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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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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56749
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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56823
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
