility trade
or business.
(iii) Inapplicability of exceptions to consolidated groups. The
exceptions in paragraphs (j)(2)(i) and (ii) of this section do not
apply when the lessor and lessee are members of the same consolidated
group.
(iv) Exception for certain REITs. The special anti-abuse rule in
paragraph (j)(1) of this section does not apply to REITs or to
partnerships making an election under paragraph (h)(7) of this section
that lease qualified lodging facilities, as defined in section
856(d)(9)(D), and qualified health care properties, as defined in
section 856(e)(6)(D).
(3) Allocations. See Sec. 1.163(j)-10(c)(3)(iii)(D) for rules
related to the allocation of the basis of assets used in lessor trades
or businesses described in paragraphs (j)(1) and (j)(2)(i) of this
section.
(4) Examples. The examples in this paragraph (j)(4) illustrate the
application of paragraphs (j)(1), (2), and (3) of this section. Unless
otherwise indicated, the parties are all domestic entities and are not
members of a single consolidated group within the meaning of Sec.
1.1502-1(h).
(i) Example 1: Related party lease of hotel--(A) Facts. X and Y are
under common control, as defined in paragraph (j)(1) of this section. X
owns one piece of real property, a hotel, that X leases to Y. Y
operates the hotel and provides hotel rooms and associated amenities to
third party guests of the hotel. The form of the arrangement with third
party hotel guests is a license to use rooms in the hotel and
associated amenities. Y is a real property trade or
[[Page 56817]]
business that has made an election under paragraph (b)(1) of this
section.
(B) Analysis. Because X leases at least 80 percent of X's real
property to a party under common control, X is subject to the anti-
abuse rule in paragraph (j)(1) of this section. However, under the de
minimis exception under paragraph (j)(2)(i) of this section, 100
percent of the fair market rental value of the building is leased to a
party under common control that has made an election to be an electing
real property trade or business. Accordingly, X is eligible to make the
election described in paragraph (b)(1) of this section for its entire
trade or business.
(ii) Example 2--(A) Facts. The facts are the same as in Example 1
in paragraph (j)(4)(i)(A) of this section, except that Y has not made
an election under paragraph (b)(1) of this section, and is not
otherwise using the real property in an excepted trade or business.
(B) Analysis. Because X leases at least 80 percent of X's real
property, determined by fair market rental value, to Y, a party under
common control, X is subject to the anti-abuse rule in paragraph (j)(1)
of this section. X is not eligible for the de minimis exception under
paragraph (j)(2)(i) of this section because X does not lease at least
90 percent of its real property to a party under common control, as
defined in paragraph (j)(1) of this section, such as Y, and Y is not
using the property in an otherwise excepted trade or business. However,
X is eligible for the look-through exception under paragraph (j)(2)(ii)
of this section because X leases 100 percent of its real property to Y,
a party that is under common control, and Y subleases 100 percent of
the real property to parties that are not under common control with X
or Y. The fact that the license provided to hotel guests is not
denominated as a lease does not prevent these licenses from being
treated as a lease for purposes of paragraph (j) of this section.
Accordingly, under the look-through exception under paragraph
(j)(2)(ii) of this section, X is eligible to make the election
described in paragraph (b)(1) of this section with regard to its entire
trade or business.
(iii) Example 3: Sublease to related party and unrelated third
party--(A) Facts. X owns one piece of real property that X leases to Y,
a party under common control, as defined in paragraph (j)(1) of this
section. Y does not operate an excepted trade or business. Y subleases
80 percent of the real property, determined by the fair market rental
value, to a party under common control with Y that does not operate an
excepted trade or business and 20 percent of the real property,
determined by the fair market rental value, to an unrelated third
party.
(B) Analysis. Because X leases at least 80 percent of X's real
property, determined by fair market rental value, to a party under
common control, X is subject to the anti-abuse rule in paragraph (j)(1)
of this section. X is not eligible for the de minimis exception in
paragraph (j)(2)(i) of this section because X is not leasing at least
90 percent of the real property, determined by fair market rental
value, to a party under common control that operates an excepted trade
or business and/or unrelated parties. Under the look-through exception
under paragraph (j)(2)(ii) of this section, X is eligible to make the
election described in paragraph (b)(1) of this section with respect to
the 20 percent of the fair market rental value of the real property
subleased to an unrelated party because X is treated as directly
leasing this portion to an unrelated party. X is not eligible to make
the election described in paragraph (b)(1) of this section with respect
to the 80 percent of the building subleased to a party under common
control because X is still treated as directly leasing this portion to
a related party. Under Sec. 1.163(j)-10(c)(3)(iii)(D), X must allocate
80 percent of the basis in the real property as a non-excepted trade or
business and 20 percent of the basis in the real property as an
excepted trade or business.
(iv) Example 4: Multiple subleases--(A) Facts. X owns a building
that X leases to Y, a party under common control as defined in
paragraph (j)(1) of this section. Y does not operate an excepted trade
or business. Y subleases 80 percent of the building, determined by fair
market rental value, to Z, a party under common control with both X and
Y. Y subleases the remaining 20 percent of the building, determined by
fair market rental value, to unrelated parties. Z subleases 50 percent
of its leasehold interest, determined by fair market rental value, to
parties unrelated to X, Y and Z, and uses the remaining leasehold
interest in its retail business. Z does not operate an excepted trade
or business.
(B) Analysis. Because X leases at least 80 percent of X's real
property, determined by fair market rental value, to a party under
common control, X is subject to the anti-abuse rule in paragraph (j)(1)
of this section. X is not eligible for the de minimis exception in
paragraph (j)(2)(i) because X is not leasing at least 90 percent of the
building, determined by fair market rental value, to a party under
common control that operates an excepted trade or business and/or
unrelated parties. Under the look-through exception under paragraph
(j)(2)(ii) of this section, X is eligible to make the election
described in paragraph (b)(1) of this section with respect to the 60
percent of the building that is subleased to unrelated parties,
determined by adding 40 percent (50 percent of the 80 percent leasehold
interest) from Z's sublease to an unrelated party and 20 percent from
Y's sublease to unrelated parties (40 + 20). X is not eligible to make
the election described in paragraph (b)(1) of this section with respect
to the 40 percent of the building subleased to Z, because Z is a
related party that does not operate an excepted trade or business.
(v) Example 5: Lessee's Trade or Business--(A) Facts. X owns a
building that X leases to W, a party under common control as defined in
paragraph (j)(1) of this section. W operates the building as a widget
manufacturing plant and does not sublease any portion of the building.
(B) Analysis. X is not eligible to make the election described in
paragraph (b)(1) of this section because X leases the entire building
to a party under common control. X is not eligible for the de minimis
exception in paragraph (j)(2)(i) of this section because X is not
leasing at least 90 percent of the real property to a party under
common control that operates an excepted trade or business and/or
unrelated parties. W's trade or business cannot be an electing real
property trade or business. X is not eligible for the look-through
exception under paragraph (j)(2)(ii) of this section because W is not
subleasing any part of the building.
(k) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
[[Page 56818]]
Sec. 1.163(j)-10 Allocation of interest expense, interest income,
and other items of expense and gross income to an excepted trade or
business.
(a) Overview--(1) In general--(i) Purposes. Except as provided in
Sec. 1.163(j)-6(m) or Sec. 1.163(j)-9(h), this section provides the
exclusive rules for allocating tax items that are properly allocable to
a trade or business between excepted trades or businesses and non-
excepted trades or businesses for purposes of section 163(j). The
amount of a taxpayer's interest expense that is properly allocable to
excepted trades or businesses is not subject to the section 163(j)
limitation. The amount of a taxpayer's other items of income, gain,
deduction, or loss, including interest income, that is properly
allocable to excepted trades or businesses is excluded from the
calculation of the taxpayer's section 163(j) limitation. See section
163(j)(6) and (j)(8)(A)(i); see also Sec. 1.163(j)-1(b)(1)(i)(H),
(b)(1)(ii)(F), and (b)(3). The general method of allocation set forth
in paragraph (c) of this section is based on the approach that money is
fungible and that interest expense is attributable to all activities
and property, regardless of any specific purpose for incurring an
obligation on which interest is paid. In no event may the amount of
interest expense allocated under this section exceed the amount of
interest paid or accrued, or treated as paid or accrued, by the
taxpayer within the taxable year.
(ii) Application of section. The amount of a taxpayer's tax items
properly allocable to a trade or business, other than interest expense
and interest income, that is properly allocable to excepted trades or
businesses for purposes of section 163(j) is determined as set forth in
paragraph (b) of this section. The amount of a taxpayer's interest
expense and interest income that is properly allocable to excepted
trades or businesses for purposes of section 163(j) generally is
determined as set forth in paragraph (c) of this section, except as
otherwise provided in paragraph (d) of this section. For purposes of
this section, a taxpayer's activities are not treated as a separate
trade or business to the extent those activities involve the provision
of real property, goods, or services to a trade or business of the
taxpayer (or, if the taxpayer is a member of a consolidated group, the
consolidated group). For example, if a taxpayer engaged in a
manufacturing trade or business has in-house legal personnel that
provide legal services solely with respect to the taxpayer's
manufacturing business, the taxpayer is not treated as also engaged in
the trade or business of providing legal services. Similarly, if the
taxpayer described in the previous sentence constructs or acquires real
property solely for use by the taxpayer's manufacturing business, the
taxpayer is not treated as also engaged in a real property trade or
business.
(2) Coordination with other rules--(i) In general. The rules of
this section apply after a taxpayer has determined whether any interest
expense or interest income paid, received, or accrued is properly
allocable to a trade or business. Similarly, the rules of this section
apply to other tax items after a taxpayer has determined whether those
items are properly allocable to a trade or business. For instance, a
taxpayer must apply Sec. 1.163-8T, if applicable, to determine which
items of interest expense are investment interest under section 163(d)
before applying the rules in paragraph (c) of this section to allocate
interest expense between excepted and non-excepted trades or
businesses. After determining whether its tax items are properly
allocable to a trade or business, a taxpayer that is engaged in both
excepted and non-excepted trades or businesses must apply the rules of
this section to determine the amount of interest expense that is
business interest expense subject to the section 163(j) limitation and
to determine which items are included or excluded in computing its
section 163(j) limitation.
(ii) Treatment of investment interest, investment income,
investment expenses, and certain other tax items of a partnership with
a C corporation or tax-exempt corporation as a partner. For rules
governing the treatment of investment interest, investment income,
investment expenses, and certain other separately stated tax items of a
partnership with a C corporation or tax-exempt corporation as a
partner, see Sec. Sec. 1.163(j)-4(b)(3) and 1.163(j)-6(k).
(3) Application of allocation rules to foreign corporations and
foreign partnerships. The rules of this section apply to foreign
corporations and foreign partnerships.
(4) Application of allocation rules to members of a consolidated
group--(i) In general. As provided in Sec. 1.163(j)-4(d), the
computations required by section 163(j) and the regulations in this
part under section 163(j) of the Code generally are made for a
consolidated group on a consolidated basis. In this regard, for
purposes of applying the allocation rules of this section, all members
of a consolidated group are treated as one corporation. Therefore, the
rules of this section apply to the activities conducted by the group as
if those activities were conducted by a single corporation. For
example, the group (rather than a particular member) is treated as
engaged in excepted or non-excepted trades or businesses. In the case
of intercompany obligations, within the meaning of Sec. 1.1502-
13(g)(2)(ii), for purposes of allocating asset basis between excepted
and non-excepted trades or businesses, the obligation of the member
borrower is not considered an asset of the creditor member. Similarly,
intercompany transactions, within the meaning of Sec. 1.1502-
13(b)(1)(i), are disregarded for purposes of this section, as are the
resulting offsetting items, and property is allocated to a trade or
business based on the activities of the group as if the members of the
group were divisions of a single corporation. Further, stock of a group
member that is owned by another member of the same group is not treated
as an asset for purposes of this section, and the transfer of any
amount of member stock to a non-member is treated by the group as a
transfer of the member's assets proportionate to the amount of member
stock transferred. Additionally, stock of a corporation that is not a
group member is treated as owned by the group.
(ii) Application of excepted business percentage to members of a
consolidated group. After a consolidated group has determined the
percentage of the group's interest expense allocable to excepted trades
or businesses for the taxable year (and thus not subject to the section
163(j) limitation), this exempt percentage is applied to the interest
paid or accrued by each member during the taxable year to any lender
that is not a group member. Therefore, except to the extent paragraph
(d) of this section (providing rules for certain qualified nonrecourse
indebtedness) applies, an identical percentage of the interest paid or
accrued by each member of the group to any lender that is not a group
member is treated as allocable to excepted trades or businesses,
regardless of whether any particular member actually engaged in an
excepted trade or business.
(iii) Basis in assets transferred in an intercompany transaction.
For purposes of allocating interest expense and interest income under
paragraph (c) of this section, the basis of property does not include
any gain or loss realized with respect to the property by another
member in an intercompany transaction, as defined in Sec. 1.1502-
13(b), whether or not the gain or loss is deferred.
(5) Tax-exempt organizations. For tax-exempt organizations, section
512 and the regulations in this part under section 512 of the Code
determine the rules for allocating all income and expenses among
multiple trades or businesses.
[[Page 56819]]
(6) Application of allocation rules to disallowed disqualified
interest. A taxpayer may apply the allocation rules of this section to
disallowed disqualified interest by either:
(i) Applying the allocation rules of this section to all of the
taxpayer's disallowed disqualified interest in the taxable year(s) in
which the disallowed disqualified interest was paid or accrued (the
historical approach); or
(ii) Treating all of the taxpayer's disallowed disqualified
interest as if it were paid or accrued in the taxpayer's first taxable
year beginning after December 31, 2017 (the effective date approach).
(7) Examples. The following examples illustrate the principles of
this paragraph (a).
(i) Example 1: Items properly allocable to a trade or business--(A)
Facts. Individual T operates Business X, a non-excepted trade or
business, as a sole proprietor. In Year 1, T pays or accrues $40x of
interest expense and receives $100x of gross income with respect to
Business X that is not eligible for a section 199A deduction. T borrows
money to buy a car for personal use, and T pays or accrues $20x of
interest expense with respect to the car loan. T also invests in
corporate bonds, and, in Year 1, T receives $50x of interest income on
those bonds.
(B) Analysis. Under paragraphs (a)(1) and (2) of this section, T
must determine which items of income and expense, including items of
interest income and interest expense, are properly allocable to a trade
or business. T's $100x of gross income and T's $40x of interest expense
with respect to Business X are properly allocable to a trade or
business. However, the interest expense on T's car loan is personal
interest within the meaning of section 163(h)(2) rather than interest
properly allocable to a trade or business. Similarly, T's interest
income from corporate bonds is not properly allocable to a trade or
business because it is interest from investment activity. See section
163(d)(4)(B).
(ii) Example 2: Intercompany transaction--(A) Facts. S is a member
of a consolidated group of which P is the common parent. P conducts an
electing real property trade or business (Business X), and S conducts a
non-excepted trade or business (Business Y). P leases Building V (which
P owns) to S for use in Business Y.
(B) Analysis. Under paragraph (a)(4)(i) of this section, a
consolidated group is treated as a single corporation for purposes of
applying the allocation rules of this section, and the consolidated
group (rather than a particular member of the group) is treated as
engaged in excepted and non-excepted trades or businesses. Thus,
intercompany transactions are disregarded for purposes of this section.
As a result, the lease of Building V by P to S is disregarded.
Moreover, because Building V is used in Business Y, basis in this asset
is allocated to Business Y rather than Business X for purposes of these
allocation rules, regardless of which member (P or S) owns the
building.
(iii) Example 3: Intercompany sale of natural gas--(A) Facts. S is
a member of a consolidated group of which P is the common parent. S
drills for natural gas and is not an excepted regulated utility trade
or business. S sells most of its natural gas production to P, which
produces electricity at its natural gas-fired power plants, and S sells
the rest of its natural gas production to third parties at market
rates. P is an excepted regulated utility trade or business to the
extent that it is engaged in a trade or business described in Sec.
1.163(j)-1(b)(15)(i).
(B) Analysis. Intercompany transactions are disregarded for
purposes of this section. As a result, the intercompany sales of
natural gas by S to P are disregarded. Moreover, the assets of S and P
are allocated between the excepted and non-excepted trades or
businesses of the P group based on the assets used in each trade or
business. Assets of S may be allocated to the P group's excepted trade
or business to the extent those assets are used in the trade or
business of the furnishing or sale of electrical energy. Likewise,
assets of P may be allocated to the P group's non-excepted trade or
business to the extent those assets are used in the trade or business
of natural gas production.
(iv) Example 4: Disallowed disqualified interest--(A) Facts. S is a
member of a consolidated group of which P is the common parent. P and S
are the only members of an affiliated group under old section
163(j)(6)(C). S operates a farm equipment leasing business (Business X)
that is not an excepted trade or business. P is engaged in an electing
farming business (Business Y). Entering its first taxable year
beginning after December 31, 2017, the P group has disallowed
disqualified interest of $120x, all of which the P group paid or
accrued in earlier taxable years in which it only operated Business X.
The P group also incurs $100x of interest expense during its 2018
taxable year, of which $25x (25 percent of $100x) is business interest
expense properly allocable to Business X and $75x (75 percent of $100x)
is properly allocable to Business Y under paragraph (c) of this
section.
(B) Analysis. Under paragraph (a)(6) of this section, the P group
may allocate disallowed disqualified interest to Business X and
Business Y by either applying the allocation rules of this section in
the taxable years in which the disallowed disqualified interest was
paid or accrued (the historical approach) or by treating such interest
as though it were paid or accrued in the P group's first taxable year
beginning after December 31, 2017 (the effective date approach).
Accordingly, if the P group chooses to rely on the historical approach,
it allocates all $120x of disallowed disqualified interest to Business
X (a non-excepted trade or business), and all $120x of disallowed
disqualified interest is subject to the section 163(j) limitation. If,
instead, the P group chooses to rely on the effective date approach, it
allocates its $120x of disallowed disqualified interest in the same
proportion as its $100x of business interest expense that was paid or
accrued in its 2018 taxable year. Of the $120x of disallowed
disqualified interest, $30x (25 percent of $120x) is allocated to
Business X and $90x (75 percent of $120x) is allocated to Business Y.
The $90x of disallowed disqualified interest that is properly allocable
to Business Y (an excepted trade or business) is not subject to the
section 163(j) limitation.
(b) Allocation of tax items other than interest expense and
interest income--(1) In general. Except as otherwise provided in Sec.
1.163(j)-6(m) or Sec. 1.163(j)-9(h), for purposes of calculating ATI,
tax items other than interest expense and interest income are allocated
to a particular trade or business in the manner described in this
paragraph (b). It is not necessary to allocate items under this
paragraph (b) for purposes of calculating ATI if all of the taxpayer's
items subject to allocation under this paragraph (b) are allocable to
excepted trades or businesses, or if all of those items are allocable
to non-excepted trades or businesses.
(2) Gross income other than dividends and interest income. A
taxpayer's gross income other than dividends and interest income is
allocated to the trade or business that generated the gross income.
(3) Dividends--(i) Look-through rule. If a taxpayer receives a
dividend, within the meaning of section 316, that is not investment
income, within the meaning of section 163(d), and if the taxpayer
satisfies the minimum ownership threshold in paragraph (c)(7) of this
section, then, solely for purposes of allocating amounts received as a
dividend during the taxable year to excepted or non-excepted trades or
[[Page 56820]]
businesses under this paragraph (b), the dividend income is treated as
allocable to excepted or non-excepted trades or businesses based upon
the relative amounts of the payor corporation's adjusted basis in the
assets used in its trades or businesses, determined pursuant to
paragraph (c) of this section. If at least 90 percent of the payor
corporation's adjusted basis in its assets during the taxable year,
determined pursuant to paragraph (c) of this section, is allocable to
either excepted trades or businesses or to non-excepted trades or
businesses, all of the taxpayer's dividend income from the payor
corporation for the taxable year is treated as allocable to either
excepted or non-excepted trades or businesses, respectively.
(ii) Inapplicability of the look-through rule. If a taxpayer
receives a dividend that is not investment income, within the meaning
of section 163(d), and if the taxpayer does not satisfy the minimum
ownership threshold in paragraph (c)(7) of this section, then the
taxpayer must treat the dividend as allocable to a non-excepted trade
or business.
(4) Gain or loss from the disposition of non-consolidated C
corporation stock, partnership interests, or S corporation stock--(i)
Non-consolidated C corporations. (A) If a taxpayer recognizes gain or
loss upon the disposition of stock in a non-consolidated C corporation
that is not property held for investment, within the meaning of section
163(d)(5), and if the taxpayer looks through to the assets of the C
corporation under paragraph (c)(5)(ii) of this section for the taxable
year, then the taxpayer must allocate gain or loss from the disposition
of stock to excepted or non-excepted trades or businesses based upon
the relative amounts of the C corporation's adjusted basis in the
assets used in its trades or businesses, determined pursuant to
paragraph (c) of this section. If at least 90 percent of the C
corporation's adjusted basis in its assets during the taxable year,
determined pursuant to paragraph (c) of this section, is allocable to
either excepted trades or businesses or to non-excepted trades or
businesses, all of the taxpayer's gain or loss from the disposition is
treated as allocable to either excepted or non-excepted trades or
businesses, respectively.
(B) If a taxpayer recognizes gain or loss upon the disposition of
stock in a non-consolidated C corporation that is not property held for
investment, within the meaning of section 163(d)(5), and if the
taxpayer does not look through to the assets of the C corporation under
paragraph (c)(5)(ii) of this section for the taxable year, then the
taxpayer must treat the gain or loss from the disposition of stock as
allocable to a non-excepted trade or business.
(C) For rules governing the transfer of stock of a member of a
consolidated group, see paragraph (a)(4)(i) of this section.
(ii) Partnerships and S corporations. (A) If a taxpayer recognizes
gain or loss upon the disposition of interests in a partnership or
stock in an S corporation that owns--
(1) Non-excepted assets and excepted assets;
(2) Investment assets; or
(3) Both;
(B) The taxpayer determines a proportionate share of the amount
properly allocable to a non-excepted trade or business in accordance
with the allocation rules set forth in paragraph (c)(5)(ii)(A) or
(c)(5)(ii)(B)(3) of this section, as appropriate, and includes such
proportionate share of gain or loss in the taxpayer's ATI. However, if
at least 90 percent of the partnership's or S corporation's adjusted
basis in its assets during the taxable year, determined pursuant to
paragraph (c) of this section, is allocable to either excepted trades
or businesses or to non-excepted trades or businesses, all of the
taxpayer's gain or loss from the disposition is treated as allocable to
either excepted or non-excepted trades or businesses, respectively.
This rule also applies to tiered passthrough entities by looking
through each passthrough entity tier (for example, an S corporation
that is the partner of the highest-tier partnership would look through
each lower-tier partnership), subject to paragraph (c)(5)(ii)(D) of
this section. With respect to a partner that is a C corporation or tax-
exempt corporation, a partnership's investment assets are taken into
account and treated as non-excepted trade or business assets. For
purposes of this paragraph, a passthrough entity means a partnership, S
corporation, or any other entity (domestic or foreign) that is not a
corporation if all items of income and deduction of the entity are
included in the income of its owners or beneficiaries.
(5) Expenses, losses, and other deductions--(i) Expenses, losses,
and other deductions that are definitely related to a trade or
business. Expenses (other than interest expense), losses, and other
deductions (collectively, deductions for purposes of this paragraph
(b)(5)) that are definitely related to a trade or business are
allocable to the trade or business to which they relate. A deduction is
considered definitely related to a trade or business if the item giving
rise to the deduction is incurred as a result of, or incident to, an
activity of the trade or business or in connection with property used
in the trade or business (see Sec. 1.861-8(b)(2)). If a deduction is
definitely related to one or more excepted trades or businesses and one
or more non-excepted trades or businesses, the deduction is apportioned
between the excepted and non-excepted trades or businesses based upon
the relative amounts of the taxpayer's adjusted basis in the assets
used in those trades or businesses, as determined under paragraph (c)
of this section.
(ii) Other deductions. Deductions that are not described in
paragraph (b)(5)(i) of this section are ratably apportioned based on
the gross income of each trade or business.
(6) Treatment of investment items and certain other items of a
partnership with a C corporation partner. Any investment income,
investment expense, or other item that a partnership receives, pays, or
accrues and that is treated as properly allocable to a trade or
business of a C corporation partner under Sec. 1.163(j)-4(b)(3)(i) is
treated as properly allocable to a non-excepted trade or business of
the C corporation partner, except that any item with respect to
property or activities for which an election has been made by the
partnership under Sec. 1.163(j)-9(b) is treated as properly allocable
to an excepted trade or business. See, for example, an election for
activities described in Sec. 1.163(j)-9(b)(2)(ii) or an election under
Sec. 1.163(j)-9(h).
(7) Examples: Allocation of income and expense. The following
examples illustrate the principles of this paragraph (b):
(i) Example 1: Allocation of income and expense between excepted
and non-excepted trades or businesses--(A) Facts. T conducts an
electing real property trade or business (Business Y), which is an
excepted trade or business. T also operates a lumber yard (Business Z),
which is a non-excepted trade or business. In Year 1, T receives $100x
of gross rental income from real property leasing activities. T also
pays or accrues $60x of expenses in connection with its real property
leasing activities and $20x of legal services performed on behalf of
both Business Y and Business Z. T receives $60x of gross income from
lumber yard customers and pays or accrues $50x of expenses related to
the lumber yard business. For purposes of expense allocations under
paragraphs (b) and (c) of this section, T has $240x of adjusted basis
in its Business Y assets and $80x of adjusted basis in its Business Z
assets.
[[Page 56821]]
(B) Analysis. Under paragraph (b)(2) of this section, for Year 1,
$100x of rental income is allocated to Business Y, and $60x of income
from lumber yard customers is allocated to Business Z. Under paragraph
(b)(5)(i) of this section, $60x of expenses paid or accrued in
connection with real property leasing activities are allocated to
Business Y, and $50x of expenses related to the lumber yard are
allocated to Business Z. The $20x of remaining expenses for legal
services performed on behalf of both Business Y and Business Z are
allocated according to the relative amounts of T's basis in the assets
used in each business. The total amount of T's basis in the assets used
in Businesses Y and Z is $320x, of which 75 percent ($240x/$320x) is
used in Business Y and 25 percent ($80x/$320x) is used in Business Z.
Accordingly, $15x of the expenses for legal services are allocated to
Business Y and $5x are allocated to Business Z.
(ii) Example 2: Allocation of partnership items from investment
activity--(A) Facts. U, a domestic C corporation, directly conducts an
electing real property trade or business. U also has an interest in
PRS, a partnership that holds real property for investment. PRS's
investment in real property is not a trade or business under section
162 or a real property trade or business under section 469. During the
taxable year, PRS sells some of its real property to third parties and
allocates $80x of income to U from these sales. In addition, PRS incurs
deductible expenses related to its investment in real property and
allocates $9x of these deductible expenses to U.
(B) Analysis. Under paragraph (b)(6) of this section, any
investment income or investment expense that a partnership receives,
pays, or accrues and that is treated as properly allocable to a trade
or business of a C corporation partner is treated as properly allocable
to a non-excepted trade or business of the C corporation partner.
Because PRS generates its income and expense from investment activity
that is not a trade or business under section 162 or a real property
trade or business under section 469, U's allocation of $80x of income
and $9x of deductible expense from PRS is treated as properly allocable
to a non-excepted trade or business.
(c) Allocating interest expense and interest income that is
properly allocable to a trade or business--(1) General rule--(i) In
general. Except as otherwise provided in this section, Sec. 1.163(j)-
6(m), or Sec. 1.163(j)-9(h), the amount of a taxpayer's interest
expense and interest income that is properly allocable to a trade or
business is allocated to the taxpayer's excepted or non-excepted trades
or businesses for purposes of section 163(j) based upon the relative
amounts of the taxpayer's adjusted basis in the assets, as determined
under paragraph (c)(5) of this section, used in its excepted or non-
excepted trades or businesses. The taxpayer must determine the adjusted
basis in its assets as of the close of each determination date, as
defined in paragraph (c)(6) of this section, in the taxable year and
average those amounts to determine the relative amounts of asset basis
for its excepted and non-excepted trades or businesses for that year.
It is not necessary to allocate interest expense or interest income
under this paragraph (c) for purposes of determining a taxpayer's
business interest expense and business interest income if all of the
taxpayer's interest income and expense is allocable to excepted trades
or businesses (in which case the taxpayer is not subject to the section
163(j) limitation) or if all of the taxpayer's interest income and
expense is allocable to non-excepted trades or businesses.
(ii) De minimis exception. If at least 90 percent of the taxpayer's
basis in its assets for the taxable year is allocable to either
excepted or non-excepted trades or businesses pursuant to this
paragraph (c), then all of the taxpayer's interest expense and interest
income for that year that is properly allocable to a trade or business
is treated as allocable to either excepted or non-excepted trades or
businesses, respectively.
(2) Example. The following example illustrates the principles of
paragraph (c)(1) of this section:
(i) Facts. T is a calendar-year C corporation engaged in an
electing real property trade or business, the business of selling wine,
and the business of selling hand-carved wooden furniture. In Year 1, T
has $100x of interest expense that is deductible except for the
potential application of section 163(j). Based upon determinations made
on the determination dates in Year 1, T's average adjusted basis in the
assets used in the electing real property trade or business (an
excepted trade or business) in Year 1 is $800x, and T's total average
adjusted basis in the assets used in the other two businesses (which
are non-excepted trades or businesses) in Year 1 is $200x.
(ii) Analysis. $80x (($800x/($800x + $200x)) x $100x) of T's
interest expense for Year 1 is allocable to T's electing real property
trade or business and is not business interest expense subject to the
section 163(j) limitation. The remaining $20x of T's interest expense
is business interest expense for Year 1 that is subject to the section
163(j) limitation.
(3) Asset used in more than one trade or business--(i) General
rule. If an asset is used in more than one trade or business during a
determination period, as defined in paragraph (c)(6) of this section,
the taxpayer's adjusted basis in the asset is allocated to each trade
or business using the permissible methodology under this paragraph
(c)(3) that most reasonably reflects the use of the asset in each trade
or business during that determination period. An allocation methodology
most reasonably reflects the use of the asset in each trade or business
if it most properly reflects the proportionate benefit derived from the
use of the asset in each trade or business. A taxpayer is not required
to use the same allocation methodology for each type of asset used in a
trade a business. Instead, a taxpayer may use different allocation
methodologies for different types of assets used in a trade or
business. If none of the permissible methodologies set forth in
paragraph (c)(3)(ii) of this section reasonably reflects the use of the
asset in each trade or business, the taxpayer's basis in the asset is
not taken into account for purposes of this paragraph (c).
(ii) Permissible methodologies for allocating asset basis between
or among two or more trades or businesses. Subject to the special rules
in paragraphs (c)(3)(iii) and (c)(5) of this section, a taxpayer's
basis in an asset used in two or more trades or businesses during a
determination period may be allocated to those trades or businesses
based upon--
(A) The relative amounts of gross income that an asset generates,
has generated, or may reasonably be expected to generate, within the
meaning of Sec. 1.861-9T(g)(3), with respect to the trades or
businesses;
(B) If the asset is land or an inherently permanent structure, the
relative amounts of physical space used by the trades or businesses; or
(C) If the trades or businesses generate the same unit of output,
the relative amounts of output of those trades or businesses (for
example, if an asset is used in two trades or businesses, one of which
is an excepted regulated utility trade or business, and the other of
which is a non-excepted regulated utility trade or business, the
taxpayer may allocate basis in the asset based upon the relative
amounts of kilowatt-hours generated by each trade or business).
(iii) Special rules--(A) Consistent allocation methodologies--(1)
In general. Except as otherwise provided in paragraph (c)(3)(iii)(A)(2)
of this
[[Page 56822]]
section, a taxpayer must maintain the same allocation methodology for a
period of at least five taxable years.
(2) Consent to change allocation methodology. If a taxpayer has
used the same allocation methodology for at least five taxable years,
the taxpayers may change its method of allocation under paragraphs
(c)(3)(i) and (ii) of this section without the consent of the
Commissioner. If a taxpayer has used the same allocation methodology
for less than five taxable years, and if the taxpayer determines that a
different allocation methodology properly reflects the proportionate
benefit derived from the use of assets in its trades or businesses, the
taxpayer may change its method of allocation under paragraphs (c)(3)(i)
and (ii) of this section only with the consent of the Commissioner. To
obtain consent, a taxpayer must submit a request for a letter ruling
under the applicable administrative procedures, and consent will be
granted only in extraordinary circumstances.
(B) De minimis exception. If at least 90 percent of the taxpayer's
basis in an asset would be allocated to either excepted trades or
businesses or non-excepted trades or businesses during a determination
period pursuant to this paragraph (c)(3), the taxpayer's entire basis
in the asset for the determination period must be allocated to either
excepted or non-excepted trades or businesses, respectively. This rule
applies before the application of paragraph (c)(1)(ii) of this section.
(C) Allocations of excepted regulated utility trades or
businesses--(1) In general. Except as provided in the de minimis rule
in paragraph (c)(3)(iii)(C)(3) of this section, a taxpayer is engaged
in an excepted regulated utility trade or business only to the extent
that the taxpayer is engaged in an excepted regulated utility trade or
business described in Sec. 1.163(j)-1(b)(15)(i)(A), (B), or (C), and
any remaining utility trade or business is a non-excepted trade or
business. Thus, for example, electricity sold by a utility trade or
business at rates not established or approved by an entity described in
Sec. 1.163(j)-1(b)(15)(i)(A)(2) and not subject to an election under
Sec. 1.163(j)-1(b)(15)(iii) must be treated as electricity sold by a
non-excepted regulated utility trade or business. The taxpayer must
allocate under this paragraph (c) the basis of assets used in the
utility trade or business between its excepted and non-excepted trades
or businesses.
(2) Permissible method for allocating asset basis for utility
trades or businesses. In the case of a utility trade or business
described in paragraph (c)(3)(iii)(C)(1) of this section, and except as
provided in the de minimis rule in paragraph (c)(3)(iii)(C)(3) of this
section, the method described in paragraph (c)(3)(ii)(C) of this
section is the only permissible method under this paragraph (c)(3) for
allocating the taxpayer's basis in assets used in both the excepted and
non-excepted trades or businesses of selling or furnishing the items
described in Sec. 1.163(j)-1(b)(15)(i)(A)(1).
(3) De minimis rule for excepted utility trades or businesses. If a
taxpayer is engaged in a utility trade or business described in
paragraph (c)(3)(iii)(C)(1) of this section, and if at least 90 percent
of the items described in Sec. 1.163(j)-1(b)(15)(i)(A)(1) are
furnished or sold by trades or businesses described in Sec. 1.163(j)-
1(b)(15)(i)(A), (B) or (C), the taxpayer's entire trade or business is
an excepted regulated utility trade or business, and paragraph
(c)(3)(iii)(C)(2) of this section does not apply. This rule applies
before the application of paragraph (c)(3)(iii)(B) of this section.
(4) Example. The following example illustrates the principles of
this paragraph (c)(3)(iii)(C):
(i) Facts. X, a C corporation, is engaged in the trade or business
of generating electrical energy. During each determination period in
the taxable year, 80 percent of the megawatt-hours generated in the
electricity generation trade or business is sold at rates negotiated
with the purchaser, and with respect to which X filed a schedule of
rates with a public utility commission. The public utility commission
has the authority to take action on the filed schedule of rates, but if
no action is taken, the rules governing the public utility commission
explicitly state that the public utility commission is deemed to have
approved the rates. The public utility has taken no action with respect
to the negotiated rate. The remaining 20 percent of the megawatt-hours
is sold on the wholesale market at rates not established or subject to
approval by a regulator described in Sec. 1.163(j)-1(b)(15)(i)(A)(2).
X has not made an election under Sec. 1.163(j)-1(b)(15)(iii). None of
the assets used in X's utility generation trade or business are used in
any other trade or business.
(ii) Analysis. For purposes of section 163(j), under paragraph
(c)(3)(iii)(C)(1) of this section, 80 percent of X's electricity
generation business is an excepted regulated utility trade or business,
because the rate for the sale of the electricity was subject to
approval by a regulator described in Sec. 1.163(j)-1(b)(15)(i)(A)(2).
The remaining 20 percent of X's business is a non-excepted utility
trade or business. Under paragraph (c)(3)(iii)(C)(2) of this section, X
must allocate 80 percent of the basis of the assets used in its utility
business to excepted trades or business and the remaining 20 percent of
the basis in the assets to non-excepted trades or businesses.
(D) Special allocation rule for real property trades or businesses
subject to special anti-abuse rule--(1) In general. In the case of a
trade or business that leases real property subject to an arrangement
described in Sec. 1.163(j)-9(j)(1), including trades or businesses to
which the look-through exception in Sec. 1.163(j)-9(j)(2)(ii) applies,
the taxpayer must allocate under this paragraph (c)(3) the basis of
property used in both the excepted and non-excepted portions of its
trade or business, as determined under Sec. 1.163(j)-9(j)(3).
(2) Allocation methodology for real property. For purposes of this
paragraph (c)(3)(iii)(D), a taxpayer must allocate the basis of real
property leased under an arrangement described in Sec. 1.163(j)-
9(j)(1) or (j)(2)(i) between the excepted and non-excepted portions of
the real property trade or business based on the relative fair market
rental value of the real property that is attributable to the excepted
and non-excepted portions of the trade or business, respectively.
(3) Example. The following example illustrates the principles of
this paragraph (c)(3)(iii)(D):
(i) Facts. X and Y are domestic C corporations under common control
within the meaning of section 267(b), but neither X nor Y are members
of a consolidated group. The small business exemption in Sec.
1.163(j)-2(d) does not apply to X or Y. X owns an office building and
leases the entire building to Y. Y subleases 80 percent of the office
building, measured by fair market rental value, to a related party. Y
subleases the remaining 20 percent of the building to unrelated third
parties. X also owns depreciable scaffolding equipment, which it uses
to clean all of the building's windows as part of its leasing
arrangement with Y.
(ii) Analysis. Under Sec. 1.163(j)-9(j)(2)(ii), X is eligible to
make an election for 20 percent of its business of leasing the office
building to be an electing real property trade or business. Assuming X
makes such an election, X must allocate the basis of assets used in
both the excepted and non-excepted portions of its leasing trade or
business under this paragraph (c). Under paragraph (c)(3)(iii)(D)(2) of
this section, X must allocate the basis of the office building based on
the relative fair market value attributable to the excepted and non-
excepted portions of its leasing business. Therefore, X must allocate
20 percent of the basis of the
[[Page 56823]]
building to the excepted portion of its leasing business, and it must
allocate the remaining 80 percent of the building to the non-excepted
portion of its leasing business. Under paragraph (c)(3)(iii)(D)(2) of
this section, X may use one of the allocation methods described in
paragraph (c)(3)(ii) of this section to allocate the basis of its
scaffolding equipment between the excepted and non-excepted portions of
its leasing trade or business.
(4) Disallowed business interest expense carryforwards; floor plan
financing interest expense. Disallowed business interest expense
carryforwards (which were treated as allocable to a non-excepted trade
or business in a prior taxable year) are not re-allocated between non-
excepted and excepted trades or businesses in a succeeding taxable
year. Instead, the carryforwards continue to be treated as allocable to
a non-excepted trade or business. Floor plan financing interest expense
also is not subject to allocation between excepted and non-excepted
trades or businesses (see Sec. 1.163(j)-1(b)(19)) and is always
treated as allocable to non-excepted trades or businesses.
(5) Additional rules relating to basis--(i) Calculation of adjusted
basis--(A) Non-depreciable property other than land. Except as
otherwise provided in paragraph (c)(5)(i)(E) of this section, for
purposes of this section, the adjusted basis of an asset other than
land with respect to which no deduction is allowable under section 167,
former section 168, or section 197, as applicable, is the adjusted
basis of the asset for determining gain or loss from the sale or other
disposition of that asset as provided in Sec. 1.1011-1. Self-created
intangible assets are not taken into account for purposes of this
paragraph (c).
(B) Depreciable property other than inherently permanent
structures. For purposes of this section, the adjusted basis of any
tangible asset with respect to which a deduction is allowable under
section 167, other than inherently permanent structures, is determined
by using the alternative depreciation system under section 168(g)
before any application of the additional first-year depreciation
deduction (for example, under section 168(k) or (m)), and the adjusted
basis of any tangible asset with respect to which a deduction is
allowable under former section 168, other than inherently permanent
structures, is determined by using the taxpayer's method of computing
depreciation for the asset under former section 168. The depreciation
deduction with respect to the property described in this paragraph
(c)(5)(i)(B) is allocated ratably to each day during the period in the
taxable year to which the depreciation relates. A change to the
alternative depreciation system should be determined in a manner
similar to that in Sec. 1.168(i)-4(d)(4) or (d)(5)(ii)(B), as
applicable.
(C) Special rule for land and inherently permanent structures.
Except as otherwise provided in paragraph (c)(5)(i)(E) of this section,
for purposes of this section, the adjusted basis of any asset that is
land, including nondepreciable improvements to land, or an inherently
permanent structure is its unadjusted basis.
(D) Depreciable or amortizable intangible property and depreciable
income forecast method property. For purposes of this section, the
adjusted basis of any intangible asset with respect to which a
deduction is allowable under section 167 or 197, as applicable, is
determined in accordance with section 167 or 197, as applicable, and
the adjusted basis of any asset described in section 167(g)(6) for
which a deduction is allowable under section 167 is determined in
accordance with section 167(g). The adjusted basis of any intangible
asset under this paragraph (c)(5)(i)(D) is determined before any
application of the additional first-year depreciation deduction. The
depreciation or amortization deduction with respect to the property
described in this paragraph (c)(5)(i)(D) is allocated ratably to each
day during the period in the taxable year to which the depreciation or
amortization relates.
(E) Assets not yet used in a trade or business. Assets that have
been acquired or that are under development but that are not yet used
in a trade or business are not taken into account for purposes of this
paragraph (c). For example, construction works in progress (such as
buildings, airplanes, or ships) are not taken into account for purposes
of this paragraph (c). Similarly, land acquired by a taxpayer for
construction of a building by the taxpayer to be used in a trade or
business is not taken into account for purposes of under this paragraph
(c) until the building is placed in service. This rule does not apply
to interests in a partnership or stock in a corporation.
(F) Trusts established to fund specific liabilities. Trusts
required to fund specific liabilities (for example, pension trusts, and
nuclear decommissioning funds (including, but not limited to, those
funds for which an election is made under section 468A)) are not taken
into account for purposes of this paragraph (c).
(G) Inherently permanent structure. For purposes of this section,
the term inherently permanent structure has the meaning provided in
Sec. 1.856-10(d)(2).
(ii) Partnership interests; stock in non-consolidated C
corporations--(A) Partnership interests--(1) Calculation of asset
basis. For purposes of this section, a partner's interest in a
partnership is treated as an asset of the partner. For these purposes,
the partner's adjusted basis in a partnership interest is reduced, but
not below zero, by the partner's share of partnership liabilities, as
determined under section 752, and is further reduced as provided in
paragraph (c)(5)(ii)(A)(2)(iii) of this section. If a partner elects or
is required to apply the rules in this paragraph (c)(5)(ii)(A) to look
through to a partnership's basis in the partnership's assets, the
partner's basis in the partnership interest is adjusted to the extent
of the partner's share of any adjustments to the basis of the
partnership's assets required pursuant to the rules in paragraph
(c)(5)(i) of this section.
(2) Allocation of asset basis--(i) In general. For purposes of
determining the extent to which a partner's adjusted basis in its
partnership interest is allocable to an excepted or non-excepted trade
or business, the partner may look through to such partner's share of
the partnership's basis in the partnership's assets, taking into
account any adjustments under sections 734(b) and 743(b), and adjusted
to the extent required under paragraph (d)(4) of this section, except
as otherwise provided in paragraph (c)(5)(ii)(D) of this section. For
purposes of the preceding sentence, such partner's share of partnership
assets is determined using a reasonable method taking into account
special allocations under section 704(b). Notwithstanding paragraph
(c)(7) of this section, if a partner's direct and indirect interest in
a partnership is greater than or equal to 80 percent of the
partnership's capital or profits, the partner must apply the rules in
this paragraph (c)(5)(ii)(A)(2) to look through to the partnership's
basis in the partnership's assets. If a partner elects or is required
to apply the rules in this paragraph (c)(5)(ii)(A)(2) to look through
to a partnership's basis in the partnership's assets, the partner
allocates the basis of its partnership interest between excepted and
non-excepted trades or businesses based on the ratio in which the
partner's share of the partnership's adjusted tax basis in its trade or
business assets is allocated between excepted and non-excepted trade or
business assets.
(ii) De minimis rule. If, after applying paragraph
(c)(5)(ii)(A)(2)(iii) of this section, at least 90 percent of a
partner's
[[Page 56824]]
share of a partnership's basis in its assets (including adjustments
under sections 734(b) and 743(b)) is allocable to either excepted
trades or businesses or non-excepted trades or businesses, without
regard to assets not properly allocable to a trade or business, the
partner's entire basis in its partnership interest is treated as
allocable to either excepted or non-excepted trades or businesses,
respectively. For purposes of the preceding sentence, such partner's
share of partnership assets is determined using a reasonable method
taking into account special allocations under section 704(b).
(iii) Partnership assets not properly allocable to a trade or
business. For purposes of applying paragraphs (c)(5)(ii)(A)(2)(i) and
(ii) of this section to a partner that is a C corporation or tax-exempt
corporation, such partner's share of a partnership's assets that are
not properly allocable to a trade or business is treated as properly
allocable to a non-excepted trade or business of such partner. However,
if the partnership made an election under Sec. 1.163(j)-9(b) or Sec.
1.163(j)-9(h) with respect to an asset or activity, the assets (or
assets related to such activities) are treated as properly allocable to
an excepted trade or business of such partner. See, for example, an
election under Sec. 1.163(j)-9(h) for an asset or an election under
Sec. 1.163(j)-9(b) with respect to activities described in Sec.
1.163(j)-9(b)(2)(ii). For a partner other than a C corporation or tax-
exempt corporation, a partnership's assets that are not properly
allocable to a trade or business are treated as neither excepted nor
non-excepted trade or business assets; instead, such partner's adjusted
basis in its partnership interest is decreased by that partner's share
of the excess of the partnership's basis in those assets over the
partnership's debt that is traced to such assets in accordance with
Sec. 1.163-8T, and it is increased by that partner's share of the
excess of the partnership's debt that is traced to such assets in
accordance with Sec. 1.163-8T over the partnership's basis in those
assets. For purposes of the preceding sentence, the partnership's asset
basis in property not allocable to a trade or business is adjusted
pursuant to the rules in paragraph (c)(5)(i) of this section. For
purposes of this paragraph (c)(5)(ii)(A)(2)(iii), such partner's share
of a partnership's assets is determined under a reasonable method
taking into account special allocations under section 704(b).
(iv) Inapplicability of partnership look-through rule. If a
partner, other than a C corporation or a tax-exempt corporation,
chooses not to look through to the partnership's basis in the
partnership's assets under paragraph (c)(5)(ii)(A)(2)(i) of this
section or is precluded by paragraph (c)(5)(ii)(D) of this section from
applying such partnership look-through rule, the partner generally will
treat its basis in the partnership interest as either an asset held for
investment or a non-excepted trade or business asset as determined
under section 163(d). If a partner that is a C corporation or a tax-
exempt corporation chooses not to look through to the partnership's
basis in the partnership's assets under paragraph (c)(5)(ii)(A)(2)(i)
of this section or is precluded by paragraph (c)(5)(ii)(D) of this
section from applying such partnership look-through rule, the taxpayer
must treat its entire basis in the partnership interest as allocable to
a non-excepted trade or business.
(B) Stock in domestic non-consolidated corporations--(1) In
general. For purposes of this section, if a taxpayer owns stock in a
domestic C corporation that is not a member of the taxpayer's
consolidated group, or if the taxpayer owns stock in an S corporation,
the stock is treated as an asset of the taxpayer.
(2) Domestic non-consolidated C corporations--(i) Allocation of
asset basis. If a shareholder satisfies the minimum ownership threshold
in paragraph (c)(7) of this section for stock in a domestic non-
consolidated C corporation, and if dividends paid on such stock would
not be included in the shareholder's investment income under section
163(d)(4)(B), then, for purposes of determining the extent to which the
shareholder's basis in the stock is allocable to an excepted or non-
excepted trade or business, the shareholder must look through to the
corporation's basis in the corporation's assets, adjusted to the extent
required under paragraph (d)(4) of this section, except as otherwise
provided in paragraph (c)(5)(ii)(D) of this section. If a shareholder
does not satisfy the minimum ownership threshold in paragraph (c)(7) of
this section for stock in a domestic non-consolidated C corporation,
but the shareholder's direct and indirect interest in such corporation
is greater than or equal to 80 percent by value, and if dividends paid
on such stock would not be included in the shareholder's investment
income under section 163(d)(4)(B), then, for purposes of determining
the extent to which the shareholder's basis in the stock is allocable
to an excepted or non-excepted trade or business, the shareholder may
look through to the corporation's basis in the corporation's assets,
adjusted to the extent required under paragraph (d)(4) of this section,
except as otherwise provided in paragraph (c)(5)(ii)(D) of this
section. For purposes of the preceding sentence, indirect stock
ownership is determined by applying the constructive ownership rules of
section 318(a).
(ii) De minimis rule. If at least 90 percent of the domestic non-
consolidated C corporation's basis in the corporation's assets is
allocable to either excepted trades or businesses or non-excepted
trades or businesses, the shareholder's entire interest in the
corporation's stock is treated as allocable to either excepted or non-
excepted trades or businesses, respectively.
(iii) Inapplicability of corporate look-through rule. If a
shareholder other than a C corporation or a tax-exempt corporation is
ineligible to look through or chooses not to look through to a
corporation's basis in its assets under paragraph (c)(5)(ii)(B)(2)(i)
of this section, the shareholder generally will treat its entire basis
in the corporation's stock as an asset held for investment. If a
shareholder that is a C corporation or a tax-exempt corporation is
ineligible to look through or chooses not to look through to a
corporation's basis in its assets under paragraph (c)(5)(ii)(B)(2)(i)
of this section, the shareholder must treat its entire basis in the
corporation's stock as allocable to a non-excepted trade or business.
(iv) Use of inside basis for purposes of C corporation look-through
rule. This paragraph (c)(5)(ii)(B)(2)(iv) applies if a shareholder
meets the requirements to look through the stock of a domestic non-
consolidated C corporation under paragraph (c)(5)(ii)(B)(2)(i) of this
section, determined without applying the constructive ownership rules
of section 318(a). If this paragraph (c)(5)(ii)(B)(2)(iv) applies, then
solely for purposes of allocating asset basis under paragraph
(c)(5)(ii)(B)(2)(i) of this section, and except as otherwise provided
in paragraph (c)(5)(ii)(D) of this section, the shareholder may look
through to such shareholder's pro rata share of the C corporation's
basis in its assets, taking into account the modifications in paragraph
(c)(5)(i) of this section with respect to the C corporation's assets,
and adjusted to the extent required under paragraph (d)(4) of this
section (asset basis look-through approach). If a shareholder applies
the asset basis look-through approach, it must do so for all domestic
non-consolidated C corporations for which the shareholder is eligible
to use this approach, and it must report its use of this approach on
the information statement described in paragraph
[[Page 56825]]
(c)(6)(iii) of this section. The shareholder also must continue to use
the asset basis look-through approach in all future taxable years in
which the shareholder is eligible to use this approach.
(3) S corporations--(i) Calculation of asset basis. For purposes of
this section, a shareholder's share of stock in an S corporation is
treated as an asset of the shareholder. Additionally, for these
purposes, the shareholder's adjusted basis in a share of S corporation
stock is adjusted to take into account the modifications in paragraph
(c)(5)(i) of this section with respect to the assets of the S
corporation (for example, a shareholder's adjusted basis in its S
corporation stock is increased by the shareholder's share of
depreciation with respect to an inherently permanent structure owned by
the S corporation).
(ii) Allocation of asset basis. For purposes of determining the
extent to which a shareholder's basis in its stock of an S corporation
is allocable to an excepted or non-excepted trade or business, the
shareholder may look through to such shareholder's share of the S
corporation's basis in the S corporation's assets, allocated on a pro
rata basis, adjusted to the extent required under paragraph (d)(4) of
this section, except as otherwise provided in paragraph (c)(5)(ii)(D)
of this section. Notwithstanding paragraph (c)(7) of this section, if a
shareholder's direct and indirect interest in an S corporation is
greater than or equal to 80 percent of the S corporation's stock by
vote and value, the shareholder must apply the rules in this paragraph
(c)(5)(ii)(B)(3) to look through to the S corporation's basis in the S
corporation's assets. For these purposes, indirect stock ownership is
determined by applying the constructive ownership rules of section
318(a).
(iii) De minimis rule. If at least 90 percent of a shareholder's
share of an S corporation's basis in its assets is allocable to either
excepted trades or businesses or non-excepted trades or businesses, the
shareholder's entire basis in its S corporation stock is treated as
allocable to either excepted or non-excepted trades or businesses,
respectively.
(iv) Inapplicability of S corporation look-through rule. If a
shareholder chooses not to look through to the S corporation's basis in
the S corporation's assets under paragraph (c)(5)(ii)(B)(3)(ii) of this
section or is precluded by paragraph (c)(5)(ii)(D) of this section from
applying such S corporation look-through rule, the shareholder will
treat its basis in the S corporation stock as either an asset held for
investment or a non-excepted trade or business asset as determined
under section 163(d).
(C) Stock in relevant foreign corporations--(1) In general. The
rules applicable to domestic non-consolidated C corporations in
paragraph (c)(5)(ii)(B) of this section also apply to relevant foreign
corporations (as defined in Sec. 1.163(j)-1(b)(33)).
(2) Special rule for CFC utilities. Solely for purposes of applying
the rules in paragraph (c)(5)(ii)(B) of this section, a utility trade
or business conducted by an applicable CFC is treated as an excepted
regulated utility trade or business, but only to the extent that the
applicable CFC sells or furnishes the items described in Sec.
1.163(j)-1(b)(15)(i)(A)(1) pursuant to rates established or approved by
an entity described in Sec. 1.163(j)-1(b)(15)(i)(A)(2), a foreign
government, a public service or public utility commission or other
similar body of any foreign government, or the governing or ratemaking
body of a foreign electric cooperative. For purposes of this paragraph
(c)(5)(ii)(C)(2), the term foreign government means any foreign
government, any political subdivision of a foreign government, or any
wholly owned agency or instrumentality of any one of the foregoing
within the meaning of Sec. 1.1471-6(b).
(D) Inapplicability of look-through rule to partnerships or non-
consolidated C corporations to which the small business exemption
applies. A taxpayer may not apply the look-through rules in paragraphs
(b)(3) and (c)(5)(ii)(A), (B), and (C) of this section to a
partnership, S corporation, or non-consolidated C corporation that is
eligible for the small business exemption under section 163(j)(3) and
Sec. 1.163(j)-2(d)(1), unless the partnership, S corporation, or non-
consolidated C corporation elects under Sec. 1.163(j)-9 for a trade or
business to be an electing real property trade or business or an
electing farming business.
(E) Tiered entities. If a taxpayer applies the look-through rules
of this paragraph (c)(5)(ii), the taxpayer must do so for all lower-
tier entities with respect to which the taxpayer satisfies, directly or
indirectly, the minimum ownership threshold in paragraph (c)(7) of this
section, subject to the limitation in paragraph (c)(5)(ii)(D) of this
section, beginning with the lowest-tier entity.
(iii) Cash and cash equivalents and customer receivables. Except as
otherwise provided in the last sentence of this paragraph (c)(5)(iii),
a taxpayer's basis in its cash and cash equivalents and customer
receivables is not taken into account for purposes of this paragraph
(c). This rule also applies to a lower-tier entity if a taxpayer looks
through to the assets of that entity under paragraph (c)(5)(ii) of this
section. For purposes of this paragraph (c)(5)(iii), the term cash and
cash equivalents includes cash, foreign currency, commercial paper, any
interest in an investment company registered under the Investment
Company Act of 1940 (1940 Act) and regulated as a money market fund
under 17 CFR 270.2a-7 (Rule 2a-7 under the 1940 Act), any obligation of
a government, and any derivative that is substantially secured by an
obligation of a government, or any similar asset. For purposes of this
paragraph (c)(5)(iii), a derivative is a derivative described in
section 59A(h)(4)(A), without regard to section 59A(h)(4)(C). For
purposes of this paragraph (c)(5)(iii), the term government means the
United States or any agency or instrumentality of the United States; a
State, a territory, a possession of the United States, the District of
Columbia, or any political subdivision thereof within the meaning of
section 103 and Sec. 1.103-1; or any foreign government, any political
subdivision of a foreign government, or any wholly owned agency or
instrumentality of any one of the foregoing within the meaning of Sec.
1.1471-6(b). This paragraph (c)(5)(iii) does not apply to an entity
that qualifies as a financial services entity as described in Sec.
1.904-4(e)(3).
(iv) Deemed asset sale. Solely for purposes of determining the
amount of basis allocable to excepted and non-excepted trades or
businesses under this section, an election under section 336, 338, or
754, as applicable, is deemed to have been made for any acquisition of
corporate stock or partnership interests with respect to which the
taxpayer demonstrates, in the information statement required by
paragraph (c)(6)(iii)(B) of this section, that the acquisition
qualified for such an election and that, immediately before the
acquisition, the acquired entity had a regulatory liability for
deferred taxes recorded on its books with respect to property
predominantly used in an excepted regulated utility trade or business.
Any additional basis taken into account under this rule is reduced
ratably over a 15-year period beginning with the month of the
acquisition and is not subject to the anti-abuse rule in paragraph
(c)(8) of this section.
(v) Other adjustments. The Commissioner may make appropriate
adjustments to prevent a taxpayer from intentionally and artificially
increasing its basis in assets attributable to an excepted trade or
business.
[[Page 56826]]
(6) Determination dates; determination periods; reporting
requirements--(i) Determination dates and determination periods--(A)
Quarterly determination periods. For purposes of this section, and
except as otherwise provided in paragraph (c)(6)(i)(B) of this section,
the term determination date means the last day of each quarter of the
taxpayer's taxable year (and the last day of the taxpayer's taxable
year, if the taxpayer has a short taxable year), and the term
determination period means the period beginning the day after one
determination date and ending on the next determination date.
(B) Annual determination periods. If a taxpayer satisfies the
requirements of the last sentence of this paragraph (c)(6)(i)(B), the
taxpayer may allocate asset basis for a taxable year based on the
average of adjusted asset basis at the beginning of the year and the
end of the year (annual determination method). For these purposes, the
term determination date means the last day of the taxpayer's taxable
year, and the term determination period has the same meaning as
provided in paragraph (c)(6)(i)(A) of this section. A taxpayer may use
the annual determination method for a taxable year only if the taxpayer
demonstrates that its total adjusted basis (as determined under
paragraph (c)(5) of this section) at the end of the year in its assets
used in its excepted trades or businesses, as a percentage of the
taxpayer's total adjusted basis at the end of such year in all of its
assets used in a trade or business, does not differ by more than 20
percent from such percentage at the beginning of the year.
(ii) Application of look-through rules. If a taxpayer that applies
the look-through rules of paragraph (c)(5)(ii) of this section has a
different taxable year than the partnership or non-consolidated C
corporation to which the taxpayer is applying those rules, then, for
purposes of this paragraph (c)(6), the taxpayer must use the most
recent asset basis figures from the partnership or non-consolidated C
corporation. For example, assume that PS1 is a partnership with a May
31 taxable year, and that C (a calendar-year C corporation that is
ineligible to use the annual determination method for the taxable year)
is a partner in PS1. PS1's determination dates are February 28, May 31,
August 31, and November 30. In turn, C's determination dates are March
31, June 30, September 30, and December 31. If C looks through to PS1's
basis in its assets under paragraph (c)(5)(ii) of this section, then,
for purposes of determining the amount of C's asset basis that is
attributable to its excepted and non-excepted businesses on March 31, C
must use PS1's asset basis calculations for February 28.
(iii) Reporting requirements--(A) Books and records. A taxpayer
must maintain books of account and other records and data as necessary
to substantiate the taxpayer's use of an asset in an excepted trade or
business and to substantiate any adjustments to asset basis for
purposes of applying this paragraph (c). One indication that a
particular asset is used in a particular trade or business is if the
taxpayer maintains separate books and records for all of its excepted
and non-excepted trades or businesses and can show the asset in the
books and records of a particular excepted or non-excepted trade or
business. For rules governing record retention, see Sec. 1.6001-1.
(B) Information statement. Except as otherwise provided in
publications, forms, instructions, or other guidance, each taxpayer
that is making an allocation under this paragraph (c), including any
taxpayer that satisfies the de minimis rule in paragraph (c)(1)(ii) of
this section, must prepare a statement titled ``Section 163(j) Asset
Basis Calculations'' containing the information described in paragraphs
(c)(6)(iii)(B)(1) through (7) of this section and must attach the
statement to its timely filed Federal income tax return for the taxable
year:
(1) The taxpayer's adjusted basis in the assets used in its
excepted and non-excepted businesses, determined as set forth in this
section, including detailed information for the different groups of
assets identified in paragraphs (c)(5)(i) and (ii) and (d) of this
section;
(2) The determination dates on which asset basis was measured
during the taxable year;
(3) The names and taxpayer identification numbers (TINs) of all
entities for which basis information is being provided, including
partnerships and corporations if the taxpayer that owns an interest in
a partnership or corporation looks through to the partnership's or
corporation's basis in the partnership's or corporation's assets under
paragraph (c)(5)(ii) of this section. If the taxpayer is a member of a
consolidated group, the name and TIN of the agent for the group, as
defined in Sec. 1.1502-77, must be provided, but the taxpayer need not
provide the names and TINs of all other consolidated group members;
(4) Asset basis information for corporations or partnerships if the
taxpayer looks through to the corporation's or partnership's basis in
the corporation's or partnership's assets under paragraph (c)(5)(ii) of
this section;
(5) A summary of the method or methods used to determine asset
basis in property used in both excepted and non-excepted businesses, as
well as information regarding any deemed sale under paragraph
(c)(5)(iv) of this section;
(6) Whether the taxpayer used the historical approach or the
effective date approach for all of its disallowed disqualified
interest; and
(7) If the taxpayer changed its methodology for allocating asset
basis between or among two or more trades or businesses under paragraph
(c)(3)(ii) of this section, a statement that the taxpayer has changed
the allocation methodology and a description of the new methodology or,
if the taxpayer is required to request consent for the allocation
methodology change under paragraph (c)(3)(iii)(A)(2) of this section, a
statement that the request has been or will be filed and a description
of the methodology change.
(iv) Failure to file statement. If a taxpayer fails to file the
statement described in paragraph (c)(6)(iii) of this section or files a
statement that does not comply with the requirements of paragraph
(c)(6)(iii) of this section, the Commissioner may treat the taxpayer as
if all of its interest expense is properly allocable to a non-excepted
trade or business, unless the taxpayer shows that there was reasonable
cause for failing to comply with, and the taxpayer acted in good faith
with respect to, the requirements of paragraph (c)(6)(iii) of this
section, taking into account all pertinent facts and circumstances.
(7) Ownership threshold for look-through rules--(i) Corporations--
(A) Asset basis. For purposes of this section, a shareholder must look
through to the assets of a domestic non-consolidated C corporation or a
relevant foreign corporation under paragraph (c)(5)(ii) of this section
if the shareholder's direct and indirect interest in the corporation
satisfies the ownership requirements of section 1504(a)(2). For
purposes of this paragraph (c)(7)(i)(A), indirect stock ownership is
determined by applying the constructive ownership rules of section
318(a). A shareholder may look through to the assets of an S
corporation under paragraph (c)(5)(ii) of this section for purposes of
allocating the shareholder's basis in its stock in the S corporation
between excepted and non-excepted trades or businesses regardless of
the shareholder's direct and indirect interest in the S corporation.
(B) Dividends. A shareholder must look through to the activities of
a domestic non-consolidated C
[[Page 56827]]
corporation or a relevant foreign corporation under paragraph (b)(3) of
this section if the shareholder's direct interest in the corporation
satisfies the ownership requirements of section 1504(a)(2). A
shareholder may look through to the activities of a domestic non-
consolidated C corporation or an applicable CFC under paragraph (b)(3)
of this section if the shareholder's direct interest in the corporation
is greater than or equal to 80 percent by value. A shareholder may look
through to the activities of an S corporation under paragraph (b)(3) of
this section regardless of the shareholder's direct interest in the S
corporation.
(ii) Partnerships. A partner may look through to the assets of a
partnership under paragraph (c)(5)(ii) of this section for purposes of
allocating the partner's basis in its partnership interest between
excepted and non-excepted trades or businesses regardless of the
partner's direct and indirect interest in the partnership.
(iii) Inapplicability of look-through rule. For circumstances in
which a taxpayer that satisfies the ownership threshold in this
paragraph (c)(7) may not apply the look-through rules in paragraphs
(b)(3) and (c)(5)(ii) of this section, see paragraph (c)(5)(ii)(D) of
this section.
(8) Anti-abuse rule. If a principal purpose for the acquisition,
disposition, or change in use of an asset was to artificially shift the
amount of basis allocable to excepted or non-excepted trades or
businesses on a determination date, the additional basis or change in
use will not be taken into account for purposes of this section. For
example, if an asset is used in a non-excepted trade or business for
most of the taxable year, and if the taxpayer begins using the asset in
an excepted trade or business towards the end of the year with a
principal purpose of shifting the amount of basis in the asset that is
allocable to the excepted trade or business, the change in use is
disregarded for purposes of this section. A purpose may be a principal
purpose even though it is outweighed by other purposes (taken together
or separately). In determining whether a taxpayer has a principal
purpose described in this paragraph (c)(8), factors to be considered
include, for example, the following: The business purpose for the
acquisition, disposition, or change in use; the length of time the
asset was used in a trade or business; whether the asset was acquired
from a related person; and whether the taxpayer's aggregate basis in
its assets increased or decreased temporarily on or around a
determination date. A principal purpose is presumed to be present in
any case in which the acquisition, disposition, or change in use lacks
a substantial business purpose and increases the taxpayer's basis in
assets used in its excepted trades or businesses by more than 10
percent during the taxable year.
(d) Direct allocations--(1) In general. It is not necessary to
allocate interest expense under this paragraph (d) if all of the
taxpayer's interest expense is allocable to excepted trades or
businesses or if all of the taxpayer's interest expense is allocable to
non-excepted trades or businesses.
(2) Qualified nonrecourse indebtedness. For purposes of this
section, a taxpayer with qualified nonrecourse indebtedness must
directly allocate interest expense from the indebtedness to the
taxpayer's assets in the manner and to the extent provided in Sec.
1.861-10T(b). For purposes of this paragraph (d)(2), the term qualified
nonrecourse indebtedness has the meaning provided in Sec. 1.861-
10T(b), except that the term cash flow from the property (within the
meaning of Sec. 1.861-10T(b)(3)(i)) includes revenue derived from the
sale or lease of inventory or similar property with respect to an
excepted regulated utility trade or business or a non-excepted
regulated utility trade or business.
(3) Assets used in more than one trade or business. If an asset is
used in more than one trade or business, the taxpayer must apply the
rules in paragraph (c)(3) of this section to determine the extent to
which interest that is directly allocated under this paragraph (d) is
allocable to excepted or non-excepted trades or businesses.
(4) Adjustments to basis of assets to account for direct
allocations. In determining the amount of a taxpayer's basis in the
assets used in its excepted and non-excepted trades or businesses for
purposes of paragraph (c) of this section, adjustments must be made to
reflect direct allocations under this paragraph (d). These adjustments
consist of reductions in the taxpayer's basis in its assets for
purposes of paragraph (c) of this section to reflect assets to which
interest expense is directly allocated under this paragraph (d). The
amount of the taxpayer's basis in these assets must be reduced, but not
below zero, by the amount of qualified nonrecourse indebtedness secured
by these assets. These adjustments must be made before the taxpayer
averages the adjusted basis in its assets as determined on each
determination date during the taxable year.
(5) Example: Direct allocation of interest expense--(i) Facts. T
conducts an electing real property trade or business (Business X) and
operates a retail store that is a non-excepted trade or business
(Business Y). In Year 1, T issues Note A to a third party in exchange
for $1,000x for the purpose of acquiring Building B. Note A is
qualified nonrecourse indebtedness (within the meaning of Sec. 1.861-
10T(b)) secured by Building B. T then uses those funds to acquire
Building B for $1,200x, and T uses Building B in Business X. During
Year 1, T pays $500x of interest, of which $100x is interest payments
on Note A. For Year 1, T's basis in its assets used in Business X (as
determined under paragraph (c) of this section) is $3,600x (excluding
cash and cash equivalents), and T's basis in its assets used in
Business Y (as determined under paragraph (c) of this section) is $800x
(excluding cash and cash equivalents). Each of Business X and Business
Y also has $100x of cash and cash equivalents.
(ii) Analysis. Because Note A is qualified nonrecourse indebtedness
that is secured by Building B, in allocating interest expense between
Businesses X and Y, T first must directly allocate the $100x of
interest expense it paid with respect to Note A to Business X in
accordance with paragraph (d)(2) of this section. Thereafter, T must
allocate the remaining $400x of interest expense between Businesses X
and Y under paragraph (c) of this section. After excluding $1,000x of
T's basis in Building B to reflect the amount of Note A (see paragraph
(d)(4) of this section), and without regard to T's $200x of cash and
cash equivalents (see paragraph (c)(5)(iii) of this section), T's basis
in its assets used in Businesses X and Y is $2,600x and $800x (76.5
percent and 23.5 percent), respectively. Thus, $306x of the remaining
$400x of interest expense would be allocated to Business X, and $94x
would be allocated to Business Y.
(e) Examples. The examples in this paragraph (e) illustrate the
principles of this section. For purposes of these examples, no taxpayer
is eligible for the small business exemption under section 163(j)(3)
and Sec. 1.163(j)-2(d), no taxpayer has floor plan financing interest
expense, and no taxpayer has qualified nonrecourse indebtedness within
the meaning of Sec. 1.861-10T(b).
(1) Example 1: Interest allocation within a consolidated group--(i)
Facts. S is a member of a consolidated group of which P is the common
parent. P conducts an electing real property trade or business
(Business X), and S conducts a non-excepted trade or business (Business
Y). In Year 1, P pays or accrues (without regard to section 163(j))
$35x of interest expense and
[[Page 56828]]
receives $10x of interest income, and S pays or accrues (without regard
to section 163(j)) $115x of interest expense and receives $5x of
interest income (for a total of $150x of interest expense and $15x of
interest income). For purposes of this example, assume that, pursuant
to paragraph (c) of this section, $30x of the P group's interest
expense and $3x of the P group's interest income is allocable to
Business X, and the remaining $120x of interest expense and $12x of
interest income is allocable to Business Y.
(ii) Analysis. Under paragraph (a)(4) of this section, 20 percent
of the P group's Year 1 interest expense ($30x/$150x) and interest
income ($3x/$15x) is allocable to an excepted trade or business. Thus,
$7x ($35x x 20 percent) of P's interest expense and $2x ($10x x 20
percent) of P's interest income is allocable to an excepted trade or
business. The remaining $28x of P's interest expense is business
interest expense subject to the section 163(j) limitation, and the
remaining $8x of P's interest income is business interest income that
increases the group's section 163(j) limitation. In turn, $23x ($115x x
20 percent) of S's interest expense and $1x ($5x x 20 percent) of S's
interest income is allocable to an excepted trade or business. The
remaining $92x of S's interest expense is business interest expense
subject to the section 163(j) limitation, and the remaining $4x of S's
interest income is business interest income that increases the group's
section 163(j) limitation.
(2) Example 2: Interest allocation within a consolidated group with
assets used in more than one trade or business--(i) Facts. S is a
member of a consolidated group of which P is the common parent. P
conducts an electing real property trade or business (Business X), and
S conducts a non-excepted trade or business (Business Y). In Year 1, P
pays or accrues (without regard to section 163(j)) $50x of interest
expense, and S pays or accrues $100x of interest expense (without
regard to section 163(j)). P leases 40 percent of space in Building V
(which P owns) to S for use in Business Y, and P leases the remaining
60 percent of space in Building V to third parties. For purposes of
allocating interest expense under paragraph (c) of this section, the P
group's basis in its assets (excluding Building V) used in Businesses X
and Y is $180x and $620x, respectively. The P group's basis in Building
V for purposes of allocating interest expense under paragraph (c) of
this section is $200x.
(ii) Analysis. Under paragraph (c)(3)(ii) of this section, the P
group's basis in Building V ($200x) is allocated to excepted and non-
excepted trades or businesses in accordance with the use of space by
Business Y (40 percent) and Business X (the remainder, or 60 percent).
Accordingly, $120x of the basis in Building V is allocated to excepted
trades or businesses (60 percent x $200x), and $80x is allocated to
non-excepted trades or businesses (40 percent x $200x). After
allocating the basis in Building V, the P group's total basis in the
assets used in excepted and non-excepted trades or businesses is $300x
and $700x, respectively. Under paragraphs (a)(4) and (c) of this
section, 30 percent ($300x/$1,000x) of the P group's Year 1 interest
expense is properly allocable to an excepted trade or business. Thus,
$15x ($50x x 30 percent) of P's interest expense is properly allocable
to an excepted trade or business, and the remaining $35x of P's
interest expense is business interest expense subject to the section
163(j) limitation. In turn, $30x ($100x x 30 percent) of S's interest
expense is properly allocable to an excepted trade or business, and the
remaining $70x of S's interest expense is business interest expense
subject to the section 163(j) limitation.
(3) Example 3: Application of look-through rules--(i) Facts. (A)
Each of Corp A, Corp B, Corp C, and Corp D is a domestic calendar-year
corporation that is not a member of a consolidated group. Corp A owns
100 percent of the stock of Corp C; the basis of Corp A's stock in Corp
C is $500x. Corp C owns 10 percent of the interests in PS1 (a domestic
partnership), and Corp B owns the remaining 90 percent. Corp C's basis
in its PS1 interests is $25x; Corp B's basis in its PS1 interests is
$225x. PS1 owns 100 percent of the stock of Corp D; the basis of PS1's
stock in Corp D is $1,000x. Corp A and Corp B are owned by unrelated,
non-overlapping shareholders.
(B) In 2021, Corp C was engaged solely in a non-excepted trade or
business. That same year, PS1's only activity was holding Corp D stock.
In turn, Corp D was engaged in both an electing farming business and a
non-excepted trade or business. Under the allocation rules in paragraph
(c) of this section, 50 percent of Corp D's asset basis in 2021 was
allocable to the electing farming business, and the remaining 50
percent was allocable to the non-excepted trade or business.
(C) Corp A and Corp B each paid or accrued (without regard to
section 163(j)) $150x of interest expense allocable to a trade or
business. Corp A's trade or business was an excepted trade or business,
and Corp B's trade or business was a non-excepted trade or business.
Corp A's basis in the assets used in its trade or business was $100x,
and Corp B's basis in the assets used in its trade or business was
$112.5x.
(ii) Analysis. (A) As provided in paragraph (c)(5)(ii)(E) of this
section, if a taxpayer applies the look-through rules of paragraph
(c)(5)(ii) of this section, the taxpayer must begin with the lowest-
tier entity to which it is eligible to apply the look-through rules.
Corp A directly owns 100 percent of the stock of Corp C; thus, Corp A
satisfies the 80 percent minimum ownership threshold with respect to
Corp C. Corp A also owns 10 percent of the interests in PS1. There is
no minimum ownership threshold for partnerships; thus, Corp A may apply
the look-through rules to PS1. However, Corp A does not directly or
indirectly own at least 80 percent of the stock of Corp D; thus, Corp A
cannot look through its indirect interest in Corp D. In turn, Corp B
directly owns 90 percent of the interests in PS1, and Corp B indirectly
owns at least 80 percent of the stock of Corp D. Thus, Corp B must
apply the look-through rules to PS1 and Corp D.
(B) From Corp A's perspective, PS1 is not engaged in a trade or
business for purposes of section 163(j); instead, PS1 is merely holding
its Corp D stock as an investment. Under paragraph (c)(5)(ii)(A)(2) of
this section, if a partnership is not engaged in a trade or business,
then its C corporation partner must treat its entire basis in the
partnership interest as allocable to a non-excepted trade or business.
Thus, for purposes of Corp A's application of the look-through rules,
Corp C's entire basis in its PS1 interest ($25x) is allocable to a non-
excepted trade or business. Corp C's basis in its other assets also is
allocable to a non-excepted trade or business (the only trade or
business in which Corp C is engaged). Thus, under paragraph (c) of this
section, Corp A's $500x basis in its Corp C stock is allocable entirely
to a non-excepted trade or business. Corp A's $100x basis in its other
business assets is allocable to an excepted trade or business. Thus,
\5/6\ (or $125x) of Corp A's $150x of interest expense is properly
allocable to a non-excepted trade or business and is business interest
expense subject to the section 163(j) limitation, and the remaining
$25x of Corp A's $150x of interest expense is allocable to an excepted
trade or business and is not subject to the section 163(j) limitation.
(C) From Corp B's perspective, PS1 must look through its stock in
Corp D to determine the extent to which PS1's basis in the stock is
allocable to an excepted or non-excepted trade or
[[Page 56829]]
business. Half of Corp D's basis in its assets is allocable to an
excepted trade or business, and the other half is allocable to a non-
excepted trade or business. Thus, from Corp B's perspective, $500x of
PS1's basis in its Corp D stock (PS1's only asset) is allocable to an
excepted trade or business, and the other half is allocable to a non-
excepted trade or business. Corp B's basis in its PS1 interests is
$225x. Applying the look-through rules to Corp B's PS1 interests,
$112.5x of Corp B's basis in its PS1 interests is allocable to an
excepted trade or business, and $112.5x of Corp B's basis in its PS1
interests is allocable to a non-excepted trade or business. Since Corp
B's basis in the assets used in its non-excepted trade or business also
was $112.5x, two-thirds of Corp B's interest expense ($100x) is
properly allocable to a non-excepted trade or business and is business
interest expense subject to the section 163(j) limitation, and one-
third of Corp B's interest expense ($50x) is allocable to an excepted
trade or business and is not subject to the section 163(j) limitation.
(4) Example 4: Excepted and non-excepted trades or businesses in a
consolidated group--(i) Facts. P is the common parent of a consolidated
group of which A and B are the only other members. A conducts an
electing real property trade or business (Business X), and B conducts a
non-excepted trade or business (Business Y). In Year 1, A pays or
accrues (without regard to section 163(j)) $50x of interest expense and
earns $70x of gross income in the conduct of Business X, and B pays or
accrues (without regard to section 163(j)) $100x of interest expense
and earns $150x of gross income in the conduct of Business Y. B owns
Building V, which it uses in Business Y. For purposes of allocating the
P group's Year 1 business interest expense between excepted and non-
excepted trades or businesses under paragraph (c) of this section, the
P group's basis in its assets (other than Building V) used in
Businesses X and Y is $180x and $620x, respectively, and the P group's
basis in Building V is $200x. At the end of Year 1, B sells Building V
to a third party and realizes a gain of $60x in addition to the $150x
of gross income B earned that year from the conduct of Business Y.
(ii) Analysis. (A) Under paragraphs (a)(4) and (c) of this section,
the P group's basis in its assets used in its trades or businesses is
allocated between the P group's excepted trade or business (Business X)
and its non-excepted trade or business (Business Y) as though these
trades or businesses were conducted by a single corporation. Under
paragraph (c) of this section, the P group's basis in its assets used
in Businesses X and Y is $180x and $820x, respectively. Accordingly, 18
percent ($180x/$1,000x) of the P group's total interest expense ($150x)
is properly allocable to an excepted trade or business ($27x), and the
remaining 82 percent of the P group's total interest expense is
business interest expense properly allocable to a non-excepted trade or
business ($123x).
(B) To determine the P group's section 163(j) limitation, paragraph
(a) of this section requires that certain items of income and deduction
be allocated to the excepted and non-excepted trades or businesses of
the P group as though these trades or businesses were conducted by a
single corporation. In Year 1, the P group's excepted trade or business
(Business X) has gross income of $70x, and the P group's non-excepted
trade or business (Business Y) has gross income of $150x. Because
Building V was used exclusively in Business Y, the $60x of gain from
the sale of Building V in Year 1 is attributed to Business Y under
paragraph (b)(2) of this section. The P group's section 163(j)
limitation is $63x (30 percent x $210x), which allows the P group to
deduct $63x of its $123x of business interest expense allocated to the
P group's non-excepted trades or businesses. The group's $27x of
interest expense that is allocable to excepted trades or businesses may
be deducted without limitation under section 163(j).
(iii) Intercompany transaction. The facts are the same as in
Example 4 in paragraph (e)(4)(i) of this section, except that A owns
Building V and leases it to B in Year 1 for $20x for use in Business Y,
and A sells Building V to a third party for a $60 gain at the end of
Year 1. Under paragraphs (a)(4) and (c) of this section, all members of
the P group are treated as a single corporation. As a result, the P
group's basis in its assets used in its trades or businesses is
allocated between the P group's excepted trade or business (Business X)
and its non-excepted trade or business (Business Y) as though these
trades or businesses were conducted by a single corporation. A lease
between two divisions of a single corporation would produce no rental
income or expense. Thus, the $20x of rent paid by B to A does not
affect the P group's ATI. Moreover, under paragraph (c) of this
section, Building V is an asset used in the P group's non-excepted
trade or business (Business Y). Accordingly, although A owns Building
V, the basis in Building V is added to the P group's basis in assets
used in Business Y for purposes of allocating interest expense under
paragraph (c) of this section. In the same vein, when A sells Building
V to a third party at a gain of $60x, the gain is included in the P
group's ATI because Building V was used in a non-excepted trade or
business of the P group (Business Y) prior to its sale.
(5) Example 5: Captive activities--(i) Facts. S and T are members
of a consolidated group of which P is the common parent. P conducts an
electing real property trade or business (Business X), S conducts a
non-excepted trade or business (Business Y), and T provides
transportation services to Businesses X and Y but does not have any
customers outside of the P group. For Year 1, T provides transportation
services using a single bus with a basis of $120x.
(ii) Analysis. Under paragraph (a)(4) of this section, activities
conducted by a consolidated group are treated as though those
activities were conducted by a single corporation. Because the
activities of T are limited to providing intercompany transportation
services, T does not conduct a trade or business for purposes of
section 163(j). Under paragraph (c)(3) of this section, business
interest expense is allocated to excepted and non-excepted trades or
businesses based on the relative basis of the assets used in those
businesses. The basis in T's only asset, a bus, is therefore allocated
between Business X and Business Y according to the use of T's bus by
these businesses. Business X uses one-third of T's services, and
Business Y uses two-thirds of T's services. Thus, $40x of the basis of
T's bus is allocated to Business X, and $80x of the basis of T's bus is
allocated to Business Y.
(6) Example 6: Constructive ownership--(i) Facts. P, S, T, and U
are domestic C corporations that are not members of a consolidated
group. P directly owns 80 percent of the stock of each of S and T as
measured by total voting power and value; an unrelated third party, X,
owns the remaining 20 percent. In turn, S and T directly own 15 percent
and 80 percent, respectively, of the stock of U as measured by total
voting power and value; P directly owns the remaining 5 percent. P
conducts both excepted and non-excepted trades or businesses. S and T
conduct only non-excepted trades or businesses, and U conducts both
excepted and non-excepted trades or businesses.
(ii) Analysis. Under paragraph (c)(7)(i)(A) of this section, a
shareholder must look through to the assets of a domestic non-
consolidated C corporation for purposes of allocating the shareholder's
basis in its stock in the corporation between excepted and non-excepted
trades or businesses if the
[[Page 56830]]
shareholder's direct and indirect interest in the corporation satisfies
the ownership requirements of section 1504(a)(2). For purposes of
paragraph (c)(7)(i)(A) of this section, a shareholder's stock ownership
is determined by applying the constructive ownership rules of section
318(a). P directly owns 80 percent of each of S and T as measured by
total voting power and value; thus, P must look through to the assets
of S and T when allocating the basis in its stock of S and T. P
directly owns 5 percent of the stock of U as measured by total voting
power and value, and P constructively owns the other 95 percent; thus,
P also must look through to U's assets when allocating the basis in its
U stock. S directly owns 15 percent of the stock of U, and S
constructively owns only 5 percent through P; thus, S cannot look
through to U's assets when allocating the basis in its U stock. T
directly owns 80 percent of the stock of U, and T constructively owns
an additional 5 percent; thus, T must look through to U's assets when
allocating the basis in its U stock.
(iii) Dividend. The facts are the same as in paragraph (e)(6)(i) of
this section, except that U distributes a $160x dividend pro rata to
its shareholders. Thus, P receives $8x (5 percent of $160x) of the U
dividend, S receives $24x (15 percent of $160x), and T receives $128x
(80 percent of $160x). Under paragraph (c)(7)(i)(B) of this section, if
a shareholder's direct interest in a corporation satisfies the
ownership requirements of section 1504(a)(2), the shareholder must look
through to the activities of a domestic non-consolidated C corporation
in determining whether dividend income is from an excepted or non-
excepted trade or business. The constructive ownership rules do not
apply in allocating dividends under paragraph (c)(7)(i)(B) of this
section. P directly owns 5 percent of the stock of U as measured by
vote and value, and S directly owns 15 percent of the stock of U as
measured by vote and value; thus, neither P nor S is required to apply
the look-through rules in allocating its dividend income from U, and
all such income is allocable to non-excepted trades or businesses. T
directly owns 80 percent of the stock of U as measured by vote and
value; thus, T must allocate its U dividend in accordance with the
activities of U's excepted and non-excepted trades or businesses.
(7) Example 7: Dispositions with a principal purpose of shifting
basis--(i) Facts. U and V are members of a consolidated group of which
P is the common parent. U conducts an electing farming business
(Business F), and V conducts a farm equipment leasing business
(Business L) that is a non-excepted trade or business. After the end of
a farming season, the P group, with a principal purpose of shifting
basis from Business L to Business F, has V sell to U all off-lease
farming equipment that previously was leased out as part of Business L.
Immediately before the start of the next season, U sells the farming
equipment back to V for use in Business L.
(ii) Analysis. Under paragraph (c)(8) of this section, in the case
of a disposition of assets undertaken with a principal purpose of
artificially shifting the amount of basis allocable to excepted or non-
excepted trades or businesses on a determination date, the additional
basis or change in use will not be taken into account. Because V's sale
of farming equipment to U for storage in Business F's facilities is
undertaken with a principal purpose of shifting basis from Business L
to Business F, the additional basis Business F receives from these
transactions will not be taken into account for purposes of this
section. Instead, the basis of the farming equipment will be allocated
as though the farming equipment continued to be used in Business L.
(f) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
Accordingly, for purposes of Sec. 1.163(j)-10(c)(5), taxpayers make
any change to the alternative depreciation system as of November 13,
2020, or if relying on the provisions of Sec. 1.163(j)-10 in
regulation project REG-106089-18 (83 FR 67490), as of December 28,
2018.
Sec. 1.163(j)-11 Transition rules.
(a) Overview. This section provides transition rules regarding the
section 163(j) limitation. Paragraph (b) of this section provides rules
regarding the application of the section 163(j) limitation to a
corporation that joins a consolidated group during a taxable year of
the group beginning before January 1, 2018 and is subject to the
section 163(j) limitation at the time of its change in status.
Paragraph (c) of this section provides rules regarding the treatment of
carryforwards of disallowed disqualified interest.
(b) Application of section 163(j) limitation if a corporation joins
a consolidated group during a taxable year of the group beginning
before January 1, 2018--(1) In general. If a corporation (S) joins a
consolidated group during a taxable year of the group beginning before
January 1, 2018, and if S is subject to the section 163(j) limitation
at the time of its change in status, then section 163(j) will apply to
S's short taxable year that ends on the day of S's change in status,
but section 163(j) will not apply to S's short taxable year that begins
the next day (when S is a member of the acquiring consolidated group).
Any business interest expense paid or accrued (without regard to
section 163(j)) by S in its short taxable year ending on the day of S's
change in status for which a deduction is disallowed under section
163(j) will be carried forward to the acquiring group's first taxable
year beginning after December 31, 2017. Those disallowed business
interest expense carryforwards may be subject to limitation under other
provisions of these regulations (see, for example, Sec. 1.163(j)-5(c),
(d), (e), and (f)).
(2) Example. Acquiring Group is a consolidated group with a fiscal
year end of November 30; Target is a stand-alone calendar-year C
corporation. On May 31, 2018, Acquiring Group acquires Target in a
transaction that is not an ownership change for purposes of section
382. Acquiring Group is not subject to the section 163(j) limitation
during its taxable year beginning December 1, 2017. As a result of the
acquisition, Target has a short taxable year beginning January 1, 2018
and ending May 31, 2018. Target is subject to the section 163(j)
limitation during this short taxable year. However, Target (as a member
of Acquiring Group) is not subject to the section 163(j) limitation
during Acquiring Group's taxable year ending November 30, 2018. Any
disallowed business interest expense carryforwards from Target's
taxable year ending May 31, 2018, will not be available for use in
Acquiring Group's taxable year ending November 30, 2018. However, that
disallowed business interest expense is carried forward to Acquiring
Group's taxable year beginning December 1, 2018, and can be deducted by
the group, subject to the
[[Page 56831]]
separate return limitation year (SRLY) limitation. See Sec. 1.163(j)-
5(d).
(c) Treatment of disallowed disqualified interest--(1) In general.
Disallowed disqualified interest is carried forward to the taxpayer's
first taxable year beginning after December 31, 2017. Disallowed
disqualified interest is subject to disallowance as a disallowed
business interest expense carryforward under section 163(j) and Sec.
1.163(j)-2 to the extent the interest is properly allocable to a non-
excepted trade or business under Sec. 1.163(j)-10. Disallowed
disqualified interest that is properly allocable to an excepted trade
or business is not subject to the section 163(j) limitation. See Sec.
1.163(j)-10(a)(6) for rules governing the allocation of disallowed
disqualified interest between excepted and non-excepted trades or
businesses.
(2) Earnings and profits. A taxpayer may not reduce its earnings
and profits in a taxable year beginning after December 31, 2017, to
reflect any disallowed disqualified interest carryforwards to the
extent the payment or accrual of the disallowed disqualified interest
reduced the earnings and profits of the taxpayer in a prior taxable
year.
(3) Disallowed disqualified interest of members of an affiliated
group--(i) Scope. This paragraph (c)(3)(i) applies to corporations that
were treated as a single taxpayer under old section 163(j)(6)(C) and
that had disallowed disqualified interest.
(ii) Allocation of disallowed disqualified interest to members of
the affiliated group--(A) In general. Each member of the affiliated
group is allocated its allocable share of the affiliated group's
disallowed disqualified interest as provided in paragraph (c)(3)(ii)(B)
of this section.
(B) Definitions. The following definitions apply for purposes of
paragraph (c)(3)(ii) of this section.
(1) Allocable share of the affiliated group's disallowed
disqualified interest. The term allocable share of the affiliated
group's disallowed disqualified interest means, with respect to any
member of an affiliated group for the member's last taxable year
beginning before January 1, 2018, the product of the total amount of
the disallowed disqualified interest of all members of the affiliated
group under old section 163(j)(6)(C) and the member's disallowed
disqualified interest ratio.
(2) Disallowed disqualified interest ratio. The term disallowed
disqualified interest ratio means, with respect to any member of an
affiliated group for the member's last taxable year beginning before
January 1, 2018, the ratio of the exempt related person interest
expense of the member for the last taxable year beginning before
January 1, 2018, to the sum of the amounts of exempt related person
interest expense for all members of the affiliated group.
(3) Exempt related person interest expense. The term exempt related
person interest expense means interest expense that is, or is treated
as, paid or accrued by a domestic C corporation, or by a foreign
corporation with income, gain, or loss that is effectively connected,
or treated as effectively connected, with the conduct of a trade or
business in the United States, to--
(i) Any person related to the taxpayer, within the meaning of
sections 267(b) or 707(b)(1), applying the constructive ownership and
attribution rules of section 267(c), if no U.S. tax is imposed with
respect to the interest under subtitle A of the Code, determined
without regard to net operating losses or net operating loss
carryovers, and taking into account any applicable treaty obligation of
the United States. For this purpose, interest that is subject to a
reduced rate of tax under any treaty obligation of the United States
applicable to the recipient is treated as, in part, subject to the
statutory tax rate under sections 871 or 881 and, in part, not subject
to tax, based on the proportion that the rate of tax under the treaty
bears to the statutory tax rate. Thus, for purposes of section 163(j),
if the statutory tax rate is 30 percent, and pursuant to a treaty U.S.
tax is instead limited to a rate of 10 percent, two-thirds of the
interest is considered interest not subject to U.S. tax under subtitle
A of the Code;
(ii) A person that is not related to the taxpayer, within the
meaning of section 267(b) or 707(b)(1), applying the constructive
ownership and attribution rules of section 267(c), with respect to
indebtedness on which there is a disqualified guarantee, within the
meaning of paragraph (6)(D) of old section 163(j), of such
indebtedness, and no gross basis U.S. tax is imposed with respect to
the interest. For purposes of this paragraph (c)(3)(ii)(B)(3)(ii), a
gross basis U.S. tax means any tax imposed by this subtitle A of the
Code that is determined by reference to the gross amount of any item of
income without any reduction for any deduction allowed by subtitle A of
the Code. Interest that is subject to a gross basis U.S. tax that is
eligible for a reduced rate of tax under any treaty obligation of the
United States applicable to the recipient is treated as, in part,
subject to the statutory tax rate under section 871 or 881 and, in
part, not subject to a gross basis U.S. tax, based on the proportion
that the rate of tax under the treaty bears to the statutory tax rate.
Thus, for purposes of section 163(j), if the statutory tax rate is 30
percent, and pursuant to a treaty U.S. tax is instead limited to a rate
of 10 percent, two-thirds of the interest is considered interest not
subject to a gross basis U.S. tax under subtitle A of the Code; or
(iii) A REIT, directly or indirectly, to the extent that the
domestic C corporation, or a foreign corporation with income, gain, or
loss that is effectively connected, or treated as effectively
connected, with the conduct of a trade or business in the United
States, is a taxable REIT subsidiary, as defined in section 856(l),
with respect to the REIT.
(iii) Treatment of carryforwards. The amount of disallowed
disqualified interest allocated to a taxpayer pursuant to paragraph
(c)(3)(ii) of this section is treated in the same manner as described
in paragraph (c)(1) of this section.
(4) Application of section 382--(i) Ownership change occurring
before November 13, 2020--(A) Pre-change loss. For purposes of section
382(d)(3), unless the rules of Sec. 1.382-2(a)(7) apply, disallowed
disqualified interest is not a pre-change loss under Sec. 1.382-2(a)
subject to a section 382 limitation with regard to an ownership change
on a change date occurring before November 13, 2020. But see section
382(h)(6)(B) (regarding built-in deduction items).
(B) Loss corporation. For purposes of section 382(k)(1), unless the
rules of Sec. 1.382-2(a)(7) apply, disallowed disqualified interest is
not a carryforward of disallowed interest described in section
381(c)(20) with regard to an ownership change on a change date
occurring before November 13, 2020. But see section 382(h)(6)
(regarding built-in deductions).
(ii) Ownership change occurring on or after November 13, 2020--(A)
Pre-change loss. For rules governing the treatment of disallowed
disqualified interest as a pre-change loss for purposes of section 382
with regard to an ownership change on a change date occurring on or
after November 13, 2020, see Sec. Sec. 1.382-2(a)(2) and 1.382-
6(c)(3).
(B) Loss corporation. For rules governing when disallowed
disqualified interest causes a corporation to be a loss corporation
with regard to an ownership change occurring on or after November 13,
2020, see Sec. 1.382-2(a)(1)(i)(A).
(5) Treatment of excess limitation from taxable years beginning
before January 1, 2018. No amount of excess limitation under old
section 163(j)(2)(B) may be carried forward to taxable years beginning
after December 31, 2017.
[[Page 56832]]
(6) Example: Members of an affiliated group--(i) Facts. A, B, and C
are calendar-year domestic C corporations that are members of an
affiliated group (within the meaning of section 1504(a)) that was
treated as a single taxpayer under old section 163(j)(6)(C) and the
proposed regulations in this part under old section 163(j) (see
formerly proposed Sec. 1.163(j)-5). For the taxable year ending
December 31, 2017, the separately determined amounts of exempt related
person interest expense of A, B, and C were $0, $600x, and $150x,
respectively (for a total of $750x). The affiliated group has $200x of
disallowed disqualified interest in that year.
(ii) Analysis. The affiliated group's disallowed disqualified
interest expense for the 2017 taxable year ($200x) is allocated among
A, B, and C based on the ratio of each member's exempt related person
interest expense to the group's exempt related person interest expense.
Because A has no exempt related person interest expense, no disallowed
disqualified interest is allocated to A. Disallowed disqualified
interest of $160x is allocated to B (($600x/$750x) x $200x), and
disallowed disqualified interest of $40x is allocated to C (($150x/
$750x) x $200x). Thus, B and C have $160x and $40x, respectively, of
disallowed disqualified interest that is carried forward to the first
taxable year beginning after December 31, 2017. No excess limitation
that was allocated to A, B, or C under old section 163(j) will carry
forward to a taxable year beginning after December 31, 2017.
(iii) Carryforward of disallowed disqualified interest to 2018
taxable year. The facts are the same as in the Example in paragraph
(c)(7)(i) of this section, except that, for the taxable year ending
December 31, 2018, A, B, and C are members of a consolidated group that
has a section 163(j) limitation of $140x, current-year business
interest expense (as defined in Sec. 1.163(j)-1(b)(9)) of $80x, and no
excepted trade or business. Under paragraph (c)(1) of this section,
disallowed disqualified interest is carried to the taxpayer's first
taxable year beginning after December 31, 2017, and is subject to
disallowance under section 163(j) and Sec. 1.163(j)-2. Under Sec.
1.163(j)-5(b)(3)(ii)(D)(1), a consolidated group that has section
163(j) limitation remaining for the current year after deducting all
current-year business interest expense deducts each member's disallowed
disqualified interest carryforwards from prior taxable years, starting
with the earliest taxable year, on a pro rata basis (subject to certain
limitations). In accordance with paragraph (c)(1) of this section, the
rule in Sec. 1.163(j)-5(b)(3)(ii)(D)(1) applies to disallowed
disqualified interest carried forward to the taxpayer's first taxable
year beginning after December 31, 2017. Accordingly, after deducting
$80x of current-year business interest expense in 2018, the group may
deduct $60x of its $200x disallowed disqualified interest
carryforwards. Under paragraph (c)(3) of this section, B has $160x of
disallowed disqualified interest carryforwards, and C has $40x of
disallowed disqualified interest carryforwards. Thus, $48x (($160x/
$200x) x $60x) of B's disallowed disqualified interest carryforwards,
and $12x (($40x/$200x) x $60x) of C's disallowed disqualified interest
carryforwards, are deducted by the consolidated group in the 2018
taxable year.
(d) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
0
Par. 4. Section 1.263A-9 is amended by revising the first and third
sentences of paragraph (g)(1)(i) to read as follows:
Sec. 1.263A-9 The avoided cost method.
* * * * *
(g) * * *
(1) * * *
(i) * * * Interest must be capitalized under section 263A(f) before
the application of section 163(d) (regarding the investment interest
limitation), section 163(j) (regarding the limitation on business
interest expense), section 266 (regarding the election to capitalize
carrying charges), section 469 (regarding the limitation on passive
losses), and section 861 (regarding the allocation of interest to
United States sources). * * * However, in applying section 263A(f) with
respect to the excess expenditure amount, the taxpayer must capitalize
all interest that is neither investment interest under section 163(d),
business interest expense under section 163(j), nor passive interest
under section 469 before capitalizing any interest that is either
investment interest, business interest expense, or passive interest. *
* *
* * * * *
0
Par. 5. Section 1.263A-15 is amended by adding paragraph (a)(4) to read
as follows:
Sec. 1.263A-15 Effective dates, transitional rules, and anti-abuse
rules.
(a) * * *
(4) Section 1.263A-9(g)(1)(i) applies to taxable years beginning on
or after November 13, 2020. However, taxpayers and their related
parties, within the meaning of sections 267(b) and 707(b)(1), may
choose to apply the rules of that section to a taxable year beginning
after December 31, 2017, so long as the taxpayers and their related
parties consistently apply the rules of the section 163(j) regulations
(as defined in Sec. 1.163(j)-1(b)(37)), and, if applicable, Sec. Sec.
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
* * * * *
0
Par. 6. Section 1.381(c)(20)-1 is added to read as follows:
Sec. 1.381(c)(20)-1 Carryforward of disallowed business interest.
(a) Carryover requirement. Section 381(c)(20) provides that the
acquiring corporation in a transaction described in section 381(a) will
succeed to and take into account the carryover of disallowed business
interest described in section 163(j)(2) to taxable years ending after
the date of distribution or transfer.
(b) Carryover of disallowed business interest described in section
163(j)(2). For purposes of section 381(c)(20) and this section, the
term carryover of disallowed business interest described in section
163(j)(2) means the disallowed business interest expense carryforward
(as defined in Sec. 1.163(j)-1(b)(11)), including any disallowed
disqualified interest (as defined in Sec. 1.163(j)-1(b)(12)), and
including the distributor or transferor corporation's disallowed
business interest expense from the taxable year that ends on the date
of distribution or transfer. For the application of section 382 to
disallowed business interest expense described in section 163(j)(2),
see the regulations in this part under section 382 of the Code,
including but not limited to Sec. 1.382-2.
[[Page 56833]]
(c) Limitation on use of disallowed business interest expense
carryforwards in the acquiring corporation's first taxable year ending
after the date of distribution or transfer--(1) In general. In
determining the extent to which the acquiring corporation may use
disallowed business interest expense carryforwards in its first taxable
year ending after the date of distribution or transfer, the principles
of Sec. Sec. 1.381(c)(1)-1 and 1.381(c)(1)-2 apply with appropriate
adjustments, including but not limited to the adjustments described in
paragraphs (c)(2) and (3) of this section.
(2) One date of distribution or transfer within the acquiring
corporation's taxable year. If the acquiring corporation succeeds to
the disallowed business interest expense carryforwards of one or more
distributor or transferor corporations on a single date of distribution
or transfer within one taxable year of the acquiring corporation, then,
for the acquiring corporation's first taxable year ending after the
date of distribution or transfer, that part of the acquiring
corporation's business interest expense deduction (if any) that is
attributable to the disallowed business interest expense carryforwards
of the distributor or transferor corporation is limited under this
paragraph (c) to an amount equal to the post-acquisition portion of the
acquiring corporation's section 163(j) limitation, as defined in
paragraph (c)(4) of this section.
(3) Two or more dates of distribution or transfer in the taxable
year. If the acquiring corporation succeeds to the disallowed business
interest expense carryforwards of two or more distributor or transferor
corporations on two or more dates of distribution or transfer within
one taxable year of the acquiring corporation, the limitation to be
applied under this paragraph (c) is determined by applying the
principles of Sec. 1.381(c)(1)-2(b) to the post-acquisition portion of
the acquiring corporation's section 163(j) limitation, as defined in
paragraph (c)(4) of this section.
(4) Definition. For purposes of this paragraph (c), the term post-
acquisition portion of the acquiring corporation's section 163(j)
limitation means the amount that bears the same ratio to the acquiring
corporation's section 163(j) limitation (within the meaning of Sec.
1.163(j)-1(b)(31)) (or, if the acquiring corporation is a member of a
consolidated group, the consolidated group's section 163(j) limitation)
for the first taxable year ending after the date of distribution or
transfer (taking into account items to which the acquiring corporation
succeeds under section 381, other than disallowed business interest
expense carryforwards) as the number of days in that year after the
date of distribution or transfer bears to the total number of days in
that year.
(5) Examples. For purposes of this paragraph (c)(5), unless
otherwise stated, X, Y, and Z are taxable domestic C corporations that
were incorporated on January 1, 2021 and that file their tax returns on
a calendar-year basis; none of X, Y, or Z is a member of a consolidated
group; the small business exemption in Sec. 1.163(j)-2(d) does not
apply; interest expense is deductible except to the extent of the
potential application of section 163(j); and the facts set forth the
only corporate activity. The principles of this paragraph (c) are
illustrated by the following examples.
(i) Example 1: Transfer before last day of acquiring corporation's
taxable year--(A) Facts. On October 31, 2022, X transferred all of its
assets to Y in a statutory merger to which section 361 applies. For the
2021 taxable year, X had $400x of disallowed business interest expense,
and Y had $0 of disallowed business interest expense. For the taxable
year ending October 31, 2022, X had an additional $350x of disallowed
business interest expense (X did not deduct any of its 2021
carryforwards in its 2022 taxable year). For the taxable year ending
December 31, 2022, Y had business interest expense of $100x, business
interest income of $200x, and ATI of $1,000x. Y's section 163(j)
limitation for the 2022 taxable year was $500x ($200x + (30 percent x
$1,000x) = $500x).
(B) Analysis. Pursuant to Sec. 1.163(j)-5(b)(2), Y deducts its
$100x of current-year business interest expense (as defined in Sec.
1.163(j)-1(b)(9)) before any disallowed business interest expense
carryforwards (including X's carryforwards) from a prior taxable year
are deducted. The aggregate disallowed business interest expense of X
carried forward under section 381(c)(20) to Y's taxable year ending
December 31, 2022, is $750x. However, pursuant to paragraph (c)(2) of
this section, for Y's first taxable year ending after the date of
distribution or transfer, the maximum amount of X's disallowed business
interest expense carryforwards that Y can deduct is equal to the post-
acquisition portion of Y's section 163(j) limitation. Pursuant to
paragraph (c)(4) of this section, the post-acquisition portion of Y's
section 163(j) limitation means Y's section 163(j) limitation times the
ratio of the number of days in the taxable year after the date of
distribution or transfer to the total number of days in that year.
Therefore, only $84x of the aggregate amount ($500x x (61/365) = $84x)
may be deducted by Y in that year, and the remaining $666x ($750x-$84x
= $666x) is carried forward to the succeeding taxable year.
(C) Transfer on last day of acquiring corporation's taxable year.
The facts are the same as in Example 1 in paragraph (c)(5)(i)(A) of
this section, except that X's transfer of its assets to Y occurred on
December 31, 2022. For the taxable year ending December 31, 2022, X had
an additional $350x of disallowed business interest expense (X did not
deduct any of its 2021 carryforwards in its 2022 taxable year). For the
taxable year ending December 31, 2023, Y had business interest expense
of $100x, business interest income of $200x, and ATI of $1,000x. Y's
section 163(j) limitation for the 2023 taxable year was $500x ($200x +
(30 percent x $1,000x) = $500x). The aggregate disallowed business
interest expense of X carried under section 381(c)(20) to Y's taxable
year ending December 31, 2023, is $750x. Paragraph (c)(2) of this
section does not limit the amount of X's disallowed business interest
expense carryforwards that may be deducted by Y in the 2023 taxable
year. Since the amount of Y's section 163(j) limit for the 2023 taxable
year was $500x, Y may deduct the full amount ($100x) of its own
business interest expense for the 2023 taxable year, along with $400x
of X's disallowed business interest expense carryforwards.
(ii) Example 2: Multiple transferors on same date--(A) Facts. On
October 31, 2022, X and Y transferred all of their assets to Z in
statutory mergers to which section 361 applies. For the 2021 taxable
year, X had $300x of disallowed business interest expense, Y had $200x,
and Z had $0. For the taxable year ending October 31, 2022, each of X
and Y had an additional $125x of disallowed business interest expense
(neither X nor Y deducted any of its 2021 carryforwards in 2022). For
the taxable year ending December 31, 2022, Z had business interest
expense of $100x, business interest income of $200x, and ATI of
$1,000x. Z's section 163(j) limitation for the 2022 taxable year was
$500x ($200x + (30 percent x $1,000x) = $500x).
(B) Analysis. The aggregate disallowed business interest expense of
X and Y carried under section 381(c)(20) to Z's taxable year ending
December 31, 2022, is $750x. However, pursuant to paragraph (c)(2) of
this section, only $84x of the aggregate amount ($500x x (61/365) =
$84x) may be deducted by Z in that year. Moreover, under paragraph
(b)(2) of this section, this amount only may be deducted by Z in that
year after
[[Page 56834]]
Z has deducted its $100x of current-year business interest expense (as
defined in Sec. 1.163(j)-1(b)(9)).
(d) Applicability date. This section applies to taxable years
beginning on or after November 13, 2020. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to ta axable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of the section 163(j)
regulations (as defined in Sec. 1.163(j)-1(b)(37)), and, if
applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.382-1, 1.382-2, 1.382-5,
1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-
5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36,
1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate
the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and
1.1504-4, to that taxable year.
0
Par. 7. Section 1.382-1 is amended by:
0
1. Adding an entry for Sec. 1.382-2(a)(1)(vi) and (a)(7) and (8);
0
2. Revising the entry for Sec. 1.382-2(b)(3);
0
3. Adding entries for Sec. 1.382-6(a)(1) and (2) and (b)(4);
0
4. Revising the entry for Sec. 1.382-6(h); and
0
5. Adding an entry for Sec. 1.382-7(c), (d), (d)(1) through (5), (e)
through (g), and (g)(1) through (4).
The additions and revisions read as follows:
Sec. 1.382-1 Table of contents.
* * * * *
Sec. 1.382-2 General rules for ownership change.
(a) * * *
(1) * * *
(vi) Any section 382 disallowed business interest carryforward.
* * * * *
(7) Section 382 disallowed business interest carryforward.
(8) Testing period.
(b) * * *
(3) Rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), (iv),
and (v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through (8)
of this section.
* * * * *
Sec. 1.382-6 Allocation of income and loss to periods before and
after the change date for purposes of section 382.
(a) * * *
(1) In general.
(2) Allocation of business interest expense.
(i) Scope.
(ii) Deductibility of business interest expense.
* * * * *
(b) * * *
(4) Allocation of business interest expense.
(i) Scope.
(ii) Deductibility of business interest expense.
(iii) Example.
* * * * *
(h) Applicability date.
(1) In general.
(2) Paragraphs (a) and (b)(1) and (4) of this section.
* * * * *
Sec. 1.382-7
* * * * *
(c) [Reserved]
(d) Special rules.
(1)-(4) [Reserved]
(5) Section 382 disallowed business interest carryforwards.
(e)-(f) [Reserved]
(g) Applicability dates.
(1)-(3) [Reserved]
(4) Paragraph (d)(5) of this section.
* * * * *
0
Par. 8. Section 1.382-2 is amended by:
0
1. Revising paragraph (a)(1)(i)(A);
0
2. Removing ``, or'' and adding ``; or'' in its place at the end of
paragraph (a)(1)(i)(B);
0
3. Revising paragraphs (a)(1)(ii) introductory text and (a)(1)(ii)(A);
0
4. Removing ``, and'' and adding ``; and'' in its place at the end of
paragraph (a)(1)(ii)(B);
0
5. Removing the last sentence in paragraphs (a)(1)(iv) and (v);
0
6. Removing the commas and adding semicolons in their place at the end
of paragraphs (a)(2)(i) and (iii);
0
7. Removing the period and adding a semicolon in its place at the end
of paragraph (a)(2)(ii);
0
8. Removing ``, and'' and adding a semicolon in its place at the end of
paragraph (a)(2)(iv);
0
9. Removing the period and adding ``; and'' in its place at the end of
paragraph (a)(2)(v);
0
10. Adding paragraph (a)(2)(vi);
0
11. Removing the last sentence in paragraphs (a)(3)(i), (a)(4)(i), and
(a)(5) and (6);
0
12. Adding paragraphs (a)(7) and (8); and
0
13. Revising paragraph (b)(3).
The revisions and additions read as follows:
Sec. 1.382-2 General rules for ownership change.
(a) * * *
(1) * * *
(i) * * *
(A) Is entitled to use a net operating loss carryforward, a capital
loss carryover, a carryover of excess foreign taxes under section
904(c), a carryforward of a general business credit under section 39, a
carryover of a minimum tax credit under section 53, or a section 382
disallowed business interest carryforward described in paragraph (a)(7)
of this section;
* * * * *
(ii) Distributor or transferor loss corporation in a transaction
under section 381. Notwithstanding that a loss corporation ceases to
exist under state law, if its disallowed business interest expense
carryforwards, net operating loss carryforwards, excess foreign taxes,
or other items described in section 381(c) are succeeded to and taken
into account by an acquiring corporation in a transaction described in
section 381(a), such loss corporation will be treated as continuing in
existence until--
(A) Any pre-change losses (excluding pre-change credits described
in Sec. 1.383-1(c)(3)), determined as if the date of such transaction
were the change date, are fully utilized or expire under section
163(j), 172, or 1212;
* * * * *
(2) * * *
(vi) Any section 382 disallowed business interest carryforward.
* * * * *
(7) Section 382 disallowed business interest carryforward. The term
section 382 disallowed business interest carryforward includes the
following items:
(i) The loss corporation's disallowed business interest expense
carryforwards (as defined in Sec. 1.163(j)-1(b)(11)), including
disallowed disqualified interest (as defined in Sec. 1.163(j)-
1(b)(12)), as of the date of the ownership change.
(ii) The loss corporation's current-year business interest expense
(as defined in Sec. 1.163(j)-1(b)(9)) in the change year (as defined
in Sec. 1.382-6(g)(1)) that is allocable to the pre-change period (as
defined in Sec. 1.382-6(g)(2)) under Sec. 1.382-6(a) or (b) and that
becomes disallowed business interest expense (as defined in Sec.
1.163(j)-1(b)(10)).
(8) Testing period. Notwithstanding the temporal limitations
provided in Sec. 1.382-2T(d)(3)(i), the testing period for a loss
corporation can begin as early as the first day of the first taxable
year from which there is a section 382 disallowed business interest
carryforward to the first taxable year ending after the testing date.
(b) * * *
(3) Rules provided in paragraphs (a)(1)(i)(A), (a)(1)(ii), (iv),
and (v), (a)(2)(iv) through (vi), (a)(3)(i), and (a)(4) through (8) of
this section. The rules provided in paragraphs (a)(1)(i)(A),
(a)(1)(ii), (iv), and (v), (a)(2)(iv) through (vi), (a)(3)(i), and
(a)(4) through (8) of this section apply to testing dates
[[Page 56835]]
occurring on or after November 13, 2020. For loss corporations that
have testing dates occurring before November 13, 2020, see Sec. 1.382-
2 as contained in 26 CFR part 1, revised April 1, 2019. However,
taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of this section to
testing dates occurring during a taxable year beginning after December
31, 2017, and before November 13, 2020, so long as the taxpayers and
their related parties consistently apply the rules of this section, the
section 163(j) regulations (as defined in Sec. 1.163(j)-1(b)(37)),
Sec. Sec. 1.382-1, 1.382-5, 1.382-6, 1.382-7, 1.383-0, and 1.383-1,
and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1,
1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of Sec. Sec. 1.382-2, 1.382-
5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
0
Par. 9. Section 1.382-5 is amended by revising the first and second
sentences of paragraph (d)(1) and by adding three sentences to the end
of paragraph (f) to read as follows:
Sec. 1.382-5 Section 382 limitation.
* * * * *
(d) * * *
(1) * * * If a loss corporation has two (or more) ownership
changes, any losses or section 382 disallowed business interest
carryforwards ((within the meaning of Sec. 1.382-2(a)(7)) attributable
to the period preceding the earlier ownership change are treated as
pre-change losses with respect to both ownership changes. Thus, the
later ownership change may result in a lesser (but never in a greater)
section 382 limitation with respect to such pre-change losses. * * *
* * * * *
(f) * * * Paragraph (d)(1) of this section applies with respect to
an ownership change occurring on or after November 13, 2020. For loss
corporations that have undergone an ownership change before or after
November 13, 2020, see Sec. 1.382-5 as contained in 26 CFR part 1,
revised April 1, 2019. However, taxpayers and their related parties,
within the meaning of sections 267(b) and 707(b)(1), may choose to
apply the rules of this section to testing dates occurring during a
taxable year beginning after December 31, 2017, so long as the
taxpayers and their related parties consistently apply the rules of
this section, the section 163(j) regulations (as defined in Sec.
1.163(j)-1(b)(37)), Sec. Sec. 1.382-1, 1.382-2, 1.382-6, 1.382-7,
1.383-0, and 1.383-1, and, if applicable, Sec. Sec. 1.263A-9, 1.263A-
15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3,
1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-
91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to
that taxable year.
0
Par. 10. Section 1.382-6 is amended by:
0
1. Redesignating the text of paragraph (a) as paragraph (a)(1);
0
2. Adding a subject heading to newly redesignated paragraph (a)(1);
0
3. Adding paragraph (a)(2);
0
4. Removing the language ``Subject to paragraphs (b)(3)(ii) and (d)''
in the first sentence of paragraph (b)(1) and adding ``Subject to
paragraphs (b)(3)(ii), (b)(4), and (d)'' in its place;
0
5. Adding paragraph (b)(4); and
0
6. Revising paragraph (h).
The additions and revision read as follows:
Sec. 1.382-6 Allocation of income and loss to periods before and
after the change date for purposes of section 382.
(a) * * *
(1) In general. * * *
(2) Allocation of business interest expense--(i) Scope. Except as
provided in paragraph (b)(4) of this section, this paragraph (a)(2)
applies if a loss corporation has business interest expense (as defined
in Sec. 1.163(j)-1(b)(3)) in the change year. The rules of this
paragraph (a)(2) apply to determine the amount of current-year business
interest expense (as defined in Sec. 1.163(j)-1(b)(9)) that is
deducted in the change year. These rules also apply to determine the
amount of any current-year business interest expense that is
characterized as disallowed business interest expense (as defined in
Sec. 1.163(j)-1(b)(10)) allocable to the pre-change period and the
post-change period, and to allocate disallowed business interest
expense carryforwards (as defined in Sec. 1.163(j)-1(b)(11)) to the
change year for deduction in the pre-change period and the post-change
period.
(ii) Deductibility of business interest expense. The rules of this
paragraph (a)(2)(ii) apply in the following order.
(A) First, the loss corporation calculates its section 163(j)
limitation (as defined in Sec. 1.163(j)-1(b)(36)) for the change year.
(B) Second, the loss corporation calculates its deductible current-
year BIE and deducts this amount in determining its taxable income or
net operating loss for the change year. For purposes of this paragraph
(a)(2)(ii), the term deductible current-year BIE means the loss
corporation's current-year business interest expense (including its
floor plan financing interest expense, as defined in Sec. 1.163(j)-
1(b)(19)), to the extent of its section 163(j) limitation.
(C) Third, if the loss corporation has disallowed business interest
expense paid or accrued (without regard to section 163(j)) in the
change year that is carried forward to post-change years, it allocates
an equal portion of that disallowed business interest expense to each
day in the change year. Any amount of disallowed business interest
expense that is allocated to the pre-change period pursuant to this
paragraph (a)(2)(ii)(C) is carried forward subject to section
382(d)(3). Any amount of disallowed business interest expense that is
allocated to the post-change period pursuant to this paragraph
(a)(2)(ii)(C) is carried forward and is not subject to section
382(d)(3).
(D) Fourth, if the loss corporation has excess section 163(j)
limitation, then the loss corporation calculates its deductible
disallowed business interest expense carryforward and allocates an
equal portion to each day in the change year. For purposes of this
paragraph (a)(2)(ii), the term excess section 163(j) limitation means
the excess, if any, of the loss corporation's section 163(j) limitation
over its deductible current-year BIE, and the term deductible
disallowed business interest expense carryforward means the loss
corporation's disallowed business interest expense carryforward to the
extent of its excess section 163(j) limitation.
(E) Fifth, the loss corporation deducts its deductible disallowed
business interest expense carryforward that was allocated to the pre-
change period under paragraph (a)(2)(ii)(D) of this section. Subject to
the application of sections 382(b)(3)(B) and 382(d)(3), the loss
corporation deducts its deductible disallowed business interest expense
carryforward that was allocated to the post-change period under
paragraph (a)(2)(ii)(D) of this section. Any amount of disallowed
business interest expense carryforward that is not deducted pursuant to
this paragraph (a)(2)(ii)(E) is carried forward subject to section
382(d)(3).
* * * * *
(b) * * *
(4) Allocation of business interest expense--(i) Scope. This
paragraph (b)(4) applies if a loss corporation makes a closing-of-the-
books election pursuant to paragraph (b) of this section and has
business interest expense in the change year. The rules of this
paragraph (b)(4)
[[Page 56836]]
apply to determine the amount of deductible current-year business
interest expense that is allocable to the pre-change period and the
post-change period for purposes of the allocations referred to in
paragraph (b)(1) of this section. These rules also apply to determine
the amount of any current-year business interest expense that is
characterized as disallowed business interest expense allocable to the
pre-change period and the post-change period, and to allocate
disallowed business interest expense carryforwards to the change year
between the pre-change period and the post-change period for deduction.
(ii) Deductibility of business interest expense. The rules of this
paragraph (b)(4)(ii) apply in the order provided.
(A) The loss corporation calculates its ATI limit, which is the
product of its ATI (as defined in Sec. 1.163(j)-1(b)(1)) for the
change year and 30 percent. For purposes of this paragraph (b)(4)(ii),
the terms pre-change ATI limit and post-change ATI limit mean the
amount of ATI limit allocated to the pre-change period or the post-
change period, respectively, computed by allocating an equal portion of
the ATI limit to each day in the change year.
(B) Pursuant to paragraph (b)(1) of this section, the loss
corporation allocates its current-year business interest expense
(including its floor plan financing interest expense) and its business
interest income (as defined in Sec. 1.163(j)-1(b)(4)) to the pre-
change and post-change periods as if the loss corporation's books were
closed on the change date. For purposes of this paragraph (b)(4)(ii),
the terms pre-change BIE and post-change BIE mean the amount of the
loss corporation's current-year business interest expense that is
allocated to the pre-change period or the post-change period,
respectively, under this paragraph (b)(4)(ii)(B).
(C) The loss corporation deducts its pre-change BIE to the extent
of its pre-change section 163(j) limit, and the loss corporation
deducts its post-change BIE to the extent of its post-change section
163(j) limit. For purposes of this paragraph (b)(4)(ii), the term pre-
change section 163(j) limit means the sum of the pre-change ATI and the
amount of business interest income and floor plan financing interest
expense allocated to the pre-change period; the term post-change
section 163(j) limit means the sum of the post-change ATI limit and the
amount of business interest income and floor plan financing interest
expense allocated to the post-change period.
(D) If any pre-change BIE or post-change BIE has not been deducted
under paragraph (b)(4)(ii)(C) of this section, the loss corporation
deducts either any pre-change BIE that has not been deducted to the
extent of its surplus post-change section 163(j) limit or any post-
change BIE that has not been deducted to the extent of its surplus pre-
change section 163(j) limit. For purposes of this paragraph (b)(4)(ii),
the term surplus pre-change section 163(j) limit means the amount by
which the pre-change section 163(j) limit exceeds the amount of pre-
change BIE deducted pursuant to paragraph (b)(4)(ii)(C) of this
section; the term surplus post-change section 163(j) limit means the
amount by which the post-change section 163(j) limit exceeds the amount
of post-change BIE deducted pursuant to paragraph (b)(4)(ii)(C) of this
section.
(E) If the loss corporation has any excess pre-change section
163(j) limit or excess post-change section 163(j) limit, the loss
corporation allocates its disallowed business interest expense
carryforward, if any, ratably between the pre-change and post-change
periods based upon the relative amounts of excess pre-change section
163(j) limit and excess post-change section 163(j) limit. For purposes
of this paragraph (b)(4)(ii), the term excess pre-change section 163(j)
limit means the amount by which the surplus pre-change section 163(j)
limit exceeds the amount of post-change BIE deducted pursuant to
paragraph (b)(4)(ii)(D) of this section; the term excess post-change
section 163(j) limit means the amount by which the surplus post-change
section 163(j) limit exceeds the amount of pre-change BIE deducted
pursuant to paragraph (b)(4)(ii)(D) of this section.
(F) The loss corporation deducts its disallowed business interest
expense carryforward that was allocated to the pre-change period under
paragraph (b)(4)(ii)(E) of this section to the extent of its excess
pre-change section 163(j) limit. Subject to the application of sections
382(b)(3)(B) and 382(d)(3), the loss corporation deducts its disallowed
business interest expense carryforward that was allocated to the post-
change period under paragraph (b)(4)(ii)(E) of this section to the
extent of its excess post-change section 163(j) limit. Any amount of
disallowed business interest expense carryforward that is not deducted
pursuant to this paragraph (b)(4)(ii)(F) is subject to section
382(d)(3) irrespective of the period to which it was allocated pursuant
to paragraph (b)(4)(ii)(E) of this section.
(iii) Example 1--(A) Facts. X is a calendar-year domestic C
corporation that is not a member of a consolidated group. As of January
1, 2021, X has no disallowed business interest expense carryforwards.
On October 19, 2021, X experiences an ownership change under section
382(g). For calendar year 2021, X's ATI is $500. For the period
beginning on January 1, 2021 and ending on October 19, 2021, X pays or
accrues $250 of current-year business interest expense that is
deductible but for the potential application of section 163(j),
including $50 of floor plan financing interest expense, and X has $60
of business interest income. For the period beginning on October 20,
2021 and ending on December 31, 2021, X pays or accrues $100 of
current-year business interest expense that is deductible but for the
potential application of section 163(j), including $40 of floor plan
financing interest expense, and X has $70 of business interest income.
X makes a closing-of-the-books election pursuant to paragraph (b) of
this section.
(B) Analysis--(1) Calculation and allocation of ATI limit. For
purposes of allocating its net operating loss or taxable income for the
change year between the pre-change period and the post-change period
under Sec. 1.382-6, X applies paragraph (b)(4) of this section to
allocate items related to section 163(j). X's ATI for calendar year
2021 is $500x. Therefore, pursuant to paragraph (b)(4)(ii)(A) of this
section, X's ATI limit is $150 ($500 x 30 percent). Additionally,
pursuant to paragraph (b)(4)(ii)(A) of this section, X's pre-change ATI
limit is $120 ($150 x (292 days/365 days)), and X's post-change ATI
limit is $30 ($150 x (73 days/365 days)).
(2) Determination of pre-change BIE and post-change BIE. Pursuant
to paragraph (b)(4)(ii)(B) of this section, X's pre-change BIE and
post-change BIE are $250 and $100, respectively.
(3) Determination of pre-change section 163(j) limit and post-
change section 163(j) limit. Pursuant to paragraph (b)(4)(ii)(C) of
this section, X's pre-change section 163(j) limit is $230 ($120 (X's
pre-change ATI limit) + $60 (X's business interest income allocated to
the pre-change period) + $50 (X's floor plan financing interest expense
allocated to the pre-change period)). Additionally, pursuant to
paragraph (b)(4)(ii)(C) of this section, X's post-change section 163(j)
limit is $140 ($30 (X's post-change ATI limit) + $70 (X's business
interest income allocated to the post-change period) + $40 (X's floor
plan financing interest expense allocated to the post-change period)).
(4) Initial deduction of BIE. Pursuant to paragraph (b)(4)(ii)(C)
of this section,
[[Page 56837]]
X deducts $230 (its pre-change section 163(j) limit) of its $250 pre-
change BIE and all $100 (less than its $140 post-change section 163(j)
limit) of its post-change BIE.
(5) Deduction of BIE due to surplus post-change section 163(j)
limit. After applying paragraph (b)(4)(ii)(C) of this section, X has
$20 of pre-change BIE that has not been deducted ($250-$230) and a
surplus post-change section 163(j) limit of $40 ($140-$100). As a
result, pursuant to paragraph (b)(4)(ii)(D) of this section, X deducts
its remaining $20 of pre-change BIE. (If, after applying paragraph
(b)(4)(ii)(C) of this section, X instead had $20 of post-change BIE
that had not yet been deducted and a $40 surplus pre-change section
163(j) limit, then X would deduct its remaining $20 of post-change BIE
pursuant to paragraph (b)(4)(ii)(D) of this section.)
(iv) Example 2--Potential deduction of disallowed business interest
expense carryforwards. The facts are the same as in paragraph
(b)(4)(iii)(A) of this section, except that, as of January 1, 2021, X
has $90 of disallowed business interest expense carryforwards and $150
(rather than $250) of pre-change BIE. X's pre-change section 163(j)
limit and post-change section 163(j) limit are the same as in paragraph
(b)(4)(iii)(B)(3) of this section. Pursuant to paragraph (b)(4)(ii)(C)
of this section, X deducts all $150 of its pre-change BIE and all $100
of its post-change BIE. X has no remaining pre-change BIE or post-
change BIE to deduct under paragraph (b)(4)(ii)(D) of this section.
Paragraph (b)(4)(ii)(E) of this section applies because X has $80 of
excess pre-change section 163(j) limit ($230-$150) and $40 of excess
post-change section 163(j) limit ($140-$100). Under paragraph
(b)(4)(ii)(E) of this section, X allocates $60 of its disallowed
business interest expense carryforwards to the pre-change period ($90 x
($80/($80 + $40))) and $30 of its disallowed business interest expense
carryforwards to the post-change period ($90 x ($40/($80 + $40))). As
provided in paragraph (b)(4)(ii)(F) of this section, X deducts all $60
of its disallowed business interest expense carryforwards that are
allocated to the pre-change period; subject to the application of
section 382, X deducts all $30 of its disallowed business interest
expense carryforwards that are allocated to the post-change period.
* * * * *
(h) Applicability date--(1) In general. This section applies to
ownership changes occurring on or after June 22, 1994.
(2) Ownership changes. Paragraphs (a) and (b)(1) and (4) of this
section apply with respect to an ownership change occurring during a
taxable year beginning on or after November 13, 2020. For ownership
changes occurring during a taxable year beginning before November 13,
2020, see Sec. 1.382-6 as contained in 26 CFR part 1, revised April 1,
2019. However, taxpayers and their related parties, within the meaning
of sections 267(b) and 707(b)(1), may choose to apply the rules of this
section to testing dates occurring during a taxable year beginning
after December 31, 2017, so long as the taxpayers and their related
parties consistently apply the rules of this section, the section
163(j) regulations (as defined in Sec. 1.163(j)-1(b)(37)), Sec. Sec.
1.382-1, 1.382-2, 1.382-5, 1.383-0, and 1.383-1, and, if applicable,
Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21,
1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they
effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, 1.382-7,
and 1.383-1), and 1.1504-4, to taxable years beginning after December
31, 2017.
0
Par. 11. Section 1.382-7 is amended by adding paragraphs (c), (d), (e),
(f), and (g) to read as follows:
Sec. 1.382-7 Built-in gains and losses.
* * * * *
(c) [Reserved]
(d) Special rules. This paragraph (d) contains special rules
regarding the identification of recognized built-in losses.
(1)-(4) [Reserved]
(5) Section 382 disallowed business interest carryforwards. Section
382 disallowed business interest carryforwards are not treated as
recognized built-in losses.
(e)-(f) [Reserved]
(g) Applicability dates.
(1)-(3) [Reserved]
(4) Paragraph (d)(5) of this section. Paragraph (d)(5) of this
section applies with respect to an ownership change occurring on or
after November 13, 2020. For loss corporations that have undergone an
ownership change before or after November 13, 2020, see Sec. 1.382-7
as contained in 26 CFR part 1, revised April 1, 2019. However,
taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of paragraph (d)(5)
of this section to testing dates occurring during a taxable year
beginning after December 31, 2017.
0
Par. 12. Section 1.383-0 is amended by revising paragraph (a) to read
as follows:
Sec. 1.383-0 Effective date.
(a) The regulations in this part under section 383 of the Code
(other than the regulations described in paragraph (b) of this section)
reflect the amendments made to sections 382 and 383 by the Tax Reform
Act of 1986 and the amendments made to section 382 by Public Law 115-97
(2017). See Sec. 1.383-1(j) for effective date rules.
* * * * *
0
Par. 13. Section 1.383-1 is amended by:
0
1. In paragraph (a):
0
a. Adding entries for paragraphs (d)(1)(i) and (ii);
0
b. Revising the entries for paragraphs (e)(3) and (j);
0
c. Adding entries for paragraphs (j)(1) and (2); and
0
d. Removing the entry for paragraph (k).
0
2. Removing ``(iv)'' and adding ``(v)'' in its place in paragraph
(c)(6)(i)(B).
0
3. Revising paragraphs (c)(6)(ii) and (d)(1).
0
4. Removing the commas and adding semicolons in their place at ends of
paragraphs (d)(2)(i), (ii), and (vi).
0
5. Revising paragraph (d)(2)(iii).
0
6. Redesignating paragraphs (d)(2)(iv) through (vii) as paragraphs
(d)(2)(v) through (viii), respectively.
0
7. Adding a new paragraph (d)(2)(iv).
0
8. Revising newly redesignated paragraph (d)(2)(v) and paragraph
(d)(3)(ii).
0
9. Removing ``(iv)'' and adding ``(v)'' in its place in paragraph
(e)(1).
0
10. In paragraph (e)(2):
0
a. Removing ``sections 11(b)(2) and (15)'' and adding ``section 15'' in
its place in the fourth sentence; and
0
b. Removing the last two sentences.
0
11. Removing and reserving paragraph (e)(3).
0
12. In paragraph (f):
0
a. Removing Example 4;
0
b. Designating Examples 1 through 3 as paragraphs (f)(1) through (3),
respectively; and
0
c. Revising newly designated paragraphs (f)(2) and (3).
0
13. In the last sentence of paragraph (g), removing ``(e.g., 0.34 for
taxable years beginning in 1989)''.
0
14. In paragraph (j):
0
a. Revising the subject heading;
0
b. Designating the text of paragraph (j) as paragraph (j)(1) and adding
a heading to newly designated paragraph (j)(1); and
0
c. Adding paragraph (j)(2).
0
15. Removing paragraph (k).
The revisions and additions read as follows:
[[Page 56838]]
Sec. 1.383-1 Special limitations on certain capital losses and
excess credits.
(a) * * *
* * * * *
(d) * * *
(1) * * *
(i) In general.
(ii) Ordering rule for losses or credits from same taxable year.
* * * * *
(e) * * *
(3) [Reserved]
* * * * *
(j) Applicability date.
(1) In general.
(2) Interaction with section 163(j).
* * * * *
(c) * * *
(6) * * *
(ii) Example. L, a new loss corporation, is a calendar-year
taxpayer. L has an ownership change on December 31, 2021. For 2022, L
has taxable income (prior to the use of any pre-change losses) of
$100,000. In addition, L has a section 382 limitation of $25,000, a
pre-change net operating loss carryover of $12,000, a pre-change
general business credit carryforward under section 39 of $50,000, and
no items described in Sec. 1.383-1(d)(2)(i) through (iv). L's section
383 credit limitation for 2022 is the excess of its regular tax
liability computed after allowing a $12,000 net operating loss
deduction (taxable income of $88,000; regular tax liability of
$18,480), over its regular tax liability computed after allowing an
additional deduction in the amount of L's section 382 limitation
remaining after the application of paragraphs (d)(2)(i) through (v) of
this section, or $13,000 (taxable income of $75,000; regular tax
liability of $15,750). L's section 383 credit limitation is therefore
$2,730 ($18,480 minus $15,750).
(d) * * *
(1) In general--(i) General rule. The amount of taxable income of a
new loss corporation for any post-change year that may be offset by
pre-change losses shall not exceed the amount of the section 382
limitation for the post-change year. The amount of the regular tax
liability of a new loss corporation for any post-change year that may
be offset by pre-change credits shall not exceed the amount of the
section 383 credit limitation for the post-change year.
(ii) Ordering rule for losses or credits from same taxable year. A
loss corporation's taxable income is offset first by losses subject to
a section 382 limitation, to the extent the section 382 limitation for
that taxable year has not yet been absorbed, before being offset by
losses of the same type from the same taxable year that are not subject
to a section 382 limitation. For example, assume that Corporation X has
an ownership change in Year 1 and carries over disallowed business
interest expense as defined in Sec. 1.163(j)-1(b)(10), some of which
constitutes a section 382 disallowed business interest carryforward,
from Year 1 to Year 2. To the extent of its section 163(j) limitation,
as defined in Sec. 1.163(j)-1(b)(36), and its remaining section 382
limitation, Corporation X offsets its Year 2 income with the section
382 disallowed business interest carryforward before using any of the
disallowed business interest expense that is not a section 382
disallowed business interest carryforward. Similar principles apply to
the use of tax credits.
(2) * * *
(iii) Pre-change losses that are described in Sec. 1.382-
2(a)(2)(iii), other than losses that are pre-change capital losses,
that are recognized and are subject to the section 382 limitation in
such post-change year;
(iv)(A) With respect to an ownership change date occurring prior to
November 13, 2020, but during the taxable year which includes November
13, 2020, the pre-change loss described in section 382(d)(3);
(B) With respect to an ownership change date occurring on or after
November 13, 2020, section 382 disallowed business interest
carryforwards (within the meaning of Sec. 1.382-2(a)(7));
(v) Pre-change losses not described in paragraphs (d)(2)(i) through
(iv) of this section;
* * * * *
(3) * * *
(ii) Example. L, a calendar-year taxpayer, has an ownership change
on December 31, 2021. For 2022, L has taxable income of $300,000 and a
regular tax liability of $63,000. L has no pre-change losses, but it
has a business credit carryforward from 2020 of $25,000. L has a
section 382 limitation for 2022 of $50,000. L's section 383 credit
limitation is $10,500, an amount equal to the excess of L's regular tax
liability ($63,000) over its regular tax liability calculated by
allowing an additional deduction of $50,000 ($52,500). Pursuant to the
limitation contained in section 38(c), however, L is entitled to use
only $9,500 (($63,000-$25,000) x 25 percent) of its business credit
carryforward in 2022. The unabsorbed portion of L's section 382
limitation, $1,000 (computed pursuant to paragraph (e) of this
section), is carried forward under section 382(b)(2). The unused
portion of L's business credit carryforward, $14,500, is carried
forward to the extent provided in section 39.
* * * * *
(f) * * *
(2) Example 2--(i) Facts. L, a calendar-year taxpayer, has an
ownership change on December 31, 2021. For 2022, L has $750,000 of
ordinary taxable income (before the application of carryovers) and a
section 382 limitation of $1,500,000. L's only carryovers are from pre-
2021 taxable years and consist of a $500,000 net operating loss (NOL)
carryover, and a $200,000 foreign tax credit carryover (all of which
may be used under the section 904 limitation). The NOL carryover is a
pre-change loss, and the foreign tax credit carryover is a pre-change
credit. L has no other pre-change losses or credits that can be used in
2022.
(ii) Analysis. The following computation illustrates the
application of this section for 2022:
Table 1 to Paragraph (f)(2)(ii)
------------------------------------------------------------------------
------------------------------------------------------------------------
1. Taxable income before carryovers........................ $750,000
2. Pre-change NOL carryover................................ 500,000
3. Section 382 limitation.................................. 1,500,000
4. Amount of pre-change NOL carryover that can be used 500,000
(least of line 1, 2, or 3)................................
5. Taxable income (line 1 minus line 4).................... 250,000
6. Section 382 limitation remaining (line 3 minus line 4).. 1,000,000
7. Pre-change credit carryover............................. 200,000
8. Regular tax liability (line 5 x section 11 rates)....... 52,500
9. Modified tax liability (line 5 minus line 6 (but not 0
less than zero) x section 11 rates).......................
10. Section 383 credit limitation (line 8 minus line 9).... 52,500
11. Amount of pre-change credits that can be used in 2022 52,500
(lesser of line 7 or line 10).............................
12. Amount of pre-change credits to be carried over to 2023 147,500
under section 904(c) (line 7 minus line 11)...............
[[Page 56839]]
13. Section 383 credit reduction amount: $52,500/0.21...... 250,000
14. Section 382 limitation to be carried to 2023 under 750,000
section 382(b)(2) (line 6 minus line 13)..................
------------------------------------------------------------------------
(3) Example 3--(i) Facts. L, a calendar-year taxpayer, has an
ownership change on December 31, 2021. L has $80,000 of ordinary
taxable income (before the application of carryovers) and a section 382
limitation of $25,000 for 2022, a post-change year. L's only carryover
is from a pre-2021 taxable year and is a general business credit
carryforward under section 39 in the amount of $10,000 (no portion of
which is attributable to the investment tax credit under section 46).
The general business credit carryforward is a pre-change credit. L has
no other credits which can be used in 2022.
(ii) Analysis. The following computation illustrates the
application of this section:
Table 2 to paragraph (f)(3)(ii)
------------------------------------------------------------------------
------------------------------------------------------------------------
1. Taxable income before carryovers........................ $80,000
2. Section 382 limitation.................................. 25,000
3. Pre-change credit carryover............................. 10,000
4. Regular tax liability (line 1 x section 11 rates)....... 16,800
5. Modified tax liability ((line 1 minus line 2) x section 11,550
11 rates).................................................
6. Section 383 credit limitation (line 4 minus line 5)..... 5,250
7. Amount of pre-change credits that can be used (lesser of 5,250
line 3 or line 6).........................................
8. Amount of pre-change credits to be carried over to 2023 4,750
under sections 39 and 382(l)(2) (line 3 minus line 7).....
9. Regular tax payable (line 4 minus line 7)............... 11,550
10. Section 383 credit reduction amount: $5,250/0.21....... 25,000
11. Section 382 limitation to be carried to 2023 under 0
section 382(b)(2) (line 2 minus line 10)..................
------------------------------------------------------------------------
* * * * *
(j) Applicability date--(1) In general. * * *
(2) Interaction with section 163(j). Paragraphs (c)(6)(i)(B) and
(c)(6)(ii), (d)(1), (d)(2)(iii) through (viii), (d)(3)(ii), (e)(1)
through (3), (f), and (g) of this section apply with respect to
ownership changes occurring during a taxable year beginning on or after
November 13, 2020. For loss corporations that have undergone an
ownership change during a taxable year beginning before November 13,
2020, see Sec. 1.383-1 as contained in 26 CFR part 1, revised April 1,
2019. However, taxpayers and their related parties, within the meaning
of sections 267(b) and 707(b)(1), may choose to apply the rules of this
section to an ownership change occurring during a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply either the rules of this section
(except paragraph (d)(2)(iv)(B) of this section), the section 163(j)
regulations (as defined in Sec. 1.163(j)-1(b)(37)), Sec. Sec. 1.382-
1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-0, and, if applicable,
Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11,
1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21,
1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they
effectuate the rules of Sec. Sec. 1.382-2, Sec. 1.382-5, 1.382-6, and
1.383-1), and 1.1504-4; or the rules of this section (except paragraph
(d)(2)(iv)(A) of this section), the section 163(j) regulations (as
defined in Sec. 1.163(j)-1(b)(37)) and Sec. Sec. 1.382-1, 1.382-2,
1.382-5, 1.382-6, and 1.383-0, and, if applicable, Sec. Sec. 1.263A-9,
1.263A-15, 1.381(c)(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-
3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79,
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, 1.382-7, and 1.383-1), and
1.1504-4, to those ownership changes.
0
Par. 14. Section 1.446-3 is amended by revising paragraphs (g)(4) and
(j)(2) to read as follows:
Sec. 1.446-3 Notional principal contracts.
* * * * *
(g) * * *
(4) Swaps with significant nonperiodic payments--(i) General rule.
Except as provided in paragraph (g)(4)(ii) of this section, a swap with
significant nonperiodic payments is treated as two separate
transactions consisting of an on-market, level payment swap and a loan.
The loan must be accounted for by the parties to the contract
independently of the swap. The time value component associated with the
loan, determined in accordance with paragraph (f)(2)(iii)(A) of this
section, is recognized as interest expense to the payor and interest
income to the recipient.
(ii) Exception for cleared swaps and non-cleared swaps subject to
margin or collateral requirements. Paragraph (g)(4)(i) of this section
does not apply to a swap if the contract is described in paragraph
(g)(4)(ii)(A) or (B) of this section.
(A) The swap is cleared by a derivatives clearing organization, as
such term is defined in section 1a of the Commodity Exchange Act (7
U.S.C. 1a), or by a clearing agency, as such term is defined in section
3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c), that is
registered as a derivatives clearing organization under the Commodity
Exchange Act or as a clearing agency under the Securities Exchange Act
of 1934, respectively, and the derivatives clearing organization or
clearing agency requires the parties to the swap to post and collect
margin or collateral.
(B) The swap is a non-cleared swap that requires the parties to
meet the margin or collateral requirements of a federal regulator or
that provides for margin or collateral requirements that are
substantially similar to a cleared swap or a non-cleared swap subject
to the margin or collateral requirements of a federal regulator. For
purposes of this paragraph (g)(4)(ii)(B), the term federal regulator
means the Securities and Exchange Commission (SEC), the Commodity
Futures Trading Commission (CFTC), or a prudential regulator, as
defined in section 1a(39) of the Commodity Exchange Act (7 U.S.C. 1a),
as amended by section 721 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010, Public Law 111-203, 124 Stat. 1376,
Title VII.
[[Page 56840]]
(iii) Coordination with section 163(j). For the treatment of swaps
with significant nonperiodic payments under section 163(j), see Sec.
1.163(j)-1(b)(22)(ii).
* * * * *
(j) * * *
(2) The rules provided in paragraph (g)(4) of this section apply to
notional principal contracts entered into on or after September 14,
2021. Taxpayers may choose to apply the rules provided in paragraph
(g)(4) of this section to notional principal contracts entered into
before September 14, 2021.
0
Par. 15. Section 1.469-9 is amended by revising paragraph (b)(2) to
read as follows:
Sec. 1.469-9 Rules for certain rental real estate activities.
* * * * *
(b) * * *
(2) Real property trade or business. The following terms have the
following meanings in determining whether a trade or business is a real
property trade or business for purposes of section 469(c)(7)(C) and
this section.
(i) Real property--(A) In general. The term real property includes
land, buildings, and other inherently permanent structures that are
permanently affixed to land. Any interest in real property, including
fee ownership, co-ownership, a leasehold, an option, or a similar
interest is real property under this section. Tenant improvements to
land, buildings, or other structures that are inherently permanent or
otherwise classified as real property under this section are real
property for purposes of section 469(c)(7)(C). However, property
manufactured or produced for sale that is not real property in the
hands of the manufacturer or producer, but that may be incorporated
into real property through installation or any similar process or
technique by any person after the manufacture or production of such
property (for example, bricks, nails, paint, and windowpanes), is not
treated as real property in the hands of any person (including any
person involved in the manufacture, production, sale, incorporation or
installation of such property) prior to the completed incorporation or
installation of such property into the real property for purposes of
section 469(c)(7)(C) and this section.
(B) Land. The term land includes water and air space superjacent to
land and natural products and deposits that are unsevered from the
land. Natural products and deposits, such as plants, crops, trees,
water, ores, and minerals, cease to be real property when they are
harvested, severed, extracted, or removed from the land. Accordingly,
any trade or business that involves the cultivation and harvesting of
plants, crops, or certain types of trees in a farming operation as
defined in section 464(e), or severing, extracting, or removing natural
products or deposits from land is not a real property trade or business
for purposes of section 469(c)(7)(C) and this section. The storage or
maintenance of severed or extracted natural products or deposits, such
as plants, crops, trees, water, ores, and minerals, in or upon real
property does not cause the stored property to be recharacterized as
real property, and any trade or business relating to or involving such
storage or maintenance of severed or extracted natural products or
deposits is not a real property trade or business, even though such
storage or maintenance otherwise may occur upon or within real
property.
(C) Inherently permanent structure. The term inherently permanent
structure means any permanently affixed building or other permanently
affixed structure. If the affixation is reasonably expected to last
indefinitely, based on all the facts and circumstances, the affixation
is considered permanent. However, an asset that serves an active
function, such as an item of machinery or equipment (for example, HVAC
system, elevator or escalator), is not a building or other inherently
permanent structure, and therefore is not real property for purposes of
section 469(c)(7)(C) and this section, even if such item of machinery
or equipment is permanently affixed to or becomes incorporated within a
building or other inherently permanent structure. Accordingly, a trade
or business that involves the manufacture, installation, operation,
maintenance, or repair of any asset that serves an active function will
not be a real property trade or business, or a unit or component of
another real property trade or business, for purposes of section
469(c)(7)(C) and this section.
(D) Building--(1) In general. A building encloses a space within
its walls and is generally covered by a roof or other external upper
covering that protects the walls and inner space from the elements.
(2) Types of buildings. Buildings include the following assets if
permanently affixed to land: Houses; townhouses; apartments;
condominiums; hotels; motels; stadiums; arenas; shopping malls; factory
and office buildings; warehouses; barns; enclosed garages; enclosed
transportation stations and terminals; and stores.
(E) Other inherently permanent structures--(1) In general. Other
inherently permanent structures include the following assets if
permanently affixed to land: Parking facilities; bridges; tunnels;
roadbeds; railroad tracks; pipelines; storage structures such as silos
and oil and gas storage tanks; and stationary wharves and docks.
(2) Facts and circumstances determination. The determination of
whether an asset is an inherently permanent structure is based on all
the facts and circumstances. In particular, the following factors must
be taken into account:
(i) The manner in which the asset is affixed to land and whether
such manner of affixation allows the asset to be easily removed from
the land;
(ii) Whether the asset is designed to be removed or to remain in
place indefinitely on the land;
(iii) The damage that removal of the asset would cause to the asset
itself or to the land to which it is affixed;
(iv) Any circumstances that suggest the expected period of
affixation is not indefinite (for example, a lease that requires or
permits removal of the asset from the land upon the expiration of the
lease); and
(v) The time and expense required to move the asset from the land.
(ii) Other definitions--(A) through (G) [Reserved]
(H) Real property operation. The term real property operation means
handling, by a direct or indirect owner of the real property, the day-
to-day operations of a trade or business, under paragraph (b)(1) of
this section, relating to the maintenance and occupancy of the real
property that affect the availability and functionality of that real
property used, or held out for use, by customers where payments
received from customers are principally for the customers' use of the
real property. The principal purpose of such business operations must
be the provision of the use of the real property, or physical space
accorded by or within the real property, to one or more customers, and
not the provision of other significant or extraordinary personal
services, under Sec. 1.469-1T(e)(3)(iv) and (v), to customers in
conjunction with the customers' incidental use of the real property or
physical space. If the real property or physical space is provided to a
customer to be used to carry on the customer's trade or business, the
principal purpose of the business operations must be to provide the
customer with exclusive use of the real property or physical space in
furtherance of the customer's trade or business, and not to provide
other significant or extraordinary personal
[[Page 56841]]
services to the customer in addition to or in conjunction with the use
of the real property or physical space, regardless of whether the
customer pays for the services separately. However, for purposes of and
with respect to the preceding sentence, other incidental personal
services may be provided to the customer in conjunction with the use of
real property or physical space, as long as such services are
insubstantial in relation to the customer's use of the real property or
physical space.
(I) Real property management. The term real property management
means handling, by a professional manager, the day-to-day operations of
a trade or business, under paragraph (b)(1) of this section, relating
to the maintenance and occupancy of real property that affect the
availability and functionality of that property used, or held out for
use, by customers where payments received from customers are
principally for the customers' use of the real property. The principal
purpose of such business operations must be the provision of the use of
the real property, or physical space accorded by or within the real
property, to one or more customers, and not the provision of other
significant or extraordinary personal services, under Sec. 1.469-
1T(e)(3)(iv) and (v), to customers in conjunction with the customers'
incidental use of the real property or physical space. If the real
property or physical space is provided to a customer to be used to
carry on the customer's trade or business, the principal purpose of the
business operations must be to provide the customer with exclusive use
of the real property or physical space in furtherance of the customer's
trade or business, and not to provide other significant or
extraordinary personal services to the customer in addition to or in
conjunction with the use of the real property or physical space,
regardless of whether the customer pays for the services separately.
However, for purposes of and with respect to the preceding sentence,
other incidental personal services may be provided to the customer in
conjunction with the use of real property or physical space, as long as
such services are insubstantial in relation to the customer's use of
the real property or physical space. A professional manager is a person
responsible, on a full-time basis, for the overall management and
oversight of the real property or properties and who is not a direct or
indirect owner of the real property or properties.
(iii) Examples. The following examples illustrate the operation of
this paragraph (b)(2):
(A) Example 1. A owns farmland and uses the land in A's farming
business to grow and harvest crops of various kinds. As part of this
farming business, A utilizes a greenhouse that is an inherently
permanent structure to grow certain crops during the winter months.
Under the rules of this section, any trade or business that involves
the cultivation and harvesting of plants, crops, or trees is not a real
property trade or business for purposes of section 469(c)(7)(C) and
this section, even though the cultivation and harvesting of crops
occurs upon or within real property. Accordingly, under these facts, A
is not engaged in a real property trade or business for purposes of
section 469(c)(7)(C) and this section.
(B) Example 2. B is a retired farmer and owns farmland that B rents
exclusively to C to operate a farm. The arrangement between B and C is
a trade or business (under paragraph (b)(1) of this section) where
payments by C are principally for C's use of B's real property. B also
provides certain farm equipment for C's use. However, C is solely
responsible for the maintenance and repair of the farm equipment along
with any costs associated with operating the equipment. B also
occasionally provides oral advice to C regarding various aspects of the
farm operation, based on B's prior experience as a farmer. Other than
the provision of this occasional advice, B does not provide any
significant or extraordinary personal services to C in connection with
the rental of the farmland to C. Under these facts, B is engaged in a
real property trade or business (which does not include the use or
deemed rental of any farm equipment) for purposes of section
469(c)(7)(C) and this section, and B's oral advice is an incidental
personal service that B provides in conjunction with C's use of the
real property. Nevertheless, under these facts, C is not engaged in a
real property trade or business for purposes of section 469(c)(7)(C)
and this section because C is engaged in the business of farming.
(C) Example 3. D owns a building in which D operates a restaurant
and bar. Even though D provides customers with use of the physical
space inside the building, D is not engaged in a trade or business
where payments by customers are principally for the use of real
property or physical space. Instead, the payments by D's customers are
principally for the receipt of significant or extraordinary personal
services (under Sec. 1.469-1T(e)(3)(iv) and (v)), mainly food and
beverage preparation and presentation services, and the use of the
physical space by customers is incidental to the receipt of these
personal services. Under the rules of this section, any trade or
business that involves the provision of significant or extraordinary
personal services to customers in conjunction with the customers'
incidental use of real property or physical space is not a real
property trade or business, even though the business operations occur
upon or within real property. Accordingly, under these facts, D is not
engaged in a real property trade or business for purposes of section
469(c)(7)(C) and this section.
(D) Example 4. E owns a majority interest in an S corporation, X,
that is engaged in the trade or business of manufacturing industrial
cooling systems for installation in commercial buildings and for other
uses. E also owns a majority interest in an S corporation, Y, that
purchases the industrial cooling systems from X and that installs,
maintains, and repairs those systems in both existing commercial
buildings and commercial buildings under construction. Under the rules
of this section, any trade or business that involves the manufacture,
installation, operation, maintenance, or repair of any machinery or
equipment that serves an active function will not be a real property
trade or business (or a unit or component of another real property
trade or business) for purposes of section 469(c)(7)(C) and this
section, even though the machinery or equipment will be permanently
affixed to real property once it is installed. In this case, the
industrial cooling systems are machinery or equipment that serves an
active function. Accordingly, under these facts, E, X and Y will not be
treated as engaged in one or more real property trades or businesses
for purposes of section 469(c)(7)(C) and this section.
(E) Example 5. (1) F owns an interest in P, a limited partnership.
P owns and operates a luxury hotel. In addition to providing rooms and
suites for use by customers, the hotel offers many additional amenities
such as in-room food and beverage service, maid and linen service,
parking valet service, concierge service, front desk and bellhop
service, dry cleaning and laundry service, and in-room barber and
hairdresser service. P contracted with M to provide maid and janitorial
services to P's hotel. M is an S corporation principally engaged in the
trade or business of providing maid and janitorial services to various
types of businesses, including hotels. G is a professional manager
employed by M
[[Page 56842]]
who handles the day-to-day business operations relating to M's
provision of maid and janitorial services to M's various customers,
including P.
(2) Even though the personal services that P provides to the
customers of its hotel are significant personal services under Sec.
1.469-1T(e)(3)(iv), the principal purpose of P's hotel business
operations is the provision of use of the hotel's rooms and suites to
customers, and not the provision of the significant personal services
to P's customers in conjunction with the customers' incidental use of
those rooms or suites. The provision of these significant personal
services by P to P's customers is incidental to the customers' use of
the hotel's real property. Accordingly, under these facts, F is treated
as owning an interest in a real property trade or business conducted by
or through P and P is treated as engaged in a real property trade or
business for purposes of section 469(c)(7)(C) and this section.
(3) With respect to the maid and janitorial services provided by M,
M's operations affect the availability and functionality of real
property used, or held out for use, by customers in a trade or business
where payments by customers are principally for the use of real
property (in this case, P's hotel). However, M does not operate or
manage real property. Instead, M is engaged in a trade or business of
providing maid and janitorial services to customers, such as P, that
are engaged in real property trades or businesses. Thus, M's business
operations are merely ancillary to real property trades or businesses.
Therefore, M is not engaged in real property operations or management
as defined in this section. Accordingly, under these facts, M is not
engaged in a real property trade or business under section 469(c)(7)(C)
and this section.
(4) With respect to the day-to-day business operations that G
handles as a professional manager of M, the business operations that G
manages is not the provision of use of P's hotel rooms and suites to
customers. G does not operate or manage real property. Instead, G
manages the provision of maid and janitorial services to customers,
including P's hotel. Therefore, G is not engaged in real property
management as defined in this section. Accordingly, under these facts,
G is not engaged in a real property trade or business under section
469(c)(7)(C) and this section.
* * * * *
0
Par. 16. Section 1.469-11 is amended by:
0
1. Revising the section heading;
0
2. Removing the period at the end of paragraph (a)(1) and adding a
semicolon in its place;
0
3. Revising paragraph (a)(3);
0
4. Redesignating paragraphs (a)(4) and (5) as paragraphs (a)(5) and
(6), respectively; and
0
5. Adding a new paragraph (a)(4).
The revision and addition read as follows:
Sec. 1.469-11 Applicability date and transition rules.
(a) * * *
(3) The rules contained in Sec. 1.469-9, other than paragraph
(b)(2), apply for taxable years beginning on or after January 1, 1995,
and to elections made under Sec. 1.469-9(g) with returns filed on or
after January 1, 1995;
(4) The rules contained in Sec. 1.469-9(b)(2) apply to taxable
years beginning on or after November 13, 2020. However, taxpayers and
their related parties, under sections 267(b) and 707(b)(1), may choose
to apply the rules of Sec. 1.469-9(b)(2) for a taxable year beginning
after December 31, 2017, so long as they consistently apply the rules
of Sec. 1.469-9(b)(2), the section 163(j) regulations (as defined in
Sec. 1.163(j)-1(b)(37)), and, if applicable, Sec. Sec. 1.263A-9,
1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7,
1.383-0, 1.383-1, 1.469-9, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79, 1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of Sec. Sec. 1.382-2, 1.382-
5, 1.382-6, 1.382-7, and 1.383-1), and 1.1504-4 to that taxable year;
* * * * *
0
Par. 17. Section 1.704-1 is amended by adding paragraph (b)(4)(xi) to
read as follows:
Sec. 1.704-1 Partner's distributive share.
* * * * *
(b) * * *
(4) * * *
(xi) Section 163(j) excess items. Allocations of section 163(j)
excess items as defined in Sec. 1.163(j)-6(b)(6) do not have
substantial economic effect under paragraph (b)(2) of this section and,
accordingly, such expenditures must be allocated in accordance with the
partners' interests in the partnership. See paragraph (b)(3)(iv) of
this section. Allocations of section 163(j) excess items will be deemed
to be in accordance with the partners' interests in the partnership if
such allocations are made in accordance with Sec. 1.163(j)-6(f).
* * * * *
0
Par. 18. Section 1.860C-2 is amended by revising paragraph (b)(2) to
read as follows:
Sec. 1.860C-2 Determination of REMIC taxable income or net loss.
* * * * *
(b) * * *
(2) Deduction allowable under section 163--(i) A REMIC is allowed a
deduction, determined without regard to section 163(d), for any
interest expense accrued during the taxable year.
(ii) For taxable years beginning after December 31, 2017, a REMIC
is allowed a deduction, determined without regard to section 163(j),
for any interest expense accrued during the taxable year.
* * * * *
0
Par. 19. Section 1.1362-3 is amended by:
0
1. Redesignating the text in paragraph (c)(3) as paragraph (c)(3)(i),
adding a subject heading to newly redesignated paragraph (c)(3)(i), and
adding paragraph (c)(3)(ii); and
0
2. Designating Examples 1 through 4 of paragraph (d) as paragraphs
(d)(1) through (d)(4), respectively.
The additions read as follows:
Sec. 1.1362-3 Treatment of S termination year.
* * * * *
(c) * * *
(3) * * *
(i) In general. * * *
(ii) Application of section 163(j). For purposes of section 163(j),
a separate limitation (as defined in Sec. 1.163(j)-1(b)(36)) applies
to each S short year and each C short year. Any items necessary to
determine the amount of business interest expense (as defined in Sec.
1.163(j)-1(b)(3)) that are deducted in each S short year or C short
year must be allocated between the S short year and C short year in
accordance with an allocation methodology provided in section 1362(e).
* * * * *
0
Par. 20. Section 1.1368-1 is amended by adding a sentence to the end of
paragraph (g)(2)(ii) to read as follows:
Sec. 1.1368-1 Distributions by S corporations.
* * * * *
(g) * * *
(2) * * *
(ii) * * * In the case of a taxable year for which an election is
made under paragraph (g)(2)(i), for purposes of section 163(j), a
separate section 163(j) limitation (as defined in Sec. 1.163(j)-
1(b)(36)) applies to each separate taxable year. Any items necessary to
determine
[[Page 56843]]
the amount of business interest expense (as defined in Sec. 1.163(j)-
1(b)(3)) that are deducted in each separate taxable year must be
allocated between the two separate taxable years in accordance with an
allocation methodology provided in this paragraph (g).
* * * * *
0
Par. 21. Section 1.1377-1 is amended by:
0
1. Redesignating paragraphs (b)(3)(ii) through (iv) as paragraphs
(b)(3)(iii) through (v), respectively; and
0
2. Adding a new paragraph (b)(3)(ii).
The addition reads as follows:
Sec. 1.1377-1 Pro rata share.
* * * * *
(b) * * *
(3) * * *
(ii) Section 163(j). If a terminating election is made to treat the
S corporation's taxable year as consisting of separate taxable years,
for purposes of section 163(j), a separate limitation (as defined in
Sec. 1.163(j)-1(b)(36)) will apply to each separate taxable year. Any
items necessary to determine the amount of business interest expense
(as defined in Sec. 1.163(j)-1(b)(3)) that are deducted in each
separate taxable year must be allocated between the separate taxable
years in accordance with an allocation methodology provided in this
section.
* * * * *
0
Par. 22. Section 1.1502-13 is amended:
0
1. In paragraph (a)(6)(ii), under the heading ``Anti-avoidance rules.
(Sec. 1.1502-13(h)(2))'', by:
0
i. Designating Examples 1 through 5 as entries (i) through (v); and
0
ii. Adding an entry (vi);
0
2. In paragraph (h)(2) by:
0
a. Designating Examples 1 through 5 as paragraphs (h)(2)(i) through
(v), respectively.
0
b. In newly designated paragraphs (h)(2)(i) through (v):
0
i. Redesignating paragraphs (h)(2)(i)(a) and (b) as paragraphs
(h)(2)(i)(A) and (B);
0
ii. Redesignating paragraphs (h)(2)(ii)(a) and (b) as paragraphs
(h)(2)(ii)(A) and (B);
0
iii. Redesignating paragraphs (h)(2)(iii)(a) and (b) as paragraphs
(h)(2)(iii)(A) and (B);
0
iv. Redesignating paragraphs (h)(2)(iv)(a) and (b) as paragraphs
(h)(2)(iv)(A) and (B);
0
v. Redesignating paragraphs (h)(2)(v)(a) and (b) as paragraphs
(h)(2)(iv)(A) and (B); and
0
c. Adding paragraph (h)(2)(vi).
The additions read as follows:
Sec. 1.1502-13 Intercompany transactions.
(a) * * *
(6) * * *
(ii) * * *
Anti-avoidance rules. (Sec. 1.1502-13(h)(2))
* * * * *
(vi) Example 6. Section 163(j) interest limitation.
* * * * *
(h) * * *
(2) * * *
(vi) Example 6: Section 163(j) interest limitation--(A) Facts. S1
and S2 are members of a consolidated group of which P is the common
parent. S1 is engaged in an excepted trade or business, and S2 is
engaged in a non-excepted trade or business. If S1 were to lend funds
directly to S2 in an intercompany transaction, under Sec. 1.163(j)-
10(a)(4)(i), the intercompany obligation of S2 would not be considered
an asset of S1 for purposes of Sec. 1.163(j)-10 (concerning
allocations of interest and other taxable items between excepted and
non-excepted trades or businesses for purposes of section 163(j)). With
a principal purpose of avoiding treatment of a lending transaction
between S1 and S2 as an intercompany transaction (and increasing the P
group's basis in its assets allocable to excepted trades or
businesses), S1 lends funds to X (an unrelated third party). X then on-
lends funds to S2 on substantially similar terms.
(B) Analysis. A principal purpose of the steps undertaken was to
avoid treatment of a lending transaction between S1 and S2 as an
intercompany transaction. Therefore, under paragraph (h)(1) of this
section, appropriate adjustments are made, and the X obligation in the
hands of S1 is not treated as an asset of S1 for purposes of Sec.
1.163(j)-10, to the extent of the loan from X to S2.
* * * * *
0
Par. 23. Section 1.1502-21 is amended by adding new paragraph (c)(3) to
read as follows:
Sec. 1.1502-21 Net operating losses.
* * * * *
(c) * * *
(3) Cross-reference. For rules governing the application of a SRLY
limitation to business interest expense for which a deduction is
disallowed under section 163(j), see Sec. 1.163(j)-5(d) and (f).
* * * * *
0
Par. 24. Section 1.1502-36 is amended by:
0
1. Revising the second sentence of paragraph (f)(2);
0
2. Revising the paragraph (h) heading;
0
3. Designating the text of paragraph (h) as paragraph (h)(1) and adding
a heading to newly designated paragraph (h)(1); and
0
4. Adding paragraph (h)(2).
The revisions and addition read as follows:
Sec. 1.1502-36 Unified loss rule.
* * * * *
(f) * * *
(2) * * * Such provisions include, for example, sections 163(j),
267(f), and 469, and Sec. 1.1502-13. * * *
* * * * *
(h) Applicability date--(1) In general. * * *
(2) Definition in paragraph (f)(2) of this section. Paragraph
(f)(2) of this section applies to taxable years beginning on or after
November 13, 2020. For taxable years beginning before November 13,
2020, see Sec. 1.1502-36 as contained in 26 CFR part 1, revised April
1, 2019. However, taxpayers and their related parties, within the
meaning of sections 267(b) and 707(b)(1), may choose to apply the rules
of this section to a taxable year beginning after December 31, 2017,
and before November 13, 2020, so long as the taxpayers and their
related parties consistently apply the rules of this section, the
section 163(j) regulations (as defined in Sec. 1.163(j)-1(b)(37)),
and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9,
1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13,
1.1502-21, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they
effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, 1.382-7,
and 1.383-1), and 1.1504-4, to that taxable year.
0
Par. 25. Section 1.1502-79 is amended by adding paragraph (f) to read
as follows:
Sec. 1.1502-79 Separate return years.
* * * * *
(f) Disallowed business interest expense carryforwards. For the
treatment of disallowed business interest expense carryforwards (as
defined in Sec. 1.163(j)-1(b)(11)) of a member arising in a separate
return limitation year, see Sec. 1.163(j)-5(d) and (f).
0
Par. 26. Section 1.1502-90 is amended by revising the entry for Sec.
1.1502-98 and adding an entry for Sec. 1.1502-99(d) to read as
follows:
Sec. 1.1502-90 Table of contents.
* * * * *
Sec. 1.1502-98 Coordination with sections 383 and 163(j).
[[Page 56844]]
Sec. 1.1502-99 Effective dates.
* * * * *
(d) Application to section 163(j).
0
Par. 27. Section 1.1502-91 is amended by revising paragraph (e)(2) to
read as follows:
Sec. 1.1502-91 Application of section 382 with respect to a
consolidated group.
* * * * *
(e) * * *
(2) Example--(i) Facts. The L group has a consolidated net
operating loss arising in Year 1 that is carried over to Year 2. The L
loss group has an ownership change at the beginning of Year 2.
(ii) Analysis. The net operating loss carryover of the L loss group
from Year 1 is a pre-change consolidated attribute because the L group
was entitled to use the loss in Year 2 and therefore the loss was
described in paragraph (c)(1)(i) of this section. Under paragraph
(a)(2)(i) of this section, the amount of consolidated taxable income of
the L group for Year 2 that may be offset by this loss carryover may
not exceed the consolidated section 382 limitation of the L group for
that year. See Sec. 1.1502-93 for rules relating to the computation of
the consolidated section 382 limitation.
(iii) Business interest expense. The facts are the same as in the
Example in paragraph (e)(2)(i) of this section, except that, rather
than a consolidated net operating loss, a member of the L group pays or
accrues a business interest expense in Year 1 for which a deduction is
disallowed in that year under section 163(j) and Sec. 1.163(j)-2(b).
The disallowed business interest expense is carried over to Year 2
under section 163(j)(2) and Sec. 1.163(j)-2(c). Thus, the disallowed
business interest expense carryforward is a pre-change loss. Under
section 163(j), the L loss group is entitled to deduct the carryforward
in Year 2; however, the amount of consolidated taxable income of the L
group for Year 2 that may be offset by this carryforward may not exceed
the consolidated section 382 limitation of the L group for that year.
See Sec. 1.1502-98(b) (providing that Sec. Sec. 1.1502-91 through
1.1502-96 apply section 382 to business interest expense, with
appropriate adjustments).
* * * * *
0
Par. 28. Section 1.1502-95 is amended in paragraph (b)(4) by:
0
1. Designating Examples 1 and 2 as paragraphs (b)(4)(i) and (ii),
respectively;
0
2. In newly designated paragraph (b)(4)(i), redesignating paragraphs
(b)(4)(i)(i) and (ii) as paragraphs (b)(4)(i)(A) and (B), respectively;
0
3. In newly designated paragraph (b)(4)(ii), redesignating paragraphs
(b)(4)(ii)(i) and (ii) as paragraphs (b)(4)(ii)(A) and (B),
respectively; and
0
4. Adding two sentences at the end of newly redesignated paragraph
(b)(4)(ii)(B).
The additions read follows:
Sec. 1.1502-95 Rules on ceasing to be a member of a consolidated
group (or loss subgroup).
* * * * *
(b) * * *
(4) * * *
(ii) * * *
(B) * * * The analysis would be similar if the L loss group had an
ownership change under Sec. 1.1502-92 in Year 2 with respect to
disallowed business interest expense paid or accrued by L2 in Year 1
and carried forward under section 163(j)(2) to Year 2 and Year 3. See
Sec. 1.1502-98(b) (providing that Sec. Sec. 1.1502-91 through 1.1502-
96 apply section 382 to business interest expense, with appropriate
adjustments).
* * * * *
0
Par. 29. Section 1.1502-98 is amended by:
0
1. Revising the section heading;
0
2. Designating the undesignated text as paragraph (a) and adding a
subject heading for newly designated paragraph (a); and
0
3. Adding paragraph (b).
The revision and additions read as follows:
Sec. 1.1502-98 Coordination with sections 383 and 163(j).
(a) Coordination with section 383. * * *
(b) Application to section 163(j)--(1) In general. The regulations
in this part under sections 163(j), 382, and 383 of the Code contain
rules governing the application of section 382 to interest expense
governed by section 163(j) and the regulations in this part under
section 163(j) of the Code. See, for example, Sec. Sec. 1.163(j)-
11(c), 1.382-2, 1.382-6, 1.382-7, and 1.383-1. The rules contained in
Sec. Sec. 1.1502-91 through 1.1502-96 apply these rules to members of
a consolidated group, or corporations that join or leave a consolidated
group, with appropriate adjustments. For example, for purposes of
Sec. Sec. 1.1502-91 through 1.1502-96, the term loss group includes a
consolidated group in which any member is entitled to use a disallowed
business interest expense carryforward, as defined in Sec. 1.163(j)-
1(b)(11), that did not arise, and is not treated as arising, in a SRLY
with regard to that group. Additionally, a reference to net operating
loss carryovers in Sec. Sec. 1.1502-91 through 1.1502-96 generally
includes a reference to disallowed business interest expense
carryforwards. References to a loss or losses in Sec. Sec. 1.1502-91
through 1.1502-96 include references to disallowed business interest
expense carryforwards or section 382 disallowed business interest
carryforwards, within the meaning of Sec. 1.382-2(a)(7), as
appropriate.
(2) Appropriate adjustments. For purposes of applying the rules in
Sec. Sec. 1.1502-91 through 1.1502-96 to current-year business
interest expense (as defined in Sec. 1.163(j)-1(b)(9)), disallowed
business interest expense carryforwards, and section 382 disallowed
business interest carryforwards, appropriate adjustments are required.
0
Par. 30. Section 1.1502-99 is amended by adding paragraph (d) to read
as follows:
Sec. 1.1502-99 Effective/applicability dates.
* * * * *
(d) Application to section 163(j)--(1) Sections 1.382-2 and 1.382-
5. To the extent the rules of Sec. Sec. 1.1502-91 through 1.1502-99
effectuate the rules of Sec. Sec. 1.382-2 and 1.382-5, the provisions
apply with respect to ownership changes occurring on or after November
13, 2020. For loss corporations that have ownership changes occurring
before November 13, 2020, see Sec. Sec. 1.1502-91 through 1.1502-99 as
contained in 26 CFR part 1, revised April 1, 2019. However, taxpayers
and their related parties, within the meaning of sections 267(b) and
707(b)(1), may choose to apply the rules of Sec. Sec. 1.1502-91
through 1.1502-99 to the extent they apply the rules of Sec. Sec.
1.382-2 and 1.382-5, to ownership changes occurring during a taxable
year beginning after December 31, 2017, as well as consistently
applying the rules of the Sec. Sec. 1.1502-91 through 1.1502-99 (to
the extent they effectuate the rules of Sec. Sec. 1.382-6 and 1.383-
1), the section 163(j) regulations (as defined in Sec. 1.163(j)-
1(b)(37)), and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-7, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3,
1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79, and 1.1504-4, to
that taxable year.
(2) Sections 1.382-6 and 1.383-1. To the extent the rules of
Sec. Sec. 1.1502-91 through 1.1502-98 effectuate the rules of
Sec. Sec. 1.382-6 and 1.383-1, the provisions apply with respect to
ownership changes occurring during a taxable year beginning on or after
November 13, 2020. For the application of these rules to an ownership
change with respect to an ownership change
[[Page 56845]]
occurring during a taxable year beginning before November 13, 2020, see
Sec. Sec. 1.1502-91 through 1.1502-99 as contained in 26 CFR part 1,
revised April 1, 2019. However, taxpayers and their related parties,
within the meaning of sections 267(b) and 707(b)(1), may choose to
apply the rules of Sec. Sec. 1.1502-91 through 1.1502-99 (to the
extent that those rules effectuate the rules of Sec. Sec. 1.382-6 and
1.383-1), to ownership changes occurring during a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties consistently apply the rules of 1.1502-91 through
1.1502-99 (to the extent that those rules effectuate the rules of
Sec. Sec. 1.382-2 and 1.382-5), the section 163(j) regulations (as
defined in Sec. 1.163(j)-1(b)(37)), and, if applicable, Sec. Sec.
1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-7, 1.469-9, 1.469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, and 1.1504-4, to a taxable year beginning after December
31, 2017.
0
Par. 31. Section 1.1504-4 is amended by:
0
1. Removing ``163(j), 864(e),'' from the first sentence of paragraph
(a)(2) and adding ``864(e)'' in its place; and
0
2. Adding two sentences at the end of paragraph (i).
The additions read as follows:
Sec. 1.1504-4 Treatment of warrants, options, convertible
obligations, and other similar interests.
* * * * *
(i) * * * Paragraph (a)(2) of this section applies with respect to
taxable years beginning on or after November 13, 2020. However,
taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of this section to
a taxable year beginning after December 31, 2017, so long as the
taxpayers and their related parties consistently apply the rules of
this section, the section 163(j) regulations (as defined in Sec.
1.163(j)-1(b)(37)), and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, 1.382-7, and 1.383-1), to that taxable year.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: July 14, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-16531 Filed 9-3-20; 4:15 pm]
BILLING CODE 4830-01-P
