Taxable Income or Loss and Currency Gain or Loss With Respect to a Qualified Business Unit, 100138-100226 [2024-28372]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 89, Number 238 (Wednesday, December 11, 2024)]
[Rules and Regulations]
[Pages 100138-100226]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-28372]



[[Page 100137]]

Vol. 89

Wednesday,

No. 238

December 11, 2024

Part IV





Department of the Treasury





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Internal Revenue Service





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26 CFR Part 1





Taxable Income or Loss and Currency Gain or Loss With Respect to a 
Qualified Business Unit; Final Rule

Federal Register / Vol. 89 , No. 238 / Wednesday, December 11, 2024 / 
Rules and Regulations

[[Page 100138]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 10016]
RIN 1545-BO07


Taxable Income or Loss and Currency Gain or Loss With Respect to 
a Qualified Business Unit

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final rule.

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SUMMARY: This document contains final regulations relating to the 
determination of taxable income or loss and foreign currency gain or 
loss with respect to a qualified business unit. These final regulations 
include an election to treat all items of a qualified business unit as 
marked items (subject to a loss suspension rule), an election to 
recognize all foreign currency gain or loss with respect to a qualified 
business unit on an annual basis, and a new transition rule.

DATES: Effective date: The final regulations are effective December 10, 
2024.
    Applicability dates: For dates of applicability, see Sec.  1.987-
15.

FOR FURTHER INFORMATION CONTACT: Concerning the final regulations 
generally, Adam G. Province at (865) 329-4546; concerning the character 
and source of section 987 gain or loss, Larry Pounders at (202) 317-
5465; concerning consolidated groups, Jeremy Aron-Dine at (202) 317-
6847 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Authority

    This document contains additions and amendments to 26 CFR part 1 
(Income Tax Regulations) addressing the application of section 987 of 
the Internal Revenue Code (Code) and related provisions (the ``final 
regulations''). The additions and amendments are issued under sections 
987, 989, and 1502, pursuant to the express delegations of authority 
provided under those sections. The express delegations relied upon are 
referenced in the Background section of this preamble and in the 
Summary of Comments and Explanation of Revisions describing the 
individual sections of the final regulations. The final regulations are 
also issued under the express delegation of authority under section 
7805 of the Code.

Background

    This document contains final regulations under section 987 of the 
Code and related provisions under sections 861, 985 through 989, and 
1502 of the Code. Section 987 applies to any taxpayer that has a 
qualified business unit (``QBU'') with a functional currency other than 
the dollar. Section 987(1) and (2) provide rules for determining and 
translating taxable income or loss (``section 987 taxable income or 
loss'') with respect to the QBU. In addition, foreign currency gain or 
loss must be determined under section 987(3) (``section 987 gain or 
loss''), which requires proper adjustments (as prescribed by the 
Secretary) for transfers of property between QBUs of the taxpayer 
having different functional currencies.
    Sections 987 and 989 provide several explicit grants of regulatory 
authority. Section 987(3) directs the Secretary to prescribe the proper 
adjustments needed to determine the taxable income of the owner of a 
section 987 QBU. Those adjustments include (but are not limited to) 
rules for sourcing section 987 gain or loss recognized under section 
987(3)(B). Similarly, section 987(2) provides that the income of a QBU 
is translated at the ``appropriate'' exchange rate. Section 989(b)(4) 
provides that the appropriate exchange rate generally is the average 
rate for the taxable year, ``except as provided in regulations.''
    Section 989(c) directs the Secretary to ``prescribe such 
regulations as may be necessary or appropriate to carry out the 
purposes of this subpart.'' \1\ The grant of authority in section 
989(c) includes regulations limiting the recognition of foreign 
currency loss on certain remittances from QBUs, providing for the 
appropriate treatment of related party transactions (including 
transactions between QBUs of the same taxpayer), and setting forth 
procedures for determining the average exchange rate for any period. 
Section 989(c)(2), (5), and (6).
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    \1\ The reference to ``this subpart'' refers to subpart J of 
part III of subchapter N of chapter 1 of the Code, which includes 
section 987.
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    On December 8, 2016, the Department of the Treasury (``Treasury 
Department'') and the Internal Revenue Service (``IRS'') published 
Treasury Decision 9794, which contained final regulations under 
sections 861, 985, 987, 988, and 989 (the ``2016 final regulations''), 
in the Federal Register (81 FR 88806). The same day, the Treasury 
Department and the IRS published Treasury Decision 9795, which 
contained temporary regulations under sections 987 and 988 (the ``2016 
temporary regulations''), in the Federal Register (81 FR 88854) and 
published a notice of proposed rulemaking (REG-128276-12, 81 FR 88882) 
(the ``2016 proposed regulations'') in the Federal Register by cross-
reference to the temporary regulations. On May 13, 2019, the Treasury 
Department and the IRS published Treasury Decision 9857, which 
contained final regulations under section 987 (the ``2019 final 
regulations''), in the Federal Register (84 FR 20790).
    On November 14, 2023, the Treasury Department and the IRS published 
proposed regulations (REG-132422-17) under sections 861, 985, 987, 988, 
989, and 1502 of the Code (the ``2023 proposed regulations'') in the 
Federal Register (88 FR 78134). The same day, the Treasury Department 
and the IRS also published a notice in the Federal Register (88 FR 
77921) that reopened the comment period for the 2016 proposed 
regulations.
    All written comments received in response to the 2016 proposed 
regulations and the 2023 proposed regulations are available at https://www.regulations.gov or upon request. A public hearing on the 2023 
proposed regulations was not held because there were no requests to 
speak.
    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-BR37) a 
notice of proposed rulemaking providing additional proposed regulations 
under section 987 (REG-117213-24) (the ``2024 proposed regulations'').

Summary of Comments and Explanation of Revisions

I. Overview

    The Treasury Department and the IRS received a number of written 
comments in response to the 2016 proposed regulations and the 2023 
proposed regulations. The comments, and the revisions made in response 
to those comments, are summarized in this Summary of Comments and 
Explanation of Revisions.
    The final regulations retain the basic approach and structure of 
the 2023 proposed regulations, with the revisions described in this 
Summary of Comments and Explanation of Revisions.

II. Comments and Changes to Proposed Sec.  1.987-1: Scope, Definitions, 
and Special Rules

    Proposed Sec.  1.987-1 would provide rules regarding the scope of 
the

[[Page 100139]]

regulations under section 987 (``section 987 regulations''), including 
which entities are subject to the regulations, rules relating to 
elections under section 987, and other rules.

A. Scope

    Under proposed Sec.  1.987-1(b)(1), the section 987 regulations 
would apply to all taxpayers, subject to a de minimis rule for pass-
through entities with minimal U.S. ownership, but they would not apply 
to foreign individuals or foreign corporations that either are not 
controlled foreign corporations (``CFCs'') or are CFCs in which no 
United States shareholders (``U.S. shareholders'') own (within the 
meaning of section 958(a)) stock. In contrast to the 2016 final 
regulations, the 2023 proposed regulations would not provide an 
exception for banks, insurance companies, leasing companies, finance 
coordination centers, regulated investment companies, or real estate 
investment trusts (``specified entities''). The preamble to the 2023 
proposed regulations explains that the current rate election and annual 
recognition election are expected to provide additional flexibility for 
specified entities to apply the section 987 regulations. 88 FR 78145. 
Taxpayers that make a current rate election would treat all assets and 
liabilities attributable to a section 987 QBU as marked items, and thus 
would not be required to track historic exchange rates. Taxpayers that 
make an annual recognition election would recognize all unrecognized 
section 987 gain or loss on an annual basis and would not be required 
to calculate the amount of a remittance with respect to a section 987 
QBU under Sec.  1.987-5. See parts II and IV of the Explanation of 
Provisions in the preamble to the 2023 proposed regulations. 88 FR 
78138 through 78139, 78141 through 78143. In addition, including 
specified entities in the scope of the section 987 regulations is 
necessary to provide these entities with sufficient guidance under 
section 987 and to provide a consistent set of rules applicable to all 
taxpayers.
1. Specified Entities
    Comments recommended that specified entities be excluded from the 
application of the section 987 regulations. The comments asserted that 
additional rules are needed to facilitate the application of the 
section 987 regulations to these entities. For example, according to 
the comments, it is unclear whether insurance reserves should be 
treated as marked items or historic items. A comment also noted that 
bank branches often engage in high volumes of intercompany transactions 
that could be difficult to account for under the section 987 
regulations.
    The Treasury Department and the IRS have determined that the final 
regulations can be applied by specified entities in an administrable 
manner and that excluding specified entities from the scope of the 
section 987 regulations would not provide sufficient guidance to ensure 
that these entities are using an appropriate method to apply section 
987. Moreover, section 987 and its legislative history give no 
indication that Congress intended for banks, insurance companies, and 
other specified entities to be treated differently from other taxpayers 
for this purpose. Accordingly, specified entities are subject to the 
final regulations. However, the final regulations contain modifications 
intended to facilitate application of the section 987 regulations to 
these entities. See parts II.B (rules relating to insurance companies), 
V.B (hedging transactions), and VI (modifications to annual remittance 
rules to reduce the burden of tracking disregarded transfers) of this 
Summary of Comments and Explanation of Revisions.
2. Partnerships and Certain Other Entities
    One comment was received relating to the application of section 987 
to partnerships, and the Treasury Department and the IRS continue to 
study this issue. The Treasury Department and the IRS have determined 
that, without additional guidance, the section 987 regulations in their 
entirety could not be applied to partnerships in an administrable way. 
Accordingly, the final regulations generally apply only with respect to 
corporations and individuals. However, as discussed in part VIII of 
this Summary of Comments and Explanation of Revisions, certain parts of 
the section 987 regulations (including the rules relating to suspension 
of section 987 loss and recognition of suspended section 987 loss) are 
applicable to partnerships and S corporations.
    The section 987 regulations do not apply to trusts or estates 
(though trusts and estates can be subject to section 987) because 
additional guidance may be needed to apply section 987 to these 
entities. In particular, the Treasury Department and the IRS are 
studying whether specific rules are needed to address the apportionment 
of section 987 gain or loss between the estate or non-grantor trust and 
the beneficiaries or whether existing rules under section 643(a) 
(defining distributable net income of an estate or trust) sufficiently 
address this issue. In addition, specific rules may be needed to 
address a beneficiary's application of section 987 with respect to an 
estate or non-grantor trust that uses a different functional currency 
(which creates a separate layer of currency exposure). The Treasury 
Department and the IRS anticipate providing rules applicable to trusts 
and estates in future guidance.
3. Application to CFCs
    The final regulations apply to individuals and corporations that 
are United States persons (``U.S. persons'') and to CFCs in which U.S. 
shareholders own stock (directly or indirectly within the meaning of 
section 958(a)). See Sec.  1.987-1(b)(1). As explained in parts II.A.2 
and VIII of this Summary of Comments and Explanation of Revisions, the 
Treasury Department and the IRS are continuing to study the appropriate 
rules for applying section 987 to partnerships.
    A comment recommended that the scope of the section 987 regulations 
be limited to section 987 QBUs owned directly by U.S. persons or by 
partnerships with partners that are U.S. persons. According to the 
comment, this would reduce the compliance burden on taxpayers and 
prevent the selective recognition of section 987 losses. The comment 
further asserted that, based on the legislative history of section 
987(3), the statute primarily was intended to address section 987 QBUs 
owned by U.S. persons.
    The comment suggested that simplified mechanics under section 
986(c) could be used to account for currency gain or loss arising 
between the time earnings are generated by a section 987 QBU and the 
time of distribution, but the comment did not explain how those 
mechanics would operate. Section 986(c) requires a U.S. shareholder to 
recognize foreign currency gain or loss with respect to distributions 
of previously taxed earnings and profits attributable to movements in 
exchange rates between the date of the income inclusion giving rise to 
the previously taxed earnings and profits and the distribution of the 
previously taxed earnings and profits.
    The final regulations do not adopt the recommendations made by the 
comment. It is necessary to apply section 987(1) and (2) to foreign 
entities because many aspects of the income tax rules effectively 
require that the determination of a taxpayer's items of income, gain, 
deduction, and loss be made in a single currency. In addition, it is 
not clear how a rule similar to section 986(c) could be applied to 
section 987 QBUs in lieu of section 987(3). Because a CFC's earnings 
and

[[Page 100140]]

profits are determined in the CFC's functional currency under section 
986(b), currency gain or loss on previously taxed earnings and profits 
arises under section 986(c) when a CFC's functional currency 
appreciates or depreciates against the U.S. dollar between the time the 
inclusion is computed and the time the CFC distributes the previously 
taxed earnings and profits. However, section 986(c) would not account 
for changes in value of a section 987 QBU's functional currency 
(measured against the functional currency of its CFC-owner or the U.S. 
shareholder) because earnings and profits are not tracked in the 
section 987 QBU's functional currency.
    However, the Treasury Department and the IRS are studying whether 
there are instances in which it would be possible to simplify the 
application of section 987 by modifying the application of section 
987(3) (and the related regulations, including Sec. Sec.  1.987-4 
through 1.987-6, 1.987-8, and 1.987-11 through 1.987-13) to certain 
entities. See part II.B of the Comments and Request for Public Hearing 
section in the preamble to the 2024 proposed regulations.

B. Special Rules for Insurance Companies

1. Insurance Reserves
    A comment requested clarification as to whether insurance reserves 
are treated as marked items. The comment noted that the definition of a 
marked item under the proposed regulations is tied to the treatment of 
an asset or liability under section 988 and that the application of 
section 988 to insurance reserves is not clear. The Treasury Department 
and the IRS agree that treating insurance reserves as marked items 
would facilitate the application of section 987 to insurance companies 
and would be consistent with the treatment of liabilities outside the 
insurance context. Accordingly, Sec.  1.987-1(d)(1)(iv) includes 
insurance reserves in the definition of marked items.
2. Assets That Support Variable Contracts
a. Background on Variable Contracts
    In general, variable contracts are life insurance and annuity 
contracts under which the amount of the insurance company's obligation 
depends, at least in part, on the value of the assets held in a 
separate account that is segregated from the general asset accounts of 
the insurance company. Provided certain requirements are met, under 
section 817(c), an insurance company that issues variable contracts (as 
defined in section 817(d)) must separately account for the various 
income, exclusion, deduction, asset, reserve, and other liability items 
properly attributable to such variable contracts.
    As a general matter, section 807 provides that increases in the 
life insurance reserves of a life insurance company are deductible and 
decreases in the life insurance reserves are includible in income. 
However, section 817(a) provides that for purposes of determining the 
net decrease or increase in reserves under section 807(a) or (b), 
amounts subtracted from or added to separate account reserves by reason 
of the depreciation or appreciation of separate account assets (whether 
or not realized) are disregarded. Under section 817(a), deductions for 
items described in section 805(a)(1) and (6), which include claims and 
benefits accrued and losses incurred during the taxable year on 
insurance and annuity contracts, are similarly adjusted for the 
depreciation or appreciation of separate account assets. Additionally, 
section 817(b) provides that the basis of each separate account asset 
is decreased by the amount of depreciation, or increased by the amount 
of appreciation, of separate account assets (whether or not realized), 
to the extent separate account reserves are adjusted for such 
depreciation or appreciation under section 817(a). Generally, the 
result is a permanent elimination of any effects on company-level 
taxable income that would otherwise result from the change in the value 
of the separate account assets.
    Sometimes, however, an insurance company may provide guarantees 
with respect to variable contracts with separate accounts that could 
require reserves to be held in a company's general account. Section 
817(d)(3) recognizes this situation and states that ``obligations under 
such guarantee which exceed obligations under the contract without 
regard to such guarantee shall be accounted for as part of the 
company's general account.'' Such guarantees might involve a limit on 
losses or guarantees of minimum crediting rates. These amounts are not 
liabilities of the separate account.
    Similarly, CFCs generally must follow the Code and subchapter L 
rules in determining their insurance income, with minor modifications 
for determining: (i) whether a contract is a life insurance or annuity 
contract, and (ii) the amount of insurance reserves. For example, U.S. 
tax requirements in sections 72(s), 101(f), 817(h), and 7702 do not 
apply so long as no policyholder, annuitant, insured, or beneficiary 
under the contract is a United States person and the contract is 
regulated as a life insurance or annuity contract in the issuer's home 
country. In addition, section 954(i) modifies the subchapter L 
computation of insurance reserves and its application to insurance 
contracts issued by CFCs. See also section 953(b)(3).
b. Treatment of Assets That Support Variable Contracts for Purposes of 
Section 987
    A comment recommended that assets which support variable annuity 
and life insurance contracts be treated as marked items. The comment 
explained that these assets are required by law to be segregated from 
the general asset accounts of the insurance company in a separate 
account, and the related contracts reflect the investment return and 
market value of the separate account assets.
    The comment asserted that both the separate account assets and the 
related insurance reserves should be treated as marked items in order 
to align the treatment of these assets and liabilities for purposes of 
section 987. Similarly, the comment recommended that these assets and 
liabilities should be treated as attributable to an eligible QBU if 
they are reflected on the books and records of the eligible QBU, even 
if they would otherwise be excluded under Sec.  1.987-2(b)(2) (for 
example, if the separate account assets consist of stock or partnership 
interests).
    The final regulations provide that separate account assets are 
treated as marked items. See Sec.  1.987-1(d)(1)(v). In addition, the 
final regulations carve out separate account assets from the exclusions 
in Sec.  1.987-2(b)(2), so that separate account assets reflected on 
the books and records of an eligible QBU generally will be attributable 
to the eligible QBU. See Sec.  1.987-2(b)(2)(ii). These rules are 
expected to facilitate matching treatment of separate account assets 
and the related insurance contracts, consistent with the treatment of 
these items for statutory and financial accounting purposes and the 
nature of the issuer's economic obligations.
    The final regulations define a separate account asset as an asset 
that is reflected on the books and records of an eligible QBU and is 
held in a separate account with respect to a separate account insurance 
contract. See Sec.  1.987-1(h). A separate account insurance contract 
generally is defined as a contract that would be treated as an 
insurance contract for Federal income tax purposes for which the assets 
supporting the insurance reserves are required to be held in a separate 
account under the local insurance regulatory rules. In addition, the 
contract generally

[[Page 100141]]

must qualify as a variable contract under section 817(d). However, if 
the contract does not qualify as a variable contract under section 
817(d) solely because it fails to meet one or more of the requirements 
in section 72(s), 101(f), 817(h), or 7702, the contract will be treated 
as a separate account insurance contract if it is regulated as a life 
insurance or annuity contract under foreign law, the contract reserves 
are computed or estimated on the basis of recognized mortality or 
morbidity tables and assumed rates of interest (treating the reflection 
of the investment return and the market value of assets in the separate 
account as an assumed rate of interest), and no policyholder, 
annuitant, insured, or beneficiary under the contract is a United 
States person. These requirements are consistent with the requirements 
for life insurance or annuity contracts issued by CFCs.
3. Assets of an Insurance Company That Produce Financial Services 
Income
    A comment recommended that assets of an insurance company that 
produce financial services income (within the meaning of section 
904(d)(2)(D)(ii)(II) and (III)) should be treated as marked items. The 
comment asserted that the assets insurance companies hold to support 
insurance obligations are closely matched to those obligations and that 
concerns related to the selective recognition of large noneconomic 
losses under section 987 are not present for insurance companies.
    The final regulations do not treat all assets that produce 
financial services income as marked assets. As a result, those assets 
are classified as marked or historic under the general rules of Sec.  
1.987-1(d) or (e). The definition of a marked item under Sec.  1.987-
1(d)(1) is intended to identify those items of a section 987 QBU that 
are directly exposed to changes in the value of a section 987 QBU's 
functional currency. This definition is designed to ensure that, in the 
absence of a current rate election, section 987 gain or loss recognized 
by the owner of a section 987 QBU represents bona fide economic gain or 
loss. To the extent that a section 987 QBU of an insurance company 
holds assets that are not directly exposed to exchange rate 
fluctuations (for example, publicly traded stock), and a current rate 
election is not in effect, those assets are properly characterized as 
historic items even if they generate financial services income.
4. Deferred Acquisition Costs
    A comment recommended that the unamortized portion of specified 
policy acquisition expenses (as defined in section 848) should be 
treated as marked items. These specified policy acquisition expenses 
are generally a specified portion of general deductions and represent 
deferred acquisition costs. The comment noted that specified policy 
acquisition expenses are akin to prepaid expenses and the amount and 
timing of the related deductions are determined under insurance-
specific tax rules.
    The final regulations do not treat the unamortized portion of 
specified policy acquisition expenses as marked items. Although certain 
prepaid expenses are treated as marked items under Sec.  1.987-
1(d)(1)(ii), that rule applies only to prepaid expenses with an 
original term of one year or less. The preamble to the 2016 final 
regulations explains that, because these prepaid expenses have a short 
duration and often are small in amount, treating them as marked items 
promotes administrability without creating significant distortions. 81 
FR 88810. By contrast, specified policy acquisition expenses under 
section 848 generally are amortized over a period of 15 years and can 
be substantial in magnitude. Thus, if specified policy acquisition 
expenses were treated as marked items, they could give rise to 
significant amounts of non-economic section 987 gain or loss.

C. Elections

    The 2023 proposed regulations would provide that a current rate 
election or an annual recognition election may not be revoked without 
consent for any taxable year beginning within 60 months of the first 
day of the taxable year for which it was made. Proposed Sec.  1.987-
1(g)(3)(ii)(B). Once revoked, a new current rate election or annual 
recognition election may not be made without consent for any taxable 
year beginning within 60 months of the first day of the taxable year 
for which it was revoked. Id.
    A comment recommended that, during the first five years in which 
the section 987 regulations are applicable, taxpayers should be allowed 
to make or revoke a current rate election without waiting 60 months or 
requesting consent. The comment noted that taxpayers may need more 
flexibility to reassess their elections during this initial period 
because they do not yet have sufficient information or experience 
regarding the impact of making (or not making) a current rate election.
    The final regulations retain the 60-month limitation for taxpayers 
that make a current rate election or an annual recognition election and 
apply a similar limitation for purposes of the section 988 mark-to-
market election (see part IV.C.1 of this Summary of Comments and 
Explanation of Revisions). Permitting taxpayers to make or revoke 
elections on a more frequent basis could increase the potential for 
manipulation and abuse. However, taxpayers that wish to change their 
elections without waiting 60 months can do so by requesting the 
Commissioner's consent, and the Commissioner may consider the need for 
additional flexibility on a case-by-case basis.

D. No Change in Method of Accounting

    Proposed Sec.  1.987-1(g)(4) provides that elections under section 
987 are not governed by the general rules concerning changes in methods 
of accounting. In addition, the final regulations clarify that an 
election under section 987 is not treated as a method of accounting for 
purposes of section 446 or 481. See Sec.  1.987-1(g)(4). Similarly, the 
final regulations provide that application of the transition rules 
under Sec.  1.987-10 is not treated as a change in method of 
accounting. See Sec.  1.987-10(k)(4). No inference is intended as to 
whether a change in section 987 methodology is considered a change in 
method of accounting before the final regulations become applicable (or 
with respect to partnerships or other entities that are not generally 
subject to the section 987 regulations).

III. Comments and Changes to Proposed Sec.  1.987-2: Attribution of 
Items of an Eligible QBU, the Definition of a Transfer, and Related 
Rules

    Proposed Sec.  1.987-2 provides rules for attributing items to 
eligible QBUs and rules relating to transfers of assets or liabilities 
to or from eligible QBUs.

A. Attribution of Items to an Eligible QBU

    Under the proposed regulations, items are attributable to an 
eligible QBU to the extent they are reflected on the eligible QBU's 
separate set of books and records. Proposed Sec.  1.987-2(b)(1). The 
final regulations clarify that an item that is not taken into account 
for financial accounting purposes is attributed to an eligible QBU to 
the extent it would have been reflected on the eligible QBU's books and 
records if it were taken into account for financial accounting purposes 
(for example, amortization attributable to an item of intangible 
property that is recognized and taken into account for tax purposes due 
to a section 338 election, but is not recognized or taken into account 
for financial reporting purposes). See Sec.  1.987-2(b)(1). Similarly, 
in preparing

[[Page 100142]]

an adjusted balance sheet for a section 987 QBU, the owner must make 
adjustments to reflect items that were not reflected on the section 987 
QBU's books and records for the taxable year but should be so reflected 
under United States tax accounting principles. See Sec.  1.987-1(h). No 
inference should be drawn from this clarification with respect to other 
similar rules that attribute items based on books and records including 
under Sec.  1.904-4(f) (foreign branch category income) or Sec.  
1.1503(d)-5(c) (income or dual consolidated loss of a separate unit).

B. Disregarded Transactions

    Under proposed Sec.  1.987-2(c)(2)(i), an asset is treated as 
transferred to a section 987 QBU from its owner if, as a result of a 
disregarded transaction, the asset is reflected on the books and 
records of (or attributable to) the section 987 QBU. Similarly, an 
asset is treated as transferred from a section 987 QBU to its owner if, 
as a result of a disregarded transaction, the asset ceases to be 
reflected on (or attributable to) the books and records of the section 
987 QBU. However, disregarded transactions do not give rise to items of 
income, gain, deduction, or loss that are taken into account in 
determining section 987 taxable income or loss under Sec.  1.987-3. 
Proposed Sec.  1.987-2(c)(2)(iii).
    A comment recommended that interbranch loans made by banks and 
other regulated financial institutions should not be treated as 
transfers for purposes of determining the amount of a remittance under 
Sec.  1.987-5(c). The comment asserted that an interbranch loan is not 
a permanent transfer because the borrower has an obligation to repay 
the lender. Another comment requested that the final regulations 
conform the treatment of disregarded transactions for purposes of 
section 987 with the reattribution rules provided in Sec.  1.904-
4(f)(2)(vi). Under this approach, disregarded payments would result in 
the reattribution of items of gross income between a section 987 QBU 
and its owner and between separate 987 QBUs of the same owner, and they 
would not be treated as transfers giving rise to the recognition of 
section 987 gain or loss. The comment noted that, under proposed Sec.  
1.987-2(c)(2), a disregarded payment for services or a sale of 
inventory (including a payment from one section 987 QBU to a different 
section 987 QBU with the same functional currency) could give rise to a 
remittance even though there is no net economic transfer of value. 
Further, because disregarded transactions do not give rise to section 
987 taxable income or loss under proposed Sec.  1.987-2(c)(2)(iii), the 
comment asserted that the amount of section 987 taxable income or loss 
may be different from the amount of income that is economically 
attributable to the section 987 QBU.
    The final regulations retain the disregarded transaction rules of 
proposed Sec.  1.987-2(c). See Sec.  1.987-2(c). These rules are needed 
to properly account for the effect of a disregarded transaction on the 
balance sheet of a section 987 QBU for purposes of determining the 
owner's net unrecognized section 987 gain or loss under Sec.  1.987-4, 
the amount of a remittance under Sec.  1.987-5(c), and to properly 
determine the owner's basis in transferred assets under Sec.  1.987-
5(f).
    In the case of a disregarded lending transaction in which a section 
987 QBU lends money to its owner, although the owner remains obligated 
to repay the borrowed funds, the disregarded loan is not an asset that 
can be attributed to the QBU for tax purposes. Accordingly, for tax 
purposes, the QBU-lender's balance sheet is diminished by the amount of 
the loan in the same way as any other transfer from the QBU to its 
owner. To the extent the loan is funded and repaid within the same 
taxable year, the two transfers will offset in computing the remittance 
amount under Sec.  1.987-5(c). However, when a disregarded loan spans 
multiple taxable years, the owner must account for the effect of the 
transaction on the net equity of the section 987 QBU (as regarded for 
tax purposes).
    In addition, the final regulations do not provide for reattribution 
of gross income between a section 987 QBU and its owner or between 
section 987 QBUs of the same owner for purposes of section 987. When a 
section 987 QBU makes a disregarded payment to its owner, the payment 
properly triggers the recognition of section 987 gain or loss because 
the transferred asset has been withdrawn from the QBU and is no longer 
accounted for in the section 987 QBU's functional currency. Even if the 
transaction does not reduce the economic value of the section 987 QBU 
on a net basis (for example, because the disregarded payment is made in 
exchange for services of equal value), it nonetheless results in a net 
withdrawal of asset basis from the functional currency environment of 
the section 987 QBU and is therefore properly treated as a remittance 
for purposes of section 987. Moreover, a rule determining the amount of 
a remittance based on the value of property transferred from a section 
987 QBU would be difficult to administer and prone to manipulation.
    Similarly, because disregarded transactions do not give rise to 
taxable income or loss under general tax principles, they are not taken 
into account in determining section 987 taxable income or loss. See 
Sec.  1.987-2(c)(2)(iii). Instead, the regarded income of an owner that 
is properly reflected on the books and records of (or attributable to) 
a section 987 QBU under Sec.  1.987-2(b) is determined in the 
functional currency of the section 987 QBU and translated into the 
owner's functional currency under the rules of Sec.  1.987-3. 
Disregarded payments do not serve to reattribute gross income between a 
section 987 QBU and its owner for purposes of determining section 987 
taxable income or loss. Such a reattribution rule would add complexity 
to the section 987 regulations (for example, when income is 
reattributed in a taxable year following the taxable year in which the 
disregarded payment is made), and it would not serve any necessary 
function.
    However, the final regulations contain targeted modifications that 
are intended to reduce the compliance burden of accounting for certain 
transfers between a section 987 QBU and its owner. See part VI of this 
Summary of Comments and Explanation of Revisions (describing 
modifications to the annual remittance rules to reduce the burden of 
tracking and translating disregarded transfers). Additionally, if an 
owner elects to group section 987 QBUs with the same functional 
currency under Sec.  1.987-1(b)(3)(ii), transactions between the 
section 987 QBUs will not be treated as transfers between the section 
987 QBUs and their owner for purposes of section 987.

IV. Comments and Changes to Proposed Sec.  1.987-3: Determination of 
Section 987 Taxable Income or Loss of an Owner of a Section 987 QBU

    Proposed Sec.  1.987-3 would provide rules for determining taxable 
income or loss of a section 987 QBU, including section 988 transactions 
of a section 987 QBU. Additional rules relating to section 988 
transactions would be provided in Sec.  1.987-3 of the 2016 proposed 
regulations, for which the comment period was reopened in 2023.

A. Treatment of Section 988 Transactions Under the 2016 Proposed 
Regulations

    The 2016 proposed regulations provide that the determination of 
whether a transaction is a section 988 transaction is made by reference 
to the section 987 QBU's functional currency. Thus, a transaction 
otherwise within the scope of section 988 that is denominated in a 
functional currency other than the section 987 QBU's

[[Page 100143]]

functional currency generally would be treated as a section 988 
transaction. See Sec.  1.987-3(b)(4)(i) of the 2016 proposed 
regulations. However, section 988 transactions of a section 987 QBU 
denominated in, or determined by reference to, the owner's functional 
currency (``specified owner functional currency transactions'') would 
not be treated as section 988 transactions of the section 987 QBU. See 
Sec.  1.987-3(b)(4)(ii) of the 2016 proposed regulations.
    The 2016 proposed regulations would further provide that section 
988 gain or loss of a section 987 QBU generally is determined by 
reference to the owner's functional currency. See Sec.  1.987-
3(b)(4)(i) of the 2016 proposed regulations. However, section 988 gain 
or loss with respect to certain short-term section 988 transactions 
(``qualified short-term section 988 transactions'') accounted for under 
a mark-to-market method of accounting would be determined in the 
functional currency of the section 987 QBU, and not the functional 
currency of its owner. See Sec.  1.987-3(b)(4)(iii) of the 2016 
proposed regulations. The 2016 proposed regulations would provide an 
election under which taxpayers can apply a mark-to-market method of 
accounting with respect to all qualified short-term section 988 
transactions. See Sec.  1.987-3(b)(4)(iii)(C) of the 2016 proposed 
regulations.
    Under the 2016 final regulations (and the 2023 proposed 
regulations), a transaction denominated in a currency other than the 
section 987 QBU's functional currency is treated as a historic item. 
See Sec.  1.987-1(d) and (e). However, the 2016 proposed regulations 
provide an exception under which a qualified short-term section 988 
transaction for which section 988 gain or loss is determined by 
reference to the functional currency of the section 987 QBU is a marked 
item. See Sec.  1.987-1(d)(3) of the 2016 proposed regulations.
    The preamble to the 2023 proposed regulations requested comments as 
to whether section 988 gain or loss on nonfunctional currency 
transactions of a section 987 QBU (including specified owner functional 
currency transactions) should be determined in the functional currency 
of the section 987 QBU when a current rate election or annual 
recognition election is in effect. 88 FR 78154. The preamble expressed 
concern that, if such a rule were adopted, specified owner functional 
currency transactions would give rise to offsetting positions in the 
functional currency of the section 987 QBU; this could create 
opportunities for taxpayers to recognize losses while deferring the 
offsetting gains. Id. For example, if a section 987 QBU held assets 
denominated in its owner's functional currency, and the section 987 
QBU's functional currency weakened against that of its owner, the 
section 987 QBU would have unrecognized section 988 gain and the owner 
would have an inverse amount of unrecognized section 987 loss. The 
owner could cause the QBU to make a remittance triggering the 
recognition of section 987 loss, while deferring the section 988 gain.

B. Comments on the 2023 Proposed Regulations Regarding Section 988 
Transactions of Section 987 QBUs

    Comments asserted that the section 988 rules of the 2016 proposed 
regulations would impose a substantial compliance burden on taxpayers. 
The comments noted that for financial accounting purposes, foreign 
currency gain or loss on nonfunctional currency transactions of a QBU 
is measured by reference to the functional currency of the QBU. In 
addition, taxpayers typically hedge their exposure to nonfunctional 
currency transactions of a QBU by reference to the QBU's functional 
currency. One comment noted that it is common for section 987 QBUs of 
insurance companies to hold assets denominated in U.S. dollars for 
commercial reasons and that treating these assets as historic items 
would increase the compliance burden on insurance companies.
    Comments suggested that the rules of the 2016 proposed regulations 
be modified to provide that: (i) section 988 gain or loss on 
nonfunctional currency transactions of a section 987 QBU is determined 
by reference to the functional currency of the section 987 QBU, (ii) 
specified owner functional currency transactions are treated as section 
988 transactions, and (iii) section 988 transactions of a section 987 
QBU are treated as marked items. Alternatively, comments requested that 
(if the default rules of the 2016 proposed regulations are retained) 
taxpayers should be permitted to elect this modified treatment.
    According to the comments, the recommended modifications would 
achieve greater consistency with financial accounting standards and 
would ease the compliance burden on taxpayers. One comment stated that 
such an approach would also be more consistent with the statutory 
requirement to determine a section 987 QBU's taxable income or loss in 
the QBU's functional currency under sections 985 and 987. Comments 
noted that the opportunity for selective recognition of losses is 
limited to the extent the taxpayer makes a current rate election 
(because section 987 losses will be subject to suspension) or an annual 
recognition election (because section 987 gain or loss is recognized 
annually without regard to whether a remittance is made). One comment 
asserted that, even if neither of these elections is in effect, it is 
difficult to selectively recognize material section 987 losses 
attributable to section 988 transactions because the remittance 
proportion under Sec.  1.987-5 is determined with respect to all the 
assets of the section 987 QBU.
    Other comments recommended providing an election under which 
taxpayers could recognize section 988 gain or loss with respect to all 
section 988 transactions of a section 987 QBU on a mark-to-market basis 
(effectively expanding the special rule for qualified short-term 
section 988 transactions to cover all section 988 transactions of a 
QBU). For example, one comment requested mark-to-market timing for 
section 988 transactions of a section 987 QBU that is subject to an 
annual recognition election. According to this comment, because mark-
to-market timing would apply to both section 988 and section 987 gains 
and losses on a current basis, the potential for abuse or selective 
loss recognition would be limited. Another comment requested that the 
definition of a qualified short-term section 988 transaction under 
proposed Sec.  1.987-3(b)(4)(iii)(B) be expanded to include long-term 
transactions that have been properly identified as a hedge for U.S. tax 
purposes.
    Finally, a comment recommended that, if the rules of the 2016 
proposed regulations relating to section 988 transactions are retained 
in the final regulations, the applicability date of the final 
regulations should be deferred until taxable years beginning after 
December 31, 2026, so that taxpayers have adequate time to update their 
internal accounting systems.

C. Treatment of Section 988 Transactions Under the Final Regulations

1. Section 988 Mark-To-Market Election
    The final regulations provide that a taxpayer may elect to 
recognize section 988 gain or loss with respect to section 988 
transactions of a section 987 QBU under a mark-to-market method of 
accounting (a ``section 988 mark-to-market election''). See Sec.  
1.987-3(b)(4)(ii). This election is expected to result in consistent 
treatment of section 988 transactions for tax and financial reporting 
purposes and to reduce the potential for selective recognition of

[[Page 100144]]

losses relating to these transactions, as indicated by the comments. 
The section 988 mark-to-market election is subject to the same timing 
and consistency requirements as a current rate election or an annual 
recognition election. See Sec.  1.987-1(g).
    The section 988 mark-to-market election does not apply to a section 
988 transaction that is contributed to a section 987 QBU with a built-
in loss if the section 988 transaction was not subject to a mark-to-
market method of accounting in the hands of the transferor. See Sec.  
1.987-3(b)(4)(ii)(B). This rule is intended to prevent taxpayers from 
accelerating the recognition of section 988 loss by contributing a 
section 988 transaction with a built-in loss to a section 987 QBU that 
is subject to the section 988 mark-to-market election.
2. Treatment of Section 988 Transactions of a Section 987 QBU Under the 
Final Regulations
    The final regulations provide new rules for applying section 988 
with respect to nonfunctional currency transactions of a section 987 
QBU. In response to the comments summarized in part IV.B of this 
Summary of Comments and Explanation of Revisions, the Treasury 
Department and the IRS have determined that a different framework is 
appropriate in order to reduce the compliance burden and complexity of 
the section 987 regulations.
    Under the final regulations, whether an asset or liability of a 
section 987 QBU is a section 988 transaction is determined by reference 
to the functional currency of the section 987 QBU (instead of the 
owner's functional currency). See Sec.  1.987-3(b)(4)(i). The final 
regulations further provide that section 988 gain or loss with respect 
to section 988 transactions of a section 987 QBU (including 
transactions denominated in the owner's functional currency) is 
determined in the functional currency of the section 987 QBU, and 
section 988 transactions are treated as marked items. See Sec. Sec.  
1.987-1(d)(1)(iii) and 1.987-3(b)(4)(i). The final regulations do not 
provide an exception for specified owner functional currency 
transactions; thus, such transactions are treated as section 988 
transactions of the section 987 QBU.
    However, the final regulations provide an anti-abuse rule to 
prevent taxpayers from entering into section 988 transactions through 
an eligible QBU for the purpose of generating offsetting amounts of 
gain and loss that can selectively be recognized or deferred. Under 
Sec.  1.987-2(b)(3)(iv), section 988 transactions will not be treated 
as attributable to an eligible QBU if they are entered into (or 
reflected on the eligible QBU's books and records) with a principal 
purpose of generating offsetting amounts of section 988 gain and 
section 987 loss or offsetting amounts of section 988 loss and section 
987 gain. Section 988 transactions also are subject to the general 
anti-avoidance rules of Sec.  1.987-2(b)(3)(i) through (iii).

V. Comments and Changes to Proposed Sec.  1.987-4: Determination of Net 
Unrecognized Section 987 Gain or Loss of a Section 987 QBU

    Proposed Sec.  1.987-4 provides rules for computing net 
unrecognized section 987 gain or loss with respect to a section 987 
QBU. In particular, proposed Sec.  1.987-4(d) provides a ten-step 
formula for computing unrecognized section 987 gain or loss for the 
current taxable year. The first step of this formula is to compute the 
change in owner functional currency net value (``OFCNV'') for the 
taxable year. Proposed Sec.  1.987-4(d)(1). The other steps make 
adjustments for changes to OFCNV that are not attributable to changes 
in the exchange rate. Steps 2 through 5 relate to transfers of assets 
and liabilities between a section 987 QBU and its owner, and steps 6 
through 9 relate to income or loss of the section 987 QBU. Proposed 
Sec.  1.987-4(d)(2) through (9). Step 10 is a residual adjustment for 
any increase or decrease to the section 987 QBU's balance sheet that is 
not otherwise accounted for. Proposed Sec.  1.987-4(d)(10). If a 
current rate election is in effect, taxpayers are required to apply 
only steps 1 through 5 and step 10.
    Under proposed Sec.  1.987-4(e), OFCNV is determined by preparing a 
tax basis balance sheet reflecting the section 987 QBU's assets and 
liabilities. The basis of each asset and the amount of each liability 
is then translated into the owner's functional currency at the 
appropriate exchange rate. Under the default rules, marked items are 
translated at the year-end spot rate, while historic items are 
translated at the applicable historic rate. However, taxpayers that 
make a current rate election under Sec.  1.987-1(d)(2) translate all 
items on the year-end balance sheet at the year-end spot rate.

A. Mechanics for Calculating Unrecognized Section 987 Gain or Loss for 
the Current Taxable Year

1. Earnings and Capital Method
    The preamble to the 2023 proposed regulations notes that, under a 
current rate election, the total amount of section 987 gain or loss 
recognized by an owner with respect to a section 987 QBU would be 
similar to the amount computed under the earnings and capital method, 
which was described in proposed regulations published in the Federal 
Register in 1991 (56 FR 48457, September 25, 1991) (the ``1991 proposed 
regulations''). 88 FR 78138 through 78139. Under the earnings and 
capital method, the owner of a section 987 QBU computes section 987 
gain or loss by maintaining an equity pool in the QBU's functional 
currency and a basis pool in the owner's functional currency. The 
equity and basis pools are increased by income of the section 987 QBU 
and contributions from the owner, and they are decreased by losses of 
the section 987 QBU and distributions from the section 987 QBU to the 
owner. The preamble to the 1991 proposed regulations explains that the 
equity pool generally represents the amount of branch equity (adjusted 
basis of assets net of liabilities), and the basis pool represents the 
owner's basis in branch equity. 56 FR 48458.
    Comments requested that the final regulations include an election 
to apply the earnings and capital method of the 1991 proposed 
regulations in lieu of the current rate election. These comments 
indicated that, even if a current rate election is in effect, proposed 
Sec.  1.987-4 imposes a heightened compliance burden (as compared to 
the earnings and capital method) because it requires taxpayers to 
prepare tax basis balance sheets for each of their section 987 QBUs on 
an annual basis. In addition, the comments asserted that taxpayers are 
already familiar with the earnings and capital method and would be less 
likely to make errors in applying that method because taxpayers track 
book-to-tax adjustments in computing taxable income but do not make 
book-to-tax adjustments to their balance sheets. One comment 
recommended allowing taxpayers to use the earnings and capital method 
only if a current rate election and an annual recognition election are 
both in effect.
    The final regulations do not permit taxpayers to use the earnings 
and capital method. As explained in the preamble to the 2023 proposed 
regulations, such an election would allow different taxpayers to apply 
section 987 using fundamentally different methodologies, which would 
increase the overall complexity of the section 987 regulations and make 
them more difficult to administer. 88 FR 78138. For example, it would 
be difficult for taxpayers to transition from one method to another in 
an administrable way. Moreover, under the earnings and capital method, 
the amount of section

[[Page 100145]]

987 gain or loss recognized is determined based on the percentage of a 
section 987 QBU's net equity remitted (rather than the percentage of 
gross assets remitted, as required under Sec.  1.987-5), which can 
inappropriately accelerate the recognition of section 987 gain or loss. 
If a section 987 QBU has negative net equity, section 987 gain or loss 
cannot be recognized under the earnings and capital method until the 
section 987 QBU terminates, which is inconsistent with the statutory 
requirement to recognize currency gain or loss on transfers of property 
from the section 987 QBU.
    However, the final regulations modify the existing framework of 
Sec.  1.987-4 to allow taxpayers that make a current rate election to 
use certain elements of the earnings and capital method in lieu of 
preparing a tax basis balance sheet.\2\ These modifications are 
expected to minimize the compliance burden of transitioning from the 
1991 proposed regulations to the final regulations. Under the final 
regulations, if a current rate election is in effect, OFCNV is computed 
by determining the aggregate basis of the QBU's assets, net of the 
QBU's liabilities, in the functional currency of the section 987 QBU 
(``QBU net value'') and translating the QBU net value into the owner's 
functional currency at the year-end spot rate. See Sec.  1.987-
4(e)(2)(i) and (ii). The final regulations provide that QBU net value 
can be computed without a tax basis balance sheet using the formula 
provided in Sec.  1.987-4(e)(2)(iii).
---------------------------------------------------------------------------

    \2\ Taxpayers would still need to track the gross assets of a 
section 987 QBU for other purposes, including the denominator of the 
remittance proportion under Sec.  1.987-5.
---------------------------------------------------------------------------

    The formula provided in Sec.  1.987-4(e)(2)(iii) is modeled on the 
formula used to track the equity pool under the 1991 proposed 
regulations, with certain modifications. Under this formula, the QBU 
net value on the last day of the taxable year is equal to the QBU net 
value at the end of the preceding taxable year, adjusted by transfers 
of assets and liabilities between the section 987 QBU and its owner and 
by income or loss of the section 987 QBU (each determined in the 
section 987 QBU's functional currency). If a taxpayer determines QBU 
net value under Sec.  1.987-4(e)(2)(iii), the taxpayer must retain the 
information used to determine QBU net value for each taxable year in 
lieu of retaining adjusted balance sheets. See Sec.  1.987-9(b)(2).
2. Cumulative Translation Adjustment
    Comments requested that taxpayers be permitted to use the 
cumulative translation adjustment (``CTA'') determined under U.S. 
generally accepted accounting principles (``U.S. GAAP'') to compute 
their unrecognized section 987 gain or loss. Alternatively, some 
comments recommended that taxpayers should be allowed to use the CTA 
for this purpose only with respect to small QBUs and subject to certain 
tax adjustments. One comment suggested that section 987 gain or loss 
with respect to small QBUs should be recognized when the CTA is 
included in income from continuing operations under U.S. GAAP.
    The final regulations do not permit taxpayers to use the CTA to 
determine their net unrecognized section 987 gain or loss. As explained 
in the preamble to the 2023 proposed regulations, section 987(3) 
requires currency gain or loss to be recognized at the time of a 
remittance, rather than when the CTA is included in income for U.S. 
GAAP purposes. 88 FR 78141. Moreover, the Treasury Department and the 
IRS have determined that significant differences may arise between the 
computation of the CTA for financial accounting purposes and the 
determination of unrecognized section 987 gain or loss under Sec.  
1.987-4(d). For example, the CTA is unlikely to reflect the correct 
amount of currency gain or loss for tax purposes because of book-to-tax 
differences in the basis of assets or because certain items are 
disregarded for tax purposes but regarded for financial accounting 
purposes. If the comment's recommended approach were adopted, complex 
rules would be needed to adjust the CTA amount in order to derive the 
correct amount to be recognized for tax purposes.
3. Simplified Accounting for Disregarded Transactions
    A comment recommended that taxpayers that make a current rate 
election should be permitted to determine unrecognized section 987 gain 
or loss for the taxable year by applying only two steps: step 1 
(determining the change in OFCNV) and step 10 (reducing the amount 
determined in step 1 by the change in QBU net value, translated into 
the owner's functional currency at the yearly average exchange rate). 
The recommended rule would have the effect of accounting for all 
transfers between the owner and the section 987 QBU (which would 
otherwise be accounted for under steps 2 through 5) as part of step 10; 
consequently, the net amount of all transfers would be translated at 
the yearly average exchange rate. The comment posited that this 
approach would simplify the computations for taxpayers with a high 
volume of disregarded intercompany transactions.
    The final regulations retain the requirement to apply steps 2 
through 5 when a current rate election is in effect. Under these steps, 
transfers of marked assets and liabilities between a section 987 QBU 
and its owner generally are translated at the spot rate applicable on 
the date of transfer. Because the applicable spot rate may differ 
significantly from the yearly average exchange rate, it would not be 
appropriate to account for all transfers between a section 987 QBU and 
its owner by translating them at the yearly average exchange rate under 
step 10. The Treasury Department and the IRS continue to study possible 
simplifications of Sec.  1.987-4 relating to disregarded transactions 
between a section 987 QBU and its owner, including whether, in certain 
circumstances, unrecognized section 987 gain or loss for a taxable year 
could be computed using only steps 1 and 10. See Sec.  1.987-2(f) of 
the 2024 proposed regulations for proposed rules containing an election 
under which certain disregarded transactions between a section 987 QBU 
and its owner would not be taken into account in computing unrecognized 
section 987 gain or loss.

B. Hedging Transactions

1. Comment on Matching Source and Character of Section 988 Gain or Loss 
From a Hedging Transaction With the Source and Character of Section 987 
Gain or Loss
    A comment recommended adoption of a hedging rule under which a 
taxpayer that hedges exchange rate risk with respect to its net 
investment in a section 987 QBU could match the source and character of 
the section 988 gain or loss arising from the hedging transaction with 
that of the section 987 gain or loss attributable to the hedged section 
987 QBU. Alternatively, the comment suggested that the hedging 
transaction could be integrated with the section 987 QBU, such that 
section 988 gain or loss with respect to the hedging transaction would 
directly offset the section 987 QBU's unrecognized section 987 gain or 
loss. The comment asserted that implementing either of these 
recommended rules would mitigate the potential for adverse consequences 
(or windfalls) under section 987 when the owner's foreign currency 
exposure is economically hedged. The comment noted that these rules 
would be particularly beneficial for taxpayers that make a current rate 
election and an

[[Page 100146]]

annual recognition election (and thus recognize section 987 gain or 
loss whether or not there is a remittance).
2. Treatment of Section 987 Hedging Transactions Under the Final 
Regulations
    The Treasury Department and the IRS agree with the comment that it 
would be appropriate to permit symmetrical treatment of currency gain 
or loss with respect to a net investment hedge and the hedged section 
987 QBU.\3\ Accordingly, Sec.  1.987-14 of the final regulations 
provides new rules that apply to certain identified hedging 
transactions entered into by the owner of a section 987 QBU (``section 
987 hedging transactions'').
---------------------------------------------------------------------------

    \3\ The Treasury Department and the IRS previously published 
proposed regulations in the Federal Register on December 19, 2017 
(82 FR 60135), which contained proposed rules relating to the 
treatment of a net investment hedge for purposes of the business 
needs exception to the definition of foreign personal holding 
company income under section 954(c)(1)(D) and Sec.  1.954-
2(g)(2)(ii). Those proposed regulations would apply only for 
purposes of the business needs exception and do not address the 
potential for mismatches in other contexts.
---------------------------------------------------------------------------

    Under Sec.  1.987-14(d), section 988 gain or loss that would 
otherwise be recognized on a section 987 hedging transaction (``hedging 
gain or loss'') is instead taken into account in adjusting the owner's 
unrecognized section 987 gain or loss for the taxable year (as 
determined under Sec.  1.987-4(d)). For example, if the owner has 
unrecognized section 987 gain for the taxable year under Sec.  1.987-
4(d), the owner's hedging loss reduces the unrecognized section 987 
gain. However, hedging loss cannot reduce unrecognized section 987 gain 
for the taxable year below zero, and hedging gain cannot reduce 
unrecognized section 987 loss for the taxable year below zero. This 
limitation ensures that hedging gain or loss in excess of the currency 
exposure generated by the section 987 QBU for the taxable year is not 
taken into account under section 987.
3. Requirements To Qualify as a Section 987 Hedging Transaction
    A section 987 hedging transaction generally is defined as a 
financial instrument (a ``hedge'') entered into by the owner of a 
section 987 QBU for the purpose of managing exchange rate risk with 
respect to the owner's net investment in the section 987 QBU as part of 
the normal course of the owner's trade or business. The hedge may be 
entered into with an unrelated counterparty or with a related person. 
For example, a CFC that owns a section 987 QBU may enter into a hedge 
with its U.S. parent, which has entered into a similar, offsetting, 
transaction with a third party.
    Several requirements must be met in order for a hedge to qualify as 
a section 987 hedging transaction. First, the hedge must be identified 
as a section 987 hedging transaction with respect to the hedged QBU on 
or before the day the owner enters into the hedge. See Sec.  1.987-
14(b)(2)(i) and (c). A hedge cannot be identified as a section 987 
hedging transaction with respect to more than one section 987 QBU. 
However, if a grouping election is in effect under Sec.  1.987-
1(b)(3)(ii), all section 987 QBUs that have the same functional 
currency will be treated as a single section 987 QBU. The final 
regulations also provide a special rule for cases in which a taxpayer 
fails to properly identify a hedge due to inadvertent error. See Sec.  
1.987-14(c)(2).
    Second, a current rate election must be in effect for the taxable 
year. See Sec.  1.987-14(b)(2)(ii). In the absence of a current rate 
election, gain or loss on a net investment hedge is unlikely to be 
comparable in amount to the owner's unrecognized section 987 gain or 
loss, and thus the rules of Sec.  1.987-14 would not serve their 
intended function.
    Third, the owner (and any members of the same controlled group that 
are parties to the hedge) must account for section 988 gain or loss 
with respect to the hedge under a mark-to-market method of accounting 
(for example, under section 1256 or in reliance on proposed Sec.  
1.988-7). See Sec.  1.987-14(b)(2)(iii). As a result of this 
requirement, foreign currency gain or loss on the hedge will be taken 
into account in the taxable year in which the related currency gain or 
loss is determined under Sec.  1.987-4(d)).
    Fourth, under U.S. GAAP, foreign currency gain or loss on the hedge 
must be properly accounted for as a cumulative foreign currency 
translation adjustment to shareholders' equity. See Sec.  1.987-
14(b)(2)(iv). This requirement helps to ensure that the hedge is 
economically related to the owner's net investment in the section 987 
QBU.
    Fifth, the hedge must be entered into by the owner of the section 
987 QBU, and not by a section 987 QBU of the owner (that is, the hedge 
cannot itself be an asset attributable to a section 987 QBU). See Sec.  
1.987-14(b)(2)(v).
    Finally, an anti-abuse rule provides that a hedge does not qualify 
as a section 987 hedging transaction if the hedge or a related 
transaction is entered into with a principal purpose of converting 
section 987 gain or loss into section 988 gain or loss. See Sec.  
1.987-14(b)(3). For example, a taxpayer that owns a section 987 QBU 
might enter into a hedging transaction with a related party without 
hedging the related party's resulting exchange rate risk (effectively 
shifting the exchange rate risk without reducing the group's overall 
foreign currency exposure) for the purpose of taking the related 
foreign currency gain or loss into account under section 988 (rather 
than section 987). Under the anti-abuse rule, the net investment hedge 
would not be treated as a section 987 hedging transaction.
4. Consolidated Groups
    With regard to consolidated groups (as defined in Sec.  1.1502-
1(h)), Sec.  1.987-14(b)(2)(v) of the final regulations requires that 
the same corporation be the owner of the QBU and enter into the section 
987 hedging transaction with respect to that QBU (similar requirements 
apply when a member of a consolidated group engages in a section 988(d) 
hedging transaction under Sec.  1.988-5(a)(5)(v) or (b)(2)(i)(F)). The 
Treasury Department and the IRS continue to study whether it would be 
possible to treat consolidated group members as a single corporation 
for purposes of Sec.  1.987-14 and the section 988(d) hedging 
transaction rules without inappropriately shifting income among members 
of the group. See also TD 8400, 57 FR 9172, 9176 (soliciting comments 
on whether to permit the rules of Sec.  1.988-5 to be applied by 
treating consolidated group members as a single corporation).

VI. Comments and Changes to Proposed Sec.  1.987-5: Recognition of 
Section 987 Gain or Loss

    Proposed Sec.  1.987-5 provides rules for determining the amount of 
section 987 gain or loss recognized by the owner of a section 987 QBU.
    Under proposed Sec.  1.987-5(a), when a section 987 QBU makes a 
remittance, the owner recognizes section 987 gain or loss. In general, 
the amount recognized equals the section 987 QBU's net unrecognized 
section 987 gain or loss multiplied by the owner's remittance 
proportion. The remittance proportion is determined in the owner's 
functional currency; it is equal to the amount of the remittance for 
the taxable year, divided by the aggregate basis of the section 987 
QBU's gross assets reflected on its year-end balance sheet (without 
reduction for the remittance). Proposed Sec.  1.987-5(b). For a taxable 
year, the amount of a remittance equals the excess of (i) the aggregate 
of all amounts transferred from the section 987 QBU to the owner during 
the taxable year; over (ii) the aggregate of all amounts transferred 
from the owner to the section 987 QBU

[[Page 100147]]

during the taxable year (each determined in the owner's functional 
currency). Proposed Sec.  1.987-5(c).
    A comment noted that, for taxpayers with a high volume of 
disregarded intercompany transactions, it can be difficult to track the 
amount of each transfer between the section 987 QBU and its owner and 
to translate the transfer into the owner's functional currency at the 
appropriate exchange rate. The comment recommended that the amount of a 
remittance should be deemed to be equal to the change in the QBU's net 
value (if negative) for the taxable year.
    Despite compliance and administrative burdens that may result in 
certain cases from tracking disregarded transfers for purposes of 
determining the amount of a remittance, it would not be appropriate to 
determine the remittance amount based solely on the negative change in 
net value of a section 987 QBU. Such an approach would not properly 
account for distributions out of a section 987 QBU's current year 
earnings. For example, if a section 987 QBU distributed an amount 
exactly equal to its current year earnings, there would be no change in 
the QBU's net value (and thus, no remittance) under the comment's 
recommended approach, even if the QBU made a substantial distribution. 
Section 987(3) and its legislative history indicate that Congress 
intended for gain or loss to be recognized on any remittance from a 
section 987 QBU, without regard to whether the remittance is sourced 
from current year earnings, prior year earnings, or capital 
contributions.
    Nonetheless, the final regulations provide two modifications that 
are intended to reduce the burden of tracking disregarded transfers for 
purposes of Sec.  1.987-5 while preserving consistency with the text 
and purpose of section 987. First, the final regulations provide an 
alternative formula for computing the annual remittance that is based 
on the comment's recommended approach (and does not require tracking of 
individual transfers) but contains an adjustment to account for 
remittances out of current-year income. Under this formula, the 
remittance amount is equal to the negative change in net value of the 
section 987 QBU (determined in the QBU's functional currency), adjusted 
for income and loss of the section 987 QBU. See Sec.  1.987-5(c)(2). 
Mathematically, this formula will produce an amount that is equal to 
the aggregate net transfer from the section 987 QBU to its owner for 
the taxable year.
    Second, Sec.  1.987-5(b) and (c) provide that the numerator and 
denominator of the remittance proportion (that is, the amount of the 
remittance and the section 987 QBU's gross assets) are determined in 
the section 987 QBU's functional currency, rather than the owner's 
functional currency. As a result, it is not necessary to separately 
translate each transfer for purposes of determining the annual 
remittance.

VII. Comments and Changes to Proposed Sec.  1.987-6: Character and 
Source of Section 987 Gain or Loss

A. Determining the Character and Source of Section 987 Gain or Loss

1. In General
    Under proposed Sec.  1.987-6, section 987 gain or loss is assigned 
to the statutory and residual groupings in two steps: an initial 
assignment under proposed Sec.  1.987-6(b)(2)(i), followed by a 
reassignment described in proposed Sec.  1.987-6(b)(2)(ii). The initial 
assignment is made using the asset method under Sec. Sec.  1.861-9(g) 
and 1.861-9T(g). It is made after the application of the income 
attribution rules of Sec.  1.904-4(f)(2)(vi) or Sec.  1.951A-2(c)(7), 
but before expenses are allocated and apportioned to gross income and 
before the application of provisions that require a net income 
computation. Section 987 gain or loss may be reassigned if required 
after the application of provisions that require a net income 
computation. For example, if an item of section 987 gain is initially 
assigned to tentative tested income, it will be reassigned to tested 
income or residual income depending on whether the taxpayer has made 
the GILTI high-tax exclusion election and, if so, whether the item 
(described in proposed Sec.  1.987-6(b)(2)(iii)) is subject to a high 
rate of tax.
2. Asset Method
    The asset method under Sec. Sec.  1.861-9 and 1.861-9T is intended 
to serve as an administrable proxy for a section 987 QBU's historical 
earnings, in line with the statutory requirement of section 987(3)(B) 
(which provides that section 987 gain or loss is sourced by reference 
to the source of the income giving rise to post-1986 accumulated 
earnings). As explained in the preamble to the 2016 final regulations, 
it would be complex and burdensome to source and characterize section 
987 gain or loss with direct reference to post-1986 accumulated 
earnings, and the gross assets of a section 987 QBU provide a 
reasonable proxy for historical earnings that is relatively easy to 
administer. 81 FR 88814.
    A comment recommended that CFCs which apportion interest expense 
using the modified gross income method be permitted to use the same 
method to determine the character and source of section 987 gain or 
loss (rather than using the asset method under Sec. Sec.  1.861-9(g) 
and 1.861-9T(g)). According to the comment, the asset method may not 
accurately reflect the income earned by the CFC for the taxable year, 
and section 987 losses often could be allocated to a subpart F income 
group in excess of the income recognized in that group for the taxable 
year. The comment noted that the use of the modified gross income 
method would be more administrable and would more readily allow section 
987 losses to be used against gross income recognized in the current 
year, since the source and character of the section 987 loss would be 
determined by reference to the section 987 QBU's gross income for the 
current year.
    The final regulations do not permit CFCs to use the modified gross 
income method to source and characterize section 987 gain or loss 
because the source and character of a section 987 QBU's gross income 
may vary significantly from year to year, including by reason of 
extraordinary events or as a result of tax planning. Accordingly, the 
gross income earned in a single year is not a sufficiently reliable 
proxy for historical earnings for purposes of section 987(3)(B).
3. Timing of Source and Character Determination
    The 2023 proposed regulations provide that the initial assignment 
of section 987 gain or loss would generally be made in the taxable year 
in which the section 987 gain or loss is treated as recognized, 
deferred, or suspended. Proposed Sec.  1.987-6(b)(1).
    Comments requested that the character and source of suspended 
section 987 loss and deferred section 987 gain or loss be determined in 
the year in which it is recognized, rather than in the year in which it 
becomes suspended or deferred. The comments noted that the proposed 
rules would require extensive tracking of the source and character of 
section 987 gain or loss in multiple categories over multiple years. 
Comments also posited that the potential for distortion due to changes 
in the basis of a QBU's assets or shifts in the character of its income 
would be present whether the section 987 gain or loss is characterized 
in the taxable year in which it becomes suspended or deferred or in the 
taxable year in which it is recognized.
    The final regulations retain the rules of proposed Sec.  1.987-
6(b)(1)(ii) and (iii), under which suspended section 987 loss and 
deferred section 987 gain or loss are

[[Page 100148]]

characterized in the year of suspension and deferral, respectively, for 
several reasons.
    First, making an initial assignment in the taxable year of deferral 
or suspension provides parity in the timing of the characterization of 
gains and losses (that is, both gains and losses are characterized in 
the year of a remittance or termination).
    Second, this rule is expected to produce source and character 
determinations that more closely align with the historical income of 
the section 987 QBU during the period in which the relevant section 987 
gain or loss arose. Making an initial assignment in the taxable year of 
deferral or suspension means that source and character are determined 
by reference to the assets of the section 987 QBU contemporaneously 
with the remittance or termination, while the affected assets are still 
taken into account for purposes of applying the asset method under 
Sec. Sec.  1.861-9 and 1.861-9T. By contrast, waiting until the year of 
recognition would require deferred section 987 gain or loss and (in 
some cases) suspended section 987 loss to be characterized after the 
section 987 QBU has been terminated and its assets have been 
transferred to a related party, which could result in substantial 
distortions.
    Third, the timing rule of Sec.  1.987-6(b)(1)(ii) is needed to 
facilitate the separate application of the loss-to-the-extent-of-gain 
rule under Sec.  1.987-11(e) to section 987 gain or loss in each 
recognition grouping. As explained in part X.B.3 of this Summary of 
Comments and Explanation of Revisions, in order to prevent taxpayers 
from avoiding the loss limitation through the selective recognition of 
section 987 gains that are subject to a low rate of tax (or are not 
subject to U.S. tax), Sec.  1.987-11(e) provides that suspended section 
987 loss in a recognition grouping is not recognized until section 987 
gain in the same recognition grouping is recognized. For this rule to 
achieve its policy objective, suspended section 987 loss must be 
sourced and characterized before determining whether it can be 
recognized under Sec.  1.987-11(e). If suspended section 987 loss were 
not characterized until the year of recognition, there would be no 
administrable way to identify suspended section 987 loss in the 
relevant recognition grouping for purposes of Sec.  1.987-11(e) because 
the source and character of the suspended section 987 loss would not 
yet have been determined.
    Finally, in response to comments regarding compliance burden 
generally, the final regulations include a number of new rules intended 
to simplify the tracking of suspended section 987 loss or deferred 
section 987 gain or loss. For instance, the new de minimis rule 
(described in part X.A.1 of this Summary of Comments and Explanation of 
Revisions) is expected to reduce the burden of tracking suspended 
section 987 loss because section 987 loss will be suspended only if it 
exceeds the de minimis threshold (the lesser of $3 million or two 
percent of gross income). See Sec.  1.987-11(c)(2). In addition, 
taxpayers that make the annual recognition election generally would not 
be subject to the deferral and loss suspension rules (and thus would 
not need to track deferred section 987 gain or loss or suspended 
section 987 loss). The lookback rule (described in part X.B.1 of this 
Summary of Comments and Explanation of Revisions) will permit suspended 
section 987 loss to be recognized in the year of a remittance to the 
extent of gain recognized during the lookback period, which will limit 
the amount of suspended section 987 loss carried forward to future 
years. Additionally, the new rules relating to the characterization of 
section 987 gain or loss for purposes of subpart F (described in part 
VII.B of this Summary of Comments and Explanation of Revisions) provide 
taxpayers more flexibility in characterizing their section 987 gain and 
loss relating to subpart F income groups, including an election that 
will limit the number of subpart F income groups for which tracking is 
required.

B. Characterization of Section 987 Gain or Loss for Purposes of Subpart 
F

1. In General
    Under proposed Sec.  1.987-6(b)(2)(i)(C), section 987 gain or loss 
assigned to a subpart F income group is treated as foreign currency 
gain or loss attributable to section 988 transactions not directly 
related to the business needs of the CFC for purposes of section 
954(c)(1)(D).
    Some comments recommended that, for subpart F purposes, section 987 
gain or loss should instead be assigned to the same subpart F income 
groups as the income generated by the section 987 QBU's assets. The 
comments noted that the recommended rule would better align the 
characterization of section 987 gain or loss with the underlying assets 
and income of the section 987 QBU and would permit broader utilization 
of section 987 loss because the loss could be netted against income in 
the same subpart F income groups. One comment asserted that the 
recommended rule would be more consistent with section 987(3)(B), which 
requires section 987 gain or loss to be sourced by reference to the 
source of the income giving rise to post-1986 accumulated earnings.
    Other comments stated that section 987 gain or loss should not be 
treated as foreign personal holding company income described in section 
954(c)(1)(D) because section 954(c)(1)(D) refers to foreign currency 
gains or losses under section 988 and makes no reference to gain or 
loss recognized under section 987(3). One comment questioned whether 
section 987 gain or loss should be assigned to any subpart F income 
group because section 954 does not explicitly identify section 987 gain 
as a category of subpart F income.
    Another comment requested that, if proposed Sec.  1.987-
6(b)(2)(i)(C) is retained for taxpayers applying the default rules, a 
different rule should be provided for taxpayers that make a current 
rate election (under which all assets and liabilities of a section 987 
QBU give rise to currency gain or loss). A comment also recommended 
that, if proposed Sec.  1.987-6(b)(2)(i)(C) is retained, the final 
regulations should clarify that, for taxpayers predominantly engaged in 
the active conduct of a banking, insurance, financing, or similar 
business, section 987 gain or loss that is assigned to a subpart F 
income group is treated as financial services income within the meaning 
of section 904(d)(2)(C).
    Other comments requested that, if section 987 gain or loss is 
treated as gain or loss from section 988 transactions not directly 
related to the business needs of the CFC, taxpayers should be permitted 
to use the elections available under Sec.  1.954-2(g)(3) 
(characterizing section 988 gain or loss that arises from a specific 
category of subpart F income as gain or loss in that category) and 
Sec.  1.954-2(g)(4) (treating all section 988 gain or loss as foreign 
personal holding company income). One comment recommended that, for 
purposes of the election under Sec.  1.954-2(g)(3), section 987 gain or 
loss should be allocated to categories of foreign base company income 
on a proportionate basis without requiring direct tracing of section 
987 gain or loss to specific transactions or assets.
    The final regulations retain the approach in the 2023 proposed 
regulations and treat section 987 gain or loss as subpart F income to 
the extent that the assets of the section 987 QBU generate subpart F 
income under the asset method of Sec. Sec.  1.861-9(g) and 1.861-9T(g). 
See Sec.  1.987-6(b)(2)(i)(A). However, the Treasury Department and the 
IRS agree with the comments that assigning section 987 gain or loss to 
the

[[Page 100149]]

same subpart F income groups as the income generated by the section 987 
QBU's assets is most consistent with the principles of section 
987(3)(B) and is therefore the most appropriate exercise of authority 
under sections 987(3) and 989(c). Accordingly, under the final 
regulations, the characterization of section 987 gain or loss is 
determined under the general rule of Sec.  1.987-6 using the asset 
method of Sec. Sec.  1.861-9(g) and 1.861-9T(g), including by assigning 
section 987 gain or loss to subpart F income groups. Thus, for example, 
if a QBU's assets generate foreign base company sales income, the 
section 987 gain or loss will be characterized as foreign base company 
sales income.
    The Treasury Department and the IRS do not agree with the 
suggestion that section 987 gain or loss cannot give rise to subpart F 
income merely because section 954 does not explicitly identify section 
987 gain as a separate category of subpart F income. Section 987(3) 
requires ``proper adjustments (as prescribed by the Secretary)'' to 
taxable income of the owner of a section 987 QBU. Further regulatory 
authority is provided in section 989(c). The adjustments required under 
section 987(3) include sourcing gain or loss recognized on a remittance 
by reference to the QBU's historical earnings under section 987(3)(B). 
This sourcing rule serves to characterize the adjustments to income 
under section 987(3) in the same way as the QBU's underlying income. 
Similarly, when a QBU's income is taken into account in determining the 
owner's subpart F income, proper adjustments must necessarily include 
adjustments to that type of income. Therefore, section 987 gain or loss 
must be characterized as foreign personal holding company income or 
other types of income described in section 952(a), in appropriate 
circumstances, to effectuate the intent of Congress reflected in the 
broader statutory scheme.
2. Election To Treat Certain Section 987 Gain or Loss as Foreign 
Currency Gain or Loss Attributable to Section 988 Transactions
    In the case of section 987 gain or loss that would otherwise be 
characterized as passive foreign personal holding company income, the 
final regulations provide an election to treat the section 987 gain or 
loss as foreign currency gain or loss of the CFC-owner that is 
attributable to section 988 transactions not directly related to the 
business needs of the CFC (the ``section 988 characterization 
election''). See Sec.  1.987-6(b)(2)(i)(C)(1). This election is 
intended to benefit taxpayers because it would generally allow section 
987 gains and losses assigned to passive foreign personal holding 
company income groups, which would otherwise be treated as separate 
items (or as allocable to separate items) of passive foreign personal 
holding company income under the rules in Sec.  1.954-1(c)(1)(iii)(B), 
to be treated as part of (or allocable to) a single item of income. 
This would generally facilitate some netting of the CFC-owner's section 
987 gains and losses (because they would be assigned to the same item 
of income) and would also generally permit a CFC-owner to net its 
foreign currency gains and losses from section 988 transactions with 
the section 987 gain or loss from its QBUs (to the extent both comprise 
passive foreign personal holding company income). Similarly, the 
section 988 characterization election should, in many cases, reduce the 
number of recognition groupings under Sec.  1.987-11(f), thereby 
simplifying the application of the loss-to-the-extent-of-gain rule and 
minimizing the tracking burden with respect to any suspended losses.
    Section 987 gain or loss subject to the section 988 
characterization election is not eligible for the business needs 
exception under Sec.  1.954-2(g)(2) because this election applies only 
to section 987 gain or loss that would otherwise be characterized by 
reference to assets that give rise to passive foreign personal holding 
company income. The business needs exception is available only for 
foreign currency gain or loss arising from a transaction or property 
that does not give rise to subpart F income (which includes foreign 
personal holding company income). See Sec.  1.954-
1(g)(2)(ii)(B)(1)(ii).
    Similarly, section 987 gain or loss subject to the section 988 
characterization election is not eligible for the election in Sec.  
1.954-2(g)(3) (election to characterize foreign currency gain or loss 
that arises from a specific category of subpart F income as gain or 
loss in that category). The Sec.  1.954-2(g)(3) election applies only 
to gain or loss that is related to income categories described in the 
foreign base company income groups of Sec.  1.954-1(c)(1)(iii)(A)(1) or 
(2) or the other subpart F income categories described in section 
952(a); it does not apply to gain or loss related to passive foreign 
personal holding company income.\4\ By contrast, the section 988 
characterization election applies only to section 987 gain or loss that 
would otherwise be characterized by reference to assets that give rise 
to passive foreign personal holding company income. Thus, the two 
elections are mutually exclusive by their terms.
---------------------------------------------------------------------------

    \4\ While Sec.  1.954-1(c)(1)(iii)(A)(1) includes categories of 
foreign personal holding company income, it expressly excludes 
passive foreign personal holding company income, which is described 
in Sec.  1.954-1(c)(1)(iii)(B). Therefore, the two elections apply 
to mutually exclusive income groups.
---------------------------------------------------------------------------

    Finally, section 987 gain or loss subject to the section 988 
characterization election is not eligible for the election in Sec.  
1.954-2(g)(4) (election to treat all foreign currency gains or losses 
as foreign personal holding company income). Extending the Sec.  1.954-
2(g)(4) election to section 987 gain or loss could permit inappropriate 
use of section 987 losses and would be inconsistent with the limited 
purpose of the section 988 characterization election. Therefore, if an 
election is in effect under Sec.  1.954-2(g)(3) or (4), the foreign 
currency gain or loss to which the election applies is simply 
determined without regard to the section 987 gain or loss treated as 
foreign currency gain or loss attributable to a section 988 transaction 
by reason of the section 988 characterization election.

C. GILTI High-Tax Exclusion

    Under the 2023 proposed regulations, for purposes of applying the 
high-tax exclusion in Sec.  1.951A-2(c)(7) (the ``GILTI HTE''), all 
section 987 gain and loss in a tentative tested income group that is 
recognized by a CFC in a taxable year is treated as a single tentative 
tested income item that is treated as recognized by a tested unit 
separate from the CFC's other tested units. Proposed Sec.  1.987-
6(b)(2)(iii). As a result, section 987 gain or loss is not taken into 
account in applying the GILTI HTE with respect to the CFC's other items 
of tentative tested income. Instead, the GILTI HTE is applied 
separately to section 987 gain and loss and, as a result, section 987 
gain or loss generally will not be eligible for the GILTI HTE unless 
the CFC is subject to foreign tax on currency gain recognized with 
respect to its interest in the QBU under the applicable foreign tax 
rules. See proposed Sec.  1.987-6(b)(3).
    Some comments noted that these rules would preclude the application 
of the GILTI HTE with respect to section 987 gain of a CFC even if the 
CFC's section 987 QBUs are operating in jurisdictions subject to a high 
foreign tax rate. Another comment noted that the proposed rules would 
treat section 987 gain or loss differently from currency gain or loss 
recognized under section 988 (for example, section 988 gain or loss on 
a net investment hedge with respect to the section 987 QBU) and would 
make it difficult to project a

[[Page 100150]]

taxpayer's effective tax rate due to the unpredictability of exchange 
rate fluctuations. This comment recommended that proposed Sec.  1.987-
6(b)(2)(iii) be modified to provide that (i) section 987 gain and loss 
is taken into account in determining the effective tax rate under Sec.  
1.951A-2(c)(7)(vi) and (ii) section 987 gain or loss associated with 
highly taxed tested units is excluded from the computation of tested 
income.
    The final regulations retain the rule that section 987 gain or loss 
is treated as a single tentative tested income item that is separate 
from the CFC's other tested units. See Sec.  1.987-6(b)(2)(iii). 
Although section 987 gain or loss is characterized by reference to the 
historical earnings of the section 987 QBU, which may correspond to one 
or more tested units, it is not equivalent to current year income or 
loss attributable to a tested unit. Section 987 gain or loss is not 
properly attributable to the tested unit that corresponds to the 
section 987 QBU or to the CFC tested unit, because in most cases 
neither the tested unit's country of residence nor the CFC's country of 
residence will take the section 987 gain or loss into account in 
determining foreign gross income. Therefore, attributing section 987 
gain or loss to either tested unit would tend to be distortive and 
generally would not further the goals of the high-tax exclusion.\5\
---------------------------------------------------------------------------

    \5\ While the legislative history relating to the GILTI high-tax 
exclusion indicates that high-taxed income does not present base 
erosion concerns, the policy rationale underlying that view does not 
extend to excluding low-taxed income from GILTI merely because it 
may be earned by an entity that also earns high-taxed income. See S. 
Comm. on the Budget, Reconciliation Recommendations Pursuant to H. 
Con. Res. 71, S. Print. No. 115-20, at 371 (2017) (``The Committee 
believes that certain items of income earned by CFCs should be 
excluded from the GILTI [regime], either because they should be 
exempt from U.S. tax--as they are generally not the type of income 
that is the source of the base erosion concerns--or are already 
taxed currently by the United States. Items of income excluded from 
GILTI because they are exempt from U.S. tax under the bill include 
foreign oil and gas extraction income (which is generally immobile) 
and income subject to high levels of foreign tax.'').
---------------------------------------------------------------------------

    In addition, treating section 987 gain or loss as a single item of 
tentative tested income, as if it were attributable to a separate 
tested unit (distinct from the section 987 QBU), is consistent with the 
determination that a branch comprises a separate tested unit, even if 
it is not a tax resident of the foreign country in which it is located, 
if the income of the branch is subject to an exclusion, exemption, or 
other similar relief (such as a preferential rate) in the CFC's country 
of tax residence. See Sec.  1.951A-2(c)(7)(iv)(A)(3). Section 987 gain 
or loss is currency gain or loss of the owner of the QBU, and these 
gains and losses are generally not subjected to residency-based 
taxation in either the country of the QBU or the country in which the 
CFC is a resident. Therefore, the section 987 gains and losses of the 
CFC are functionally equivalent to gain or loss of a branch that is not 
a tax resident in any country and whose income is not subject to 
residency-based taxation in the CFC's country of tax residence.
    Accordingly, it is appropriate to test the effective rate of 
foreign tax on section 987 gains and losses as a separate item of 
tentative tested income. The alternative approach recommended by a 
comment (which would incorporate section 987 gain or loss in the tested 
units that correspond to the section 987 QBU) would distort the 
effective tax rate computation with respect to a CFC's other income 
because section 987 gain or loss typically is not subject to foreign 
tax. These distortions could be favorable or unfavorable to taxpayers, 
depending on the circumstances. Moreover, the comment's recommended 
approach would complicate the ordering rules and mechanics needed to 
apply the loss-to-the-extent-of-gain rule of Sec.  1.987-11(e) with 
respect to section 987 gain or loss assigned to a tested income group, 
which would increase the administrative and compliance burden of the 
section 987 regulations.
    The approach set forth in the proposed regulations is also most 
consistent with the policy underlying the determination of an 
appropriate ``item'' of income for purposes of applying the high-tax 
exception under section 954(b)(4) as is reflected in the legislative 
history to that section, which directs the Treasury Department and the 
IRS to allow reasonable groupings of items of income that are 
substantially taxed at the same rate in a single country. See H.R. 
Rept. No. 99-426, at 400-01 (1985) (``Although this rule applies 
separately with respect to each `item of income' received by a [CFC], 
the committee expects that the Secretary will provide rules permitting 
reasonable groupings of items of income that bear substantially equal 
effective rates of tax in a given country. For example, all interest 
income received by a [CFC] from sources within its country of 
incorporation may reasonably be treated as a single item of income for 
purposes of this rule, if such interest is subject to uniform taxing 
rules in that country.''). The Treasury Department and the IRS have 
determined that section 987 gains and losses are likely to be taxed at 
a different rate of tax than other income generally subject to tax 
either in the country of the tested unit or in the country of residence 
of the CFC and therefore should reasonably be grouped and tested as a 
separate ``item'' of income for this purpose.
    As noted in a comment, for purposes of the GILTI HTE, the final 
regulations treat section 987 gain or loss differently from section 988 
gain or loss on a net investment hedge. However, the new hedging rule 
in Sec.  1.987-14 will enable taxpayers to account for the hedge as an 
adjustment to unrecognized section 987 gain or loss, as described in 
part V.B of this Summary of Comments and Explanation of Revisions.

VIII. Comments and Changes to Proposed Sec. Sec.  1.987-7A, 1.987-7B, 
and 1.987-7C--Partnerships

A. Partnership Rules Under the 2023 Proposed Regulations

    The 2023 proposed regulations (and the 2016 final regulations) 
generally would apply aggregate theory to partnerships wholly owned by 
related persons (``section 987 aggregate partnerships''). See proposed 
Sec.  1.987-7B. Under proposed Sec.  1.987-1(b)(5)(ii), each partner in 
a section 987 aggregate partnership would be treated as an indirect 
owner of the partnership's eligible QBUs (and a section 987 aggregate 
partnership is not itself a QBU under section 989(a)). Thus, exchange 
gain or loss under section 987 would be measured from the perspective 
of the partners (rather than the partnership). The aggregate approach 
would serve to prevent a group of related parties from holding an 
eligible QBU through a partnership (rather than owning it directly) in 
order to change the section 987 treatment of the eligible QBU without 
meaningfully altering the group's economic position.
    The 2023 proposed regulations would provide a different set of 
rules for partnerships that are not wholly owned by related partners. 
See proposed Sec.  1.987-7A. For these partnerships, the 2023 proposed 
regulations would apply a hybrid approach to entity theory, under which 
unrecognized section 987 gain or loss of the partnership's eligible 
QBUs for a taxable year is determined at the partnership level and then 
allocated to the partners for purposes of computing the pool of net 
unrecognized section 987 gain or loss. Any section 987 gain or loss 
would be recognized and taken into account at the partner level.
    The preamble to the 2023 proposed regulations notes that the 
Treasury Department and the IRS considered whether it would be 
appropriate to apply a hybrid approach to all

[[Page 100151]]

partnerships, regardless of whether the partners are related. 88 FR 
78147 through 78148. The preamble explains that such an approach might 
reduce the complexity and compliance burden of the section 987 
regulations, but that it could permit taxpayers to manipulate the 
application of section 987 by holding a section 987 QBU through a 
partnership rather than holding it directly. Id. at 78148.
    The 2023 proposed regulations would not provide rules relating to a 
partner's application of section 987 with respect to a partnership that 
uses a different functional currency (which creates a separate layer of 
currency exposure). However, the preamble to the 2023 proposed 
regulations discusses alternative methodologies under which the 
partners could determine and recognize section 987 gain or loss with 
respect to their partnership interests. 88 FR 78148 through 78149.

B. Partnership Rules in the Final Regulations

1. In General
    The Treasury Department and the IRS continue to study the 
appropriate treatment of partnerships for purposes of section 987 and, 
accordingly, the final regulations do not provide detailed rules 
concerning the determination of section 987 taxable income or loss and 
section 987 gain or loss in the case of a partnership. The final 
regulations also reserve on the treatment of a partnership as a QBU 
under section 989(a) and Sec.  1.989(a)-1(b)(2)(i). See Sec.  1.989(a)-
1(b)(2)(i)(C).
    Only one comment regarding partnerships was received in response to 
the 2023 proposed regulations. The portions of the comment that relate 
to partnership rules that are not included in the final regulations 
have not been adopted because they are outside the scope of these 
regulations. The Treasury Department and the IRS expect to address 
these issues in future guidance.
    Pending future guidance, taxpayers must apply sections 987 and 
989(a) with respect to partnerships using a reasonable method 
consistent with the statute. For example, if a domestic corporation 
owns an interest in a foreign partnership (which would use the euro as 
its functional currency if it is treated as a QBU under section 
989(a)), and the partnership owns an eligible QBU that uses the Swiss 
franc as its functional currency, the domestic corporation may apply 
section 987 to the eligible QBU under an aggregate approach. 
Alternatively, under an entity approach, the partnership could be 
treated as a section 987 QBU of the domestic corporation, and the 
eligible QBU could be treated as a section 987 QBU of the partnership. 
The domestic corporation could also apply a hybrid approach under the 
principles of the 2023 proposed regulations. However, taxpayers will 
not be considered to have applied a reasonable method unless they apply 
the same method consistently from year to year with respect to a 
particular partnership or eligible QBU. Members of a controlled group 
that are partners in the same partnership must apply the same method 
with respect to a particular partnership or eligible QBU, but unrelated 
partners are not subject to a consistency requirement. See Sec.  1.987-
7(b).
2. Application of the Final Regulations to Partnerships
    Although section 987 applies to partnerships, only certain parts of 
the final regulations apply to partnerships. See Sec.  1.987-7(b) and 
(c). In particular, the rules relating to suspended section 987 loss in 
Sec. Sec.  1.987-11 and 1.987-13 apply to partnerships, and the 
deferral rules of Sec.  1.987-12 continue to apply to partnerships, 
with certain modifications. See Sec.  1.987-7(c)(2)(i) and (d). These 
rules are needed to prevent the selective recognition of losses. In 
addition, the final regulations provide that an annual recognition 
election and a section 988 mark-to-market election can be made with 
respect to a partnership (whether an aggregate or entity approach is 
applied). See Sec.  1.987-7(c)(2)(ii) and (iii). These elections are 
expected to reduce the compliance burden of applying section 987 in the 
partnership context.
    Similarly, the rules for determining the source and character of 
section 987 gain or loss under Sec.  1.987-6 apply to partnerships, in 
order to facilitate application of the loss-to-the-extent-of-gain rule. 
See Sec.  1.987-7(c)(2)(i). A comment suggested that special rules 
should apply to determine the source and character of section 987 gain 
or loss recognized in connection with the sale or redemption of a 
partnership interest under the principles of Sec.  1.864(c)(8)-1. The 
final regulations do not adopt this approach because it would be 
inconsistent with section 987(3)(B) (under which section 987 gain or 
loss is sourced by reference to historical earnings) and could allow 
taxpayers to manipulate the source and character of section 987 gain or 
loss.
    Because the section 987 regulations generally do not apply to 
partnerships, the general rules of the section 987 regulations must be 
adapted as necessary to apply Sec.  1.987-7 and the other applicable 
provisions to partnerships. See Sec.  1.987-7(c)(3). The rules must 
also be applied in this manner to an S corporation, which is treated 
the same way as a partnership for purposes of the section 987 
regulations. See Sec.  1.987-7(f).
3. Loss Suspension Rule
    Under the final regulations, the general loss suspension rule in 
Sec.  1.987-11(c)(1) does not apply to partnerships. See Sec.  1.987-
7(d)(1)(i). Instead, section 987 loss generally will be suspended in 
the taxable year in which it would otherwise be recognized under the 
method used by the taxpayer to apply section 987 with respect to the 
partnership. See Sec.  1.987-7(d)(1)(ii). The loss suspension rule of 
Sec.  1.987-7(d)(1)(ii) applies to an eligible QBU that is directly 
owned by a partnership, regardless of whether an aggregate approach, an 
entity approach, or a hybrid approach is applied. See Sec.  1.987-
7(d)(1)(ii)(A). However, if a partnership is itself treated as a 
section 987 QBU of its partners under an entity approach, the loss 
suspension rule applies only if at least 95% of the capital and profits 
interests in the partnership are owned by related persons. See Sec.  
1.987-7(d)(1)(ii)(B). This limitation is intended to reduce the 
complexity and compliance burden of the section 987 regulations for 
partnerships owned by unrelated persons.
    The final regulations provide several other exceptions to the loss 
suspension rule of Sec.  1.987-7(d)(1)(ii). First, section 987 loss 
with respect to an eligible QBU owned by a partnership is not suspended 
if section 987 is consistently applied using a method under which 
section 987 gain or loss does not arise with respect to historic items 
(for example, a method that follows the principles of Sec. Sec.  1.987-
3 through 1.987-5, under which historic items are assigned a historic 
rate, such that their balance sheet value does not change in response 
to changes in the value of the section 987 QBU's functional currency). 
See Sec.  1.987-7(d)(2)(i). Second, section 987 loss is not suspended 
if an annual recognition election is in effect. See Sec.  1.987-
7(d)(2)(ii). Finally, section 987 loss is not suspended if the de 
minimis rule in Sec.  1.987-11(c)(2) applies (that is, if the amount of 
section 987 loss subject to suspension does not exceed the lesser of $3 
million or two percent of gross income, as described in part X.A.1 of 
this Summary of Comments and Explanation of Revisions). See Sec.  
1.987-7(d)(2)(iii). These rules generally align with the scope of the 
loss suspension rule in Sec.  1.987-11(c)(1).

[[Page 100152]]

4. Adjustments to the Basis of a Partner's Interest in the Partnership
    The proposed regulations would provide that a partner's basis in a 
partnership is adjusted when the partner recognizes section 987 gain or 
loss, defers section 987 gain or loss, or suspends section 987 loss 
attributable to the partnership. Proposed Sec.  1.987-7A(e). This rule 
is intended to avoid duplication of section 987 gain or loss (for 
example, when the partnership interest is sold). The final regulations 
retain this rule for taxpayers that apply section 987 using a method 
that results in recognition, deferral, or suspension of section 987 
gain or loss at the partner level. Under Sec.  1.987-7(e), the 
partner's basis in its partnership interest is adjusted under the 
principles of section 705 as though the section 987 gain or loss was 
part of the partner's distributive share of partnership items. See 
Sec.  1.987-7(e).
    A commenter requested clarification concerning the interaction of 
this basis adjustment rule with section 704(d). Section 704(d)(1) 
provides that a partner's distributive share of partnership loss 
(including capital loss) shall be allowed only to the extent of the 
basis of that partner's interest in the partnership at the end of the 
partnership year in which such loss occurred. Section 704(d)(2) 
provides for the carryover of the excess of any loss over such basis to 
the next taxable year. To the extent that basis is available in the 
next taxable year, the partner is able to take the loss into account. 
Relatedly, the partner will decrease the adjusted basis in its 
partnership interest to the extent that any loss carryover is taken 
into account within the taxable year. See section 705(a)(2).
    The final regulations clarify that the principles of section 704(d) 
are applied as though items of section 987 loss, deferred section 987 
loss, or suspended section 987 loss were part of the partner's 
distributive share of partnership items. See Sec.  1.987-7(e). The 
basis adjustment rule in Sec.  1.987-7(e) is intended to replicate the 
basis adjustments that would occur if the relevant section 987 gain or 
loss was taken into account as part of the partner's distributive share 
of partnership income or loss (including the effects of section 
704(d)).
5. Other Special Rules for Partnerships
    The final regulations contain several other rules that facilitate 
the application of section 987 to partnerships. If a partner in a 
partnership is treated as the owner of a section 987 QBU directly owned 
by the partnership (for example, under an aggregate approach), Sec.  
1.987-7(c)(3)(ii) provides a special rule that is used to determine the 
members of the owner's controlled group for purposes of Sec. Sec.  
1.987-12 and 1.987-13. Under this rule, any member of the partnership's 
controlled group is treated as a member of the partner's controlled 
group so long as the partner continues to be a partner in the 
partnership. Thus, for example, if the partnership contributes the 
section 987 QBU's assets to a wholly owned subsidiary of the 
partnership, the subsidiary will be treated as a member of the 
partner's controlled group and the contribution may be treated as a 
deferral event for purposes of Sec.  1.987-12.
    When a partnership is itself treated as a QBU of a partner that is 
subject to section 987, and the partnership is not engaged in any trade 
or business (for example, a partnership that functions as a holding 
company), the rules of Sec.  1.987-13(b) through (d) do not apply. 
Those rules are designed to attribute suspended section 987 loss to a 
successor suspended loss QBU if the assets of a section 987 QBU 
continue to be used in the same trade or business by a member of the 
controlled group, and they trigger the recognition of suspended section 
987 loss if the section 987 QBU terminates without a successor. 
However, when a QBU that has suspended section 987 loss is not engaged 
in any trade or business, the rules of Sec.  1.987-13(b) through (d) 
would not result in the appropriate recognition of suspended section 
987 loss and could be prone to manipulation. Accordingly, the suspended 
section 987 loss can be recognized only under the loss-to-the-extent-
of-gain rule of Sec.  1.987-11(e).
    The transition rules in Sec.  1.987-10 do not apply to 
partnerships. Instead, the applicable rules of the section 987 
regulations take effect on the transition date with respect to section 
987 gain or loss determined and recognized under the taxpayer's 
existing method. In addition, taxpayers may not apply the fresh start 
transition method with respect to a partnership. As explained in the 
preamble to the 2023 proposed regulations, the fresh start transition 
method is no longer available because that method results in the 
elimination of pretransition gain or loss, and (if it were available) 
it could be opportunistically used by taxpayers to eliminate their 
pretransition gain. 88 FR 78150 and 78156.
    The final regulations also clarify that the rule in Sec.  1.988-
1(a)(10)(i), which provides that transactions between a taxpayer and 
its QBU generally are not section 988 transactions, applies only to 
disregarded transactions. Thus, a nonfunctional currency transaction 
between a partner and a partnership could be treated as a section 988 
transaction even though the partnership is treated as a QBU subject to 
section 987.

IX. Comments and Changes to Proposed Sec.  1.987-10: Transition Rules

    Proposed Sec.  1.987-10 would provide transition rules for the 
first year in which the section 987 regulations are applicable. In 
particular, proposed Sec.  1.987-10(e) would provide rules for 
determining and recognizing pretransition gain or loss with respect to 
each of a taxpayer's QBUs.

A. Computation of Pretransition Gain or Loss

1. Taxpayers That Applied Section 987 Using an Eligible Pretransition 
Method
    Under the 2023 proposed regulations, the computation of 
pretransition gain or loss would differ depending on how the taxpayer 
applied section 987 before the transition date. If the taxpayer applied 
section 987 to a section 987 QBU using an eligible pretransition method 
(as described in part IX.B of this Summary of Comments and Explanation 
of Revisions), the owner would use that method to compute pretransition 
gain or loss. Proposed Sec.  1.987-10(e)(2). The owner's pretransition 
gain or loss would be equal to the amount of section 987 gain or loss 
that it would have recognized under the eligible pretransition method 
if the QBU terminated on the day before the transition date, with 
certain adjustments. Proposed Sec.  1.987-10(e)(2)(i)(A).
    Under proposed Sec.  1.987-10(e)(2)(i)(B), the amount of 
pretransition gain or loss would be increased or reduced by the owner 
functional currency net value adjustment (``OFCNV adjustment''), which 
reflects any change to the basis of the section 987 QBU's assets (net 
of liabilities) that occurs as a result of the transition. For example, 
if a taxpayer applied an earnings only method under which currency gain 
or loss on the QBU's capital was not recognized at the time of a 
remittance but was separately tracked and accounted for in determining 
the basis of distributed assets, the currency gain or loss on capital 
would be accounted for as part of the OFCNV adjustment.
    Two comments were received relating to the OFCNV adjustment. One 
comment requested that taxpayers be permitted to use the CTA prepared 
for financial accounting purposes rather than making the OFCNV 
adjustment. The comment asserted that taxpayers applying an earnings 
only method might

[[Page 100153]]

not have the information necessary to compute the OFCNV adjustment.
    The final regulations do not permit taxpayers to use the CTA in 
lieu of making the OFCNV adjustment. As explained in part V.A.2 of this 
Summary of Comments and Explanation of Revisions, the CTA amount may be 
substantially different from the amount of section 987 gain or loss 
that is properly taken into account for tax purposes. Moreover, it 
should not be unduly burdensome for a taxpayer to compute the OFCNV 
adjustment because the relevant information is already needed to apply 
the taxpayer's existing pretransition method.
    Another comment recommended that, in the case of taxpayers applying 
an earnings only method, currency gain or loss with respect to the 
QBU's capital should not be taken into account in determining 
pretransition gain or loss (which is ultimately recognized as section 
987 gain or loss after the transition date). The comment noted that 
taxpayers may have adopted the earnings only method to reduce the size 
of their section 987 gain or loss pools and that the earnings only 
method serves to mitigate the potential for selective recognition of 
large section 987 losses. Therefore, the comment requested that the 
OFCNV adjustment instead be taken into account as an adjustment to 
asset basis.
    The Treasury Department and the IRS agree that, for taxpayers 
applying an earnings only method, accounting for the OFCNV adjustment 
in determining the basis of a section 987 QBU's assets would produce a 
reasonable result that is consistent with these taxpayers' 
pretransition method. Accordingly, under the final regulations, if a 
taxpayer applied an earnings only method before the transition date and 
does not make a current rate election for the taxable year beginning on 
the transition date, the historic rate assigned to the section 987 
QBU's historic assets (other than inventory) is equal to the exchange 
rate that would have been used to translate those assets if they had 
been distributed to the owner on the day before the transition date 
(the ``pretransition translation rate''). See Sec.  1.987-10(d)(3)(ii). 
As a result, no OFCNV adjustment is made with respect to those assets, 
but currency gain or loss related to those assets will be accounted for 
as the assets are sold or depreciated under Sec.  1.987-3. For 
taxpayers that make a current rate election (and thus will not take 
historic rates into account under Sec.  1.987-3), currency gain or loss 
on the QBU's capital must be accounted for in determining pretransition 
gain or loss. See Sec.  1.987-10(d)(3)(i) and (e)(2)(i)(B).
    A comment raised a question as to whether the delegation of 
regulatory authority under section 987(3) is self-executing. The 
comment suggested that, if section 987(3) is not self-executing, then 
it might not be appropriate to attribute pretransition gain or loss to 
taxpayers that have not accounted for section 987 gain or loss before 
the transition date. The Treasury Department and the IRS have concluded 
that section 987(3) is self-executing because it provides a mandatory 
delegation under which the Secretary is directed to determine how 
(rather than whether) the owner of a section 987 QBU should make proper 
adjustments in computing its taxable income. See, e.g., 15 W 17th St. 
LLC v. Commissioner, 147 T.C. 557 (2016) (articulating standard for 
determining whether a statute is self-executing in the absence of 
regulations); Est. of Neumann v. Commissioner, 106 T.C. 216 (1996) 
(holding delegation was self-executing because it related to how, 
rather than whether, the statute applied). Therefore, taxpayers 
currently are obligated to determine section 987 gain or loss in a 
reasonable manner and must account for pretransition gain or loss once 
the regulations become applicable.
2. Taxpayers That Did Not Apply Section 987 Using an Eligible 
Pretransition Method
    Under proposed Sec.  1.987-10(e)(3), taxpayers that did not apply 
an eligible pretransition method would be required to determine 
pretransition gain or loss by applying a simplified version of the 
computation described in Sec.  1.987-4(d) to determine unrecognized 
section 987 gain or loss (``annual unrecognized section 987 gain or 
loss'') for each taxable year since the section 987 QBU's inception. 
Proposed Sec.  1.987-10(e)(3)(iii). Pretransition gain or loss would be 
reduced by any section 987 gain or loss recognized before the 
transition date. Proposed Sec.  1.987-10(e)(3)(ii)(B).
    Comments asserted that the method provided in proposed Sec.  1.987-
10(e)(3) could be burdensome to apply and difficult to administer. Some 
comments recommended that taxpayers should not be required to compute 
annual unrecognized section 987 gain or loss for each taxable year 
since the QBU's inception. Instead, the comments suggested that the 
final regulations provide a reasonable cutoff date before which 
pretransition gain or loss would not be computed. Another comment 
requested that taxpayers be permitted to determine pretransition gain 
or loss using the earnings and capital method described in the 1991 
proposed regulations, as this would avoid the need to prepare tax basis 
balance sheets. A further comment recommended adoption of a de minimis 
rule for taxpayers with minimal pretransition gain or loss.
    The Treasury Department and the IRS agree that, when a QBU has been 
operating for a long period, computing annual unrecognized section 987 
gain or loss for all taxable years since the QBU's inception could be 
burdensome. Accordingly, the final regulations provide a cutoff date of 
September 7, 2006, which is the date on which proposed section 987 
regulations were published in the Federal Register (71 FR 52876) (the 
``2006 proposed regulations''). Under the final regulations, taxpayers 
that did not apply an eligible pretransition method must compute 
pretransition gain or loss only for taxable years beginning on or after 
September 7, 2006. The publication date of the 2006 proposed 
regulations is an appropriate cutoff date for this purpose because the 
2006 proposed regulations contained transition rules that were 
conditioned on the application of section 987 using a reasonable 
method. See Sec.  1.987-10(a)(2) of the 2006 proposed regulations.
    The final regulations also provide a de minimis rule to reduce the 
compliance burden on small businesses that own section 987 QBUs.\6\ 
Under the de minimis rule, a qualifying taxpayer may elect to treat all 
QBUs that fall below the de minimis threshold as having no 
pretransition gain or loss. To qualify for the de minimis rule, the 
owner of a section 987 QBU must have gross receipts that fall below the 
threshold for the small business exception in section 163(j)(3) (that 
is, the owner must have gross receipts of $25 million or less, indexed 
to inflation and averaged over the prior 3-year period). If this test 
is met, the de minimis rule applies to any section 987 QBU with gross 
assets of less than $10 million (averaged over the same 3-year period 
and taking into account the assets of all section 987 QBUs in the same 
country that are owned by the same owner or a member of its controlled 
group).
---------------------------------------------------------------------------

    \6\ Although taxpayers that own section 987 QBUs generally are 
not small businesses, this rule is intended to limit the compliance 
burden for small businesses that may be affected.
---------------------------------------------------------------------------

    The final regulations do not permit taxpayers to apply an earnings 
and capital method in lieu of computing annual unrecognized section 987 
gain or loss under Sec.  1.987-10(e)(3). However, as explained in part 
V.A.1 of this Summary

[[Page 100154]]

of Comments and Explanation of Revisions, the rules for computing 
unrecognized section 987 gain or loss for a taxable year under Sec.  
1.987-4(d) have been modified so that they can be applied without the 
need for tax basis balance sheets. As a result, the method provided in 
Sec.  1.987-10(e)(3) can similarly be applied without tax basis balance 
sheets (that is, by computing QBU net value using the formula provided 
in Sec.  1.987-4(e)(2)(iii)).

B. Definition of an Eligible Pretransition Method

    Under the 2023 proposed regulations, an eligible pretransition 
method would be defined to include a reasonable application of the 
earnings and capital method described in the 1991 proposed regulations, 
any other reasonable method that produces the same total amount of 
income as the earnings and capital method over the life of the owner, 
or an earnings only method that does not produce the same total amount 
of lifetime income as an earnings and capital method (subject to 
certain restrictions, including a consistency requirement). Proposed 
Sec.  1.987-10(e)(4)(i) through (iii). The owner must have applied the 
eligible pretransition method with respect to each taxable year 
beginning before the transition date in which it was the owner of the 
section 987 QBU. Proposed Sec.  1.987-10(e)(4). For this purpose, a 
method under which the owner of a section 987 QBU defers the 
recognition of section 987 gain or loss until the section 987 QBU is 
terminated, sold, or liquidated is not a reasonable method. Proposed 
Sec.  1.987-10(e)(4)(iv).
    Comments requested clarification concerning the definition of an 
eligible pretransition method. The comments noted that some taxpayers 
have applied the 1991 proposed regulations with modifications; for 
example, some taxpayers apply an annual netting convention to determine 
the amount of a remittance or treat a group of QBUs with the same 
functional currency as a single QBU. Other comments indicated that 
taxpayers may not account for frequently recurring intercompany 
transactions in computing their section 987 gain or loss.
    One comment suggested that taxpayers should be treated as having 
applied an eligible pretransition method so long as they made a good 
faith effort to apply section 987 using a reasonable method. Another 
comment recommended that taxpayers that have consistently relied on 
their CTA account as an estimate of unrealized section 987 gain or loss 
should be considered to have applied an eligible pretransition method 
(and thus should be permitted to use their CTA account to determine the 
amount of pretransition gain or loss).
    Another comment suggested that a CFC that has consistently applied 
a reasonable method since the enactment of the Tax Cuts and Jobs Act 
(``TCJA''), Public Law 115-97, 131 Stat. 2054 (2017), should be treated 
as having applied an eligible pretransition method, even if the method 
was not applied in previous taxable years. In particular, the comment 
recommended that an owner that began applying an earnings only method 
described in proposed Sec.  1.987-10(e)(4)(iii) after the TCJA was 
enacted should be deemed to meet the consistency requirement of 
proposed Sec.  1.987-10(e)(4)(iii)(B).
    In response to these comments, the final regulations clarify and 
expand the definition of an eligible pretransition method under Sec.  
1.987-10(e)(4). The definition is intended broadly to include any 
method that complies with the statutory requirements of section 987 in 
a reasonable manner.\7\
---------------------------------------------------------------------------

    \7\ In certain instances, a method that does not constitute a 
reasonable application of section 987 is treated as an eligible 
pretransition method in order to reduce the compliance burden of 
transitioning onto the section 987 regulations.
---------------------------------------------------------------------------

1. Errors Made in Applying a Pretransition Method and Certain 
Consistent Practices That Are Not Treated as Errors
    The final regulations provide that a taxpayer is treated as 
applying an eligible pretransition method even if the taxpayer made an 
error in the application of its method or did not apply the method in 
all taxable years in which it was the owner of the section 987 QBU. 
Sec.  1.987-10(e)(4)(iv). However, taxpayers are required to compute 
pretransition gain or loss under Sec.  1.987-10(e)(2) as though the 
eligible pretransition method had been applied without error for all 
prior taxable years. Thus, for example, if a taxpayer made an error in 
applying its method for a prior year, the deemed termination amount 
under Sec.  1.987-10(e)(2)(i)(A) is equal to the amount of section 987 
gain or loss the taxpayer would have recognized on termination if it 
had not made the error and its section 987 QBU terminated on the day 
before the transition date.
    If a taxpayer consistently used a reasonable convention to apply 
section 987 before the transition date, the taxpayer must use the same 
convention in determining pretransition gain or loss under Sec.  1.987-
10(e)(2). See Sec.  1.987-10(e)(4)(v)(B)(1). Thus, unlike a taxpayer 
that made an error in applying its pretransition method, a taxpayer 
that used a reasonable convention would not be required to recompute 
pretransition gain or loss without regard to the convention. Similarly, 
if a taxpayer had a consistent practice under which it did not account 
for frequently recurring disregarded transactions in determining the 
amount of section 987 gain or loss recognized upon a remittance, this 
practice is not treated as an error. See Sec.  1.987-10(e)(4)(v)(B)(2). 
However, this rule does not apply unless the taxpayer reasonably 
accounted for the disregarded transactions in determining the amount of 
unrecognized section 987 gain or loss with respect to the section 987 
QBU (for example, in the case of a taxpayer applying the 1991 proposed 
regulations, by adjusting the equity and basis pools to reflect the 
amount of each transfer).
2. Timing for Application of an Eligible Pretransition Method
    The final regulations provide that a method of applying section 987 
is not an eligible pretransition method unless it was applied on at 
least one tax return filed before November 9, 2023 (when the 2023 
proposed regulations were filed with the Federal Register). See Sec.  
1.987-10(e)(4). Thus, a taxpayer that first adopted a reasonable method 
in the first taxable year after the TCJA was enacted would be treated 
as applying an eligible pretransition method, but a method adopted 
after November 9, 2023, would not qualify. Similarly, the final 
regulations modify the consistency requirement for the earnings only 
method under Sec.  1.987-10(e)(4)(iii)(B) to require consistent 
application for all taxable years since the first taxable year in which 
the owner applied an eligible pretransition method. As a result, an 
owner that began applying the earnings only method after the TCJA was 
enacted (and did not previously apply a different eligible 
pretransition method) would meet this requirement.
3. Reliance on the CTA
    Under the final regulations, a method that relies on the CTA 
determined for financial accounting purposes would not qualify as an 
eligible pretransition method; thus, taxpayers relying on CTA 
computations must determine pretransition gain or loss using the method 
provided in Sec.  1.987-10(e)(3). As discussed in part V.A.2 of this 
Summary of Comments and Explanation of Revisions, because the amount of 
the CTA can be substantially different from the amount of section 987 
gain or loss properly computed for tax purposes, reliance on the CTA 
could result in the recognition of significant amounts of artificial 
pretransition gain or loss.

[[Page 100155]]

C. Recognition of Pretransition Gain or Loss

    In general, under the proposed regulations, pretransition gain is 
treated as net unrecognized section 987 gain, while pretransition loss 
is treated as suspended section 987 loss. Proposed Sec.  1.987-
10(e)(5)(i)(A) and (B). This rule is intended to prevent taxpayers from 
selectively recognizing pretransition loss while deferring 
pretransition gain until the year of a remittance. Alternatively, 
taxpayers could elect to amortize pretransition gain or loss over a 
period of ten years beginning on the transition date. Proposed Sec.  
1.987-10(e)(5)(ii).
    A comment recommended that pretransition loss should not be treated 
as suspended section 987 loss in the first taxable year in which the 
section 987 regulations apply. Instead, the comment recommended that 
pretransition loss should be treated as net unrecognized section 987 
loss upon transition, which would later become suspended in the year of 
a remittance. The comment noted that this would create parity between 
pretransition loss and pretransition gain, which is treated as net 
unrecognized section 987 gain in the first taxable year in which the 
regulations apply.
    Another comment recommended that, instead of determining 
pretransition gain or loss separately with respect to each QBU, the 
total amount of pretransition gain or loss in each category should be 
aggregated and netted among all QBUs of the same owner, with the net 
amounts reallocated to each QBU on a pro rata basis. In the case of a 
consolidated group or a group of related CFCs, the comment suggested 
further netting between all members of the consolidated group or group 
of related CFCs, respectively.
    With respect to the amortization election under proposed Sec.  
1.987-10(e)(5)(ii), a comment suggested that taxpayers should be 
allowed to elect a shorter amortization period in which to recognize 
pretransition gain or loss (either four or five years), which would 
better align with certain taxpayers' internal forecasting and planning 
windows. A comment also requested clarification as to how the 
amortization election applies with respect to a terminating QBU (that 
is, a section 987 QBU that terminated after November 9, 2023, and 
before the taxable year in which the section 987 regulations are 
generally applicable).
    The final regulations provide that, if a current rate election is 
in effect in the taxable year beginning on the transition date (and an 
annual recognition election is not in effect), pretransition gain or 
loss is treated as net unrecognized section 987 gain or loss. Thus, 
pretransition losses are treated the same way as pretransition gains. 
However, if a current rate election is not in effect (or an annual 
recognition election is in effect) in the taxable year beginning on the 
transition date, pretransition loss is treated as suspended section 987 
loss upon transition. This rule is necessary to prevent pretransition 
loss from being recognized without limitation.
    The final regulations do not permit aggregation and netting of 
pretransition gain or loss within the same category. Absent an 
amortization election, the source and character of pretransition gains 
and losses generally will not be assigned in the taxable year beginning 
on the transition date, so it would not be possible to net gains and 
losses separately within each recognition grouping. In addition, 
aggregation and netting would make the transition rules more 
complicated and would increase the burden of administering these rules. 
Finally, taxpayers that make the amortization election can, as a 
practical matter, achieve the effect of netting pretransition gains and 
losses, because those gains and losses will be recognized over the same 
ten-year period.
    The final regulations retain the ten-year amortization period under 
Sec.  1.987-10(e)(5)(ii) and do not permit taxpayers to elect a shorter 
amortization period. The Treasury Department and the IRS have 
determined that a uniform amortization period should apply to all 
electing taxpayers to prevent the potential for whipsaw that could 
result from taxpayers with losses electing shorter amortization periods 
than taxpayers with gains. In addition, a ten-year period is 
appropriate given the expected magnitude of the pretransition gains and 
losses that are subject to amortization. However, taxpayers that do not 
make the amortization election will retain some control over when gains 
and losses are recognized (by choosing whether or not to make 
remittances). The final regulations also expand the acceleration rule 
of Sec.  1.987-10(e)(5)(ii)(B) to cover transactions entered into with 
a principal purpose of avoiding the recognition of pretransition gain 
that is subject to the amortization election. See Sec.  1.987-
10(e)(5)(ii)(B)(1).
    In addition, the final regulations clarify the application of the 
amortization election in the case of a terminating QBU. Under Sec.  
1.987-10(e)(5)(ii)(C), any deferred section 987 gain or suspended 
section 987 loss with respect to a terminating QBU that has not been 
recognized before the first taxable year in which the section 987 
regulations are generally applicable is subject to amortization 
beginning in that year. However, the final regulations do not modify 
the treatment of section 987 gain or loss that has already been 
recognized before the transition date; thus, such section 987 gain or 
loss is not subject to amortization.

X. Comments and Changes to Proposed Sec.  1.987-11: Suspended Section 
987 Loss Relating to Certain Elections; Loss-to-the-Extent-of-Gain Rule

    Proposed Sec.  1.987-11 provides rules that suspend the recognition 
of section 987 loss in connection with certain elections and rules 
under which suspended section 987 loss is recognized to the extent of 
recognized section 987 gain (the ``loss-to-the-extent-of-gain rule'').

A. Loss Suspension Rule

1. In General
    Under proposed Sec.  1.987-11(c), in a taxable year in which a 
current rate election is in effect (and an annual recognition election 
is not in effect), any section 987 loss that would otherwise be 
recognized as a result of a remittance or termination would be treated 
as suspended section 987 loss.
    A comment requested that the loss suspension rule of Sec.  1.987-
11(c) be eliminated because it prevents taxpayers from recognizing 
section 987 losses in connection with legitimate commercial 
transactions. The comment noted that the recognition of section 987 
loss often is not the primary factor in determining whether a taxpayer 
causes its branch to make a remittance.
    The final regulations retain the loss suspension rule in Sec.  
1.987-11(c). Congress specifically authorized loss limitation rules to 
address the potential for selective recognition of losses. See section 
989(c)(2). These rules are integral to the current rate election; 
without a loss limitation the current rate election would create 
opportunities for abuse. Although remittances are often made for non-
tax reasons, taxpayers can cause section 987 QBUs to make otherwise 
disregarded transfers for the purpose of recognizing large section 987 
losses, and taxpayers have the ability to structure transactions in 
ways that defer the recognition of section 987 gain.
    However, the final regulations limit the scope of the loss 
suspension rule to cover transactions that would otherwise result in 
the recognition of substantial section 987 losses. Under Sec.  1.987-
11(c)(2), if a current rate election is in effect, section 987 loss is 
not suspended unless the amount of section 987 loss

[[Page 100156]]

subject to suspension in the taxable year exceeds the lesser of $3 
million or two percent of the controlled group's gross income. This 
threshold is applied collectively to the section 987 loss of the owner 
and all members of the owner's controlled group. This rule is expected 
to reduce the compliance burden of tracking suspended section 987 
losses, particularly for taxpayers with small section 987 QBUs.
2. Exception for QBUs With De Minimis Historic Assets
    Comments requested an exception from the loss suspension rule for 
section 987 QBUs with minimal historic assets (such as financial 
institutions and insurance companies). Alternatively, a comment 
recommended that the loss suspension rule should apply solely to 
section 987 loss associated with historic items.
    The final regulations do not provide an exception to the loss 
suspension rule for taxpayers with a de minimis amount of historic 
assets. Such an exception would be difficult to administer because it 
would require long-term tracking to ensure that the de minimis 
threshold was met in all prior taxable years over which the pool of net 
unrecognized section 987 gain or loss accrued. Further, for taxpayers 
with minimal historic assets, the compliance burden of applying the 
default rules of the final regulations (that is, the rules that apply 
in the absence of a current rate election) is expected to be more 
limited. A taxpayer that does not make a current rate election 
generally would not be subject to the loss suspension rule.
    Similarly, under the final regulations, the loss suspension rule of 
Sec.  1.987-11(c) is not limited to section 987 loss associated with 
historic items. Under Sec.  1.987-4, the pool of net unrecognized 
section 987 gain or loss is determined with respect to a section 987 
QBU as a whole. Separate computations of unrecognized section 987 loss 
associated with marked and historic items, respectively, would add 
significant complexity. Moreover, concerns related to selective 
recognition of section 987 loss can arise with respect to both marked 
and historic items.

B. Loss-to-the-Extent-of-Gain Rule

    Under proposed Sec.  1.987-11(e), an owner of a section 987 QBU 
recognizes suspended section 987 loss to the extent that it recognizes 
section 987 gain in the same recognition grouping (that is, section 987 
gain that has the same source and character as the suspended section 
987 loss) in the same taxable year. As explained in the preamble to the 
2023 proposed regulations, this rule is intended to prevent taxpayers 
from selectively recognizing section 987 losses when a current rate 
election is in effect. 88 FR 78139.
1. Lookback Rule
    The 2023 proposed regulations do not include a lookback rule under 
which suspended section 987 loss can be recognized to the extent of 
section 987 gain recognized in previous taxable years. The preamble to 
the 2023 proposed regulations expressed concern that taxpayers might 
exploit a lookback rule by selectively triggering the recognition of 
section 987 gain in a taxable year in which the gain could be offset by 
losses or in which a taxpayer had excess foreign tax credits. 88 FR 
78139.
    Several comments recommended adoption of a lookback rule. 
Alternatively, a comment recommended modifying proposed Sec.  1.987-
11(e) to permit taxpayers to carry back section 987 losses to earlier 
years. Comments posited that, even if section 987 gain recognized in a 
previous year is offset by a loss carryforward or other tax attribute, 
the section 987 gain would still have a net impact on U.S. tax because 
the attribute would no longer be available to be utilized in subsequent 
years. However, the same comment expressed a minority view that a 
lookback rule would afford some potential for abuse, and suggested 
consideration of an anti-abuse rule targeting remittances that do not 
have economic effect. One comment recommended that the lookback period 
for section 987 gains should include years ending before the transition 
date, while another comment suggested that the lookback period should 
include only post-transition years.
    The Treasury Department and the IRS agree that a lookback rule 
would allow for more evenhanded treatment of section 987 gains and 
losses when section 987 gain is recognized in an earlier taxable year 
and that a lookback rule could be tailored to prevent abuse. 
Accordingly, the final regulations provide that suspended section 987 
loss is recognized to the extent of net section 987 gain recognized in 
the current year and the three preceding taxable years. See Sec.  
1.987-11(e)(3). Taxable years beginning before the transition date are 
not included in the lookback period, given the substantial flexibility 
taxpayers have had in determining the timing, amount, and character of 
section 987 gain or loss recognized before the applicability date of 
the final regulations.
    Under an anti-abuse rule, section 987 gain is disregarded for 
purposes of the loss-to-the-extent-of-gain rule if it is recognized 
with a principal purpose of reducing U.S. Federal income tax liability, 
including over multiple taxable years. See Sec.  1.987-11(e)(3)(v). For 
example, this rule would apply if an owner recognizes section 987 gain 
in a taxable year (``year 1'') in which the section 987 gain is offset 
by a tax attribute that would not otherwise be used, the section 987 
gain is recognized with a principal purpose of releasing suspended 
section 987 loss in a subsequent taxable year (``year 2''), and the net 
effect of recognizing both the section 987 gain and the suspended 
section 987 loss would reduce the combined U.S. Federal income tax 
liability for years 1 and 2. In determining whether such a principal 
purpose exists, one relevant factor is the extent to which a remittance 
does not result in a sustained economic contraction of the section 987 
QBU (over a period of at least 12 months). Thus, for example, if a 
section 987 QBU makes a remittance giving rise to the recognition of 
section 987 gain, and the owner makes an offsetting contribution to the 
section 987 QBU within 12 months of the remittance, the section 987 
gain may be disregarded for purposes of the loss-to-the-extent-of-gain 
rule.
    The lookback period generally is limited to three years, because a 
longer lookback period would require additional tracking of section 987 
gains recognized in prior taxable years and would increase the 
compliance and administrative burden of the section 987 regulations. In 
addition, this rule is consistent with other Code provisions that limit 
loss carryforward or carryback periods to a fixed number of years. See, 
e.g., section 1212(a)(1) (generally permitting capital losses to be 
carried forward for five years and carried back for three years). 
Moreover, it may be difficult to enforce the anti-abuse rule in Sec.  
1.987-11(e)(3)(v) with respect to transactions occurring more than 
three years before the taxable year in which suspended section 987 loss 
is recognized.
    The final regulations provide a different lookback period for 
taxpayers that make both an annual recognition election and a current 
rate election. For these taxpayers, the lookback period includes all 
taxable years in which both elections are continuously in effect. See 
Sec.  1.987-11(e)(3)(iv)(B). As a result, for purposes of applying the 
loss-to-the-extent-of-gain rule, the total amount of section 987 gain 
recognized under the annual recognition election for all

[[Page 100157]]

taxable years in which both elections are continuously in effect is 
offset by the total amount of section 987 loss recognized under the 
annual recognition election for all taxable years in which both 
elections are continuously in effect. As explained in the preamble to 
the proposed regulations, the Treasury Department and the IRS are 
concerned that, in the absence of such a rule, taxpayers would be able 
to recognize net losses on a cumulative basis for the taxable years to 
which the annual recognition election applies. 88 FR 78140. In 
addition, the tracking burden in this context should be more limited 
because losses generally are not suspended in taxable years in which an 
annual recognition election is in effect.
    In general, following a transaction described in section 381(a), 
section 987 gain recognized by the transferor corporation in the three 
years preceding the transaction is taken into account for purposes of 
the lookback rule. See Sec.  1.987-11(e)(5)(i). However, this rule does 
not apply in the case of an inbound reorganization or liquidation. See 
Sec.  1.987-11(e)(5)(ii). Thus, section 987 gain recognized by the 
foreign transferor corporation (which may have been subject to a lower 
effective tax rate) cannot be used to release suspended section 987 
loss of the domestic acquiring corporation.
2. Application of the Loss-to-the-Extent-of-Gain Rule at the Owner 
Level
    Under proposed Sec.  1.987-11(e), the loss-to-extent-of-gain rule 
is applied separately to each owner with respect to all of its section 
987 QBUs. Comments asserted that the loss-to-the-extent-of-gain rule 
could produce harsh results when one CFC recognizes section 987 gain 
and a related CFC has suspended section 987 loss. One comment noted 
that concerns about selective recognition of section 987 loss should be 
mitigated to the extent that a different CFC in the same group 
recognizes section 987 gain.
    Another comment recommended that, with respect to section 987 gain 
or loss that is characterized as tested income, the loss-to-the-extent-
of-gain rule should be applied at the level of the U.S. shareholder 
with respect to all section 987 QBUs of CFCs owned by the U.S. 
shareholder, consistent with the general framework of section 951A. 
Under this approach, the excess of the U.S. shareholder's pro rata 
share of section 987 losses of any CFC attributable to a tested income 
group over its pro rata share of section 987 gains attributable to the 
same tested income group would be suspended (and available for 
recognition to the extent of the U.S. shareholder's pro rata share of 
section 987 gains recognized in future years). Another comment 
recommended that the loss-to-the-extent of gain rule should be applied 
to a group of related CFCs by treating the group as a single owner. 
Under this approach, one CFC could recognize suspended section 987 loss 
to the extent that another CFC recognized section 987 gain.
    The final regulations generally apply the loss-to-the-extent of 
gain rule separately to each owner, taking into account section 987 
gain or loss with respect to all of the owner's section 987 QBUs. The 
final regulations do not apply the loss-to-the-extent of gain rule at 
the level of the U.S. shareholder. Because section 987 gain or loss is 
a CFC-level income item that is taken into account in computing each 
CFC's taxable income and earnings and profits, a U.S. shareholder level 
loss limitation rule could reach inappropriate results for minority 
shareholders and would be difficult to administer. For example, if a 
CFC is owned by multiple U.S. shareholders, application of the loss-to-
the-extent-of-gain rule at the U.S. shareholder level would require 
multiple separate computations to determine the suspended section 987 
loss recognized by a single CFC.
    Similarly, the final regulations do not treat a group of related 
CFCs as a single owner for purposes of the loss-to-the-extent-of-gain 
rule. A CFC grouping rule would make the loss-to-the-extent-of-gain-
rule more complex and more difficult to administer. Moreover, under a 
CFC grouping rule, a CFC could recognize suspended section 987 loss as 
a result of a different CFC's recognition of section 987 gain in the 
same recognition grouping in a taxable year in which the loss cannot be 
utilized.
3. Expansion of the Loss-to-the-Extent-of-Gain Rule
    A comment recommended expansion of the loss-to-the-extent-of-gain 
rule so that suspended section 987 loss could be recognized to the 
extent of any income recognized by the owner (including but not limited 
to section 987 gain) that has the same source and character as the 
suspended section 987 loss. Another comment recommended that suspended 
section 987 loss should be recognized to the extent of any section 987 
gain recognized by the owner, even if the section 987 gain is in a 
different recognition grouping. The comment suggested that the 
requirement for section 987 gain to be in the same recognition grouping 
as suspended section 987 loss does not serve the policy goals of 
section 987, and that concerns relating to mismatches between the 
source and character of section 987 gains and losses are adequately 
policed by other provisions of the Code.
    The final regulations do not expand the scope of the loss-to-the-
extent of gain rule to cover taxable income other than section 987 
gain. Taxable income other than section 987 gain does not release 
suspended section 987 loss under the loss-to-the-extent-of-gain rule 
because this rule is intended to target selective recognition of 
section 987 loss and deferral of section 987 gain.
    In addition, the final regulations retain the rule that section 987 
gain can only release suspended section 987 loss in the same 
recognition grouping. This rule ensures that the loss-to-the-extent-of-
gain rule effectively limits selective recognition of losses pursuant 
to the authority provided in section 989(c)(2). In particular, it 
prevents taxpayers from avoiding the loss limitation by recognizing 
gains that are subject to a low rate of tax (or are not subject to U.S. 
tax).
    As explained in part VII.B of this Summary of Comments and 
Explanation of Revisions, the final regulations allow section 987 gain 
or loss to be assigned to multiple subpart F income groups. Therefore, 
each separate subpart F income group (as defined in Sec.  1.960-
1(d)(2)(ii)(B)) constitutes a separate recognition grouping. See Sec.  
1.987-11(f)(2)(ii). However, as explained in part VII.B.2 of this 
Summary of Comments and Explanation of Revisions, taxpayers can reduce 
the number of subpart F recognition groupings by making the section 988 
characterization election provided in Sec.  1.987-6(b)(2)(i)(C).
4. Application to Terminating QBUs
    A comment requested clarification concerning the application of the 
loss-to-the-extent-of-gain rule in the case of a terminating QBU. The 
final regulations clarify that, when a terminating QBU has suspended 
section 987 loss in a taxable year before the final regulations are 
generally applicable, section 987 gain with respect to a taxpayer's 
other section 987 QBUs is assigned to a recognition grouping under the 
method applied by the taxpayer before the transition date. The owner 
recognizes suspended section 987 loss with respect to a terminating QBU 
only to the extent of its net section 987 gain in the same recognition 
grouping for the taxable year.

[[Page 100158]]

5. SRLY Rule Relating to Suspended Section 987 Losses
    When a corporation that is the owner of a section 987 QBU joins a 
consolidated group, the corporation may have suspended section 987 
losses that arose in earlier years. As explained in the preamble to the 
2023 proposed regulations, the regulations issued under the authority 
of section 1502 generally limit a consolidated group's ability to use 
tax attributes generated in separate return years (as defined in Sec.  
1.1502-1(e)). 88 FR 78154. The Treasury Department and the IRS 
requested comments on how rules similar to the rules of Sec.  1.1502-
21(c) (limiting the use of net operating losses) should apply to 
suspended and deferred section 987 losses. Id. No comments were 
received in response to this request.
    To prevent inappropriate trafficking of section 987 losses, Sec.  
1.987-11(e)(6)(ii) of the final regulations provides that the separate 
return limitation year (SRLY) limitation principles of Sec.  1.1502-
21(c) apply to suspended section 987 losses that arose in separate 
return years. The rule in Sec.  1.987-11(e)(6)(ii) is based on the SRLY 
rules for capital loss carryovers in Sec.  1.1502-22(c). To simplify 
the administration of this rule, when a corporation that is the owner 
of a section 987 QBU joins a consolidated group, the SRLY limitation is 
not applied separately to each recognition grouping determined under 
Sec.  1.987-11(f), but rather to the corporation's section 987 losses 
overall.
    Because deferred section 987 losses under Sec.  1.987-12 are not 
subject to a loss-to-the-extent-of-gain rule, but rather are treated 
similarly under the section 987 regulations to other unrecognized 
section 987 losses, the SRLY limitation in Sec.  1.987-11(e)(6)(ii) 
does not apply to such losses.

XI. Comments and Changes to Proposed Sec.  1.987-13: Suspended Section 
987 Loss Upon Terminations

    Proposed Sec.  1.987-13 would provide suspended loss rules that 
apply in connection with certain transactions in which a section 987 
QBU or a successor suspended loss QBU terminates.

A. Successor Rules

    Under the 2023 proposed regulations, if an owner has suspended 
section 987 loss with respect to a section 987 QBU that terminates, an 
eligible QBU that holds the assets of the section 987 QBU after the 
termination would be treated as a successor suspended loss QBU if it 
meets three requirements. Proposed Sec.  1.987-13(b)(1)(i). First, a 
significant portion of the assets of the terminating section 987 QBU 
must be reflected on the books and records of the eligible QBU. Second, 
the eligible QBU must carry on a trade or business of the section 987 
QBU. Finally, the eligible QBU must be owned by the owner of the 
section 987 QBU or by a member of its controlled group (the owner of 
the successor is referred to as the ``successor suspended loss QBU 
owner''). Following a termination, if the terminated section 987 QBU 
has a successor, suspended section 987 loss with respect to the section 
987 QBU would be attributed to the successor. Similar successor rules 
would apply upon termination of a successor suspended loss QBU. 
Proposed Sec.  1.987-13(c)(1)(i).
    If a section 987 QBU or successor suspended loss QBU terminates 
without a successor, the owner would recognize its cumulative suspended 
section 987 loss with respect to the QBU. Proposed Sec.  1.987-13(b)(2) 
and (c)(2). Similarly, the cumulative suspended section 987 loss with 
respect to a successor suspended loss QBU would be recognized if the 
original suspended loss QBU owner ceases to be a member of the same 
controlled group as the successor suspended loss QBU owner due to the 
transfer of an ownership interest in the successor suspended loss QBU 
owner. Proposed Sec.  1.987-13(d).
    A comment recommended that the definition of a successor suspended 
loss QBU should be aligned with the definition of a successor deferral 
QBU as provided in proposed Sec.  1.987-12(g)(2), so that the same 
definition would apply for both purposes. The final regulations 
generally retain the definition of a successor suspended loss QBU 
provided in the proposed regulations because this definition is needed 
to ensure that suspended section 987 loss can be recognized (in excess 
of section 987 gain) only when the trade or business of a section 987 
QBU ceases to be operated by a member of the same controlled group. The 
successor rule in Sec.  1.987-12(g)(2) (which requires the successor to 
itself be a section 987 QBU) would not serve this function, because it 
would require suspended section 987 loss to be recognized when a 
section 987 QBU is transferred to a related owner that has the same 
functional currency as the section 987 QBU.

B. Elimination or Limited Recognition of Suspended Section 987 Loss 
Following Certain Transactions

    Proposed Sec.  1.987-13(e), (f), and (g) would provide rules that 
eliminate or limit the recognition of suspended section 987 loss 
following certain transactions. First, under proposed Sec.  1.987-
13(e), if the original suspended loss QBU owner ceases to be a member 
of the same controlled group as the successor suspended loss QBU owner 
due to the transfer of an ownership interest in the original suspended 
loss QBU owner, the original suspended loss QBU owner's suspended 
section 987 loss would cease to be attributable to any section 987 QBU 
or successor suspended loss QBU. After the transaction, the owner's 
suspended section 987 loss can be recognized under Sec.  1.987-11(e) to 
the extent that the owner recognizes section 987 gain; however, the 
suspended section 987 loss cannot be recognized under proposed Sec.  
1.987-13(b)(2), (c)(2), or (d). This rule would prevent taxpayers from 
transferring the stock of the original suspended loss QBU owner out of 
its controlled group for the purpose of selectively recognizing 
suspended section 987 loss, while retaining the assets and activities 
of the section 987 QBU in the hands of a different controlled group 
member.
    Proposed Sec.  1.987-13(f) would provide that, if an original 
suspended loss QBU owner ceases to exist as a result of a transaction 
in which there is no successor described in section 381(a) (for 
example, as a result of a section 331 liquidation), then any suspended 
section 987 loss that is not recognized after applying the loss-to-the-
extent-of-gain rule cannot be recognized and is eliminated. This rule 
is intended to prevent taxpayers from entering into section 331 
liquidations in order to trigger the recognition of suspended section 
987 loss.
    Similarly, under proposed Sec.  1.987-13(g), if an owner of a 
section 987 QBU with suspended section 987 loss, or an original 
suspended loss QBU owner, ceases to exist in an inbound section 332 
liquidation or in an inbound reorganization described in section 
381(a)(2), then any suspended section 987 loss of the owner or original 
suspended loss QBU owner that is not recognized after application of 
the loss-to-the-extent-of-gain rule under proposed Sec.  1.987-11(e) 
would be eliminated. This rule would prevent suspended section 987 loss 
that was generated offshore from being imported into the United States.
    Several comments requested that the rules of proposed Sec.  1.987-
13(e) through (g) be replaced with anti-abuse rules tied to the purpose 
for which a taxpayer enters into the relevant transaction. One comment 
noted that if a CFC liquidates into its U.S. shareholder and a current 
rate election is not in effect, the transaction results in a 
termination of

[[Page 100159]]

the CFC's section 987 QBUs under Sec.  1.987-8, and the CFC recognizes 
its net unrecognized section 987 gain or loss immediately before the 
liquidation. The comment proposed that suspended section 987 loss 
should similarly be recognized in connection with an inbound 
liquidation.
    Other comments recommended that, following a section 331 
liquidation or inbound transaction, suspended section 987 loss should 
be amortized over a ten-year period or added to the acquiring 
corporation's outside stock basis. One comment suggested that the 
suspended section 987 loss should be allocated pro rata among the U.S. 
shareholder's other foreign entities that own section 987 QBUs. Another 
comment requested that Sec.  1.987-13(f) be modified to provide that 
suspended section 987 loss is recognized to the extent of the owner's 
overall gain (not limited to section 987 gain) recognized in connection 
with the section 331 liquidation. One comment suggested that, in 
connection with an inbound transaction, suspended section 987 loss 
could be recognized to the extent of the inbounded section 987 gain.
    The Treasury Department and the IRS have determined that, in order 
to facilitate the current rate election (which can have the effect of 
enlarging the pools of unrecognized section 987 gain or loss), 
effective loss limitation rules are needed to prevent the selective 
recognition of section 987 losses by, for example, entering into a 
section 331 liquidation, inbound liquidation or reorganization, or a 
transfer of the original suspended loss QBU owner. Further, an anti-
avoidance rule tied to the taxpayer's subjective purpose for entering 
into a particular transaction would be difficult to administer and, 
consequently, would not be an adequate safeguard against abuse given 
the critical function served by the loss limitation rules. A subjective 
anti-abuse rule would also provide less certainty for taxpayers and the 
IRS. Therefore, the final regulations generally retain the rules of 
proposed Sec.  1.987-13(e) through (g).
    The final regulations do not permit suspended section 987 loss to 
be amortized by the acquiring corporation over a ten-year period 
following an inbound transaction or section 331 liquidation because 
this would nevertheless facilitate loss importation (in the case of an 
inbound transaction), even though the benefit would only be recognized 
over time, or would allow for losses to be carried over to the acquirer 
in a transaction not described in section 381(a) (in the case of a 
section 331 liquidation). Similarly, reallocating losses to foreign 
entities other than the acquiring corporation would be inconsistent 
with the principles of section 381 and would be unduly complex. Adding 
suspended section 987 loss of a CFC to the outside basis of a domestic 
acquiring corporation's stock would have the same effect as loss 
importation (because the increased basis could reduce the taxable 
income of the domestic corporation's shareholders upon a sale of stock) 
and would also shift losses in a manner that is contrary to general tax 
principles.
    The final regulations also do not permit suspended section 987 loss 
to be recognized to the extent of gain (other than section 987 gain) 
recognized in connection with a section 331 liquidation. As explained 
in part X.B.3 of this Summary of Comments and Explanation of Revisions, 
the loss-to-the-extent of gain rule generally does not allow suspended 
section 987 loss to be recognized in excess of section 987 gain. If a 
different rule were adopted for section 331 liquidations, taxpayers 
could enter into a section 331 liquidation in order to step up the 
basis of their assets, with any gain recognized with respect to those 
assets being offset by the recognition of suspended section 987 loss.
    However, consistent with the 2023 proposed regulations, the final 
regulations permit suspended section 987 loss to be recognized to the 
extent of section 987 gain recognized in connection with a transaction 
described in Sec.  1.987-13(f) or (g). Because those transactions 
generally would be treated as terminations under Sec.  1.987-8, any net 
unrecognized section 987 gain of the owner will be recognized 
immediately before the transaction and will be taken into account under 
the loss-to-the-extent-of-gain rule.

C. Clarification of Sec.  1.987-13

    A comment requested clarification as to the mechanics for 
recognizing suspended section 987 loss following a transaction 
described in Sec.  1.987-13(e), in which an original suspended loss QBU 
owner is transferred outside the controlled group. The comment also 
suggested clarifying the interaction between the successor rules of 
Sec.  1.987-13(b) and (c) and the inbound transaction rule in proposed 
Sec.  1.987-13(g).
    The final regulations clarify that, following a transaction 
described in Sec.  1.987-13(e) (in which the original suspended loss 
QBU owner is transferred outside the controlled group), the original 
owner recognizes suspended section 987 loss to the extent that it 
recognizes section 987 gain in the same recognition grouping. Further, 
in the case of a transaction described in Sec.  1.987-13(e) (transfer 
of original suspended loss QBU owner), Sec.  1.987-13(f) (section 331 
liquidation), or Sec.  1.987-13(g) (inbound transaction), suspended 
section 987 loss is not recognized or attributed to a successor 
suspended loss QBU under Sec.  1.987-13(b) or (c). The final 
regulations also clarify that the rules of Sec.  1.987-13(f) apply to a 
transaction (such as a section 331 liquidation) in which the owner of a 
section 987 QBU ceases to exist without having a successor (that is, 
this rule applies even if the section 987 QBU with respect to which the 
suspended section 987 loss arose had not previously been terminated, 
such that the owner was not an original suspended loss QBU owner).

XII. Comments and Changes to Proposed Sec.  1.987-14: Applicability 
Date

    Proposed Sec.  1.987-14 would provide rules relating to the 
applicability date of the section 987 regulations.
    In general, the 2023 proposed regulations are proposed to apply to 
taxable years beginning after December 31, 2024. Proposed Sec.  1.987-
14(a)(1). In the case of a terminating QBU (that is, a section 987 QBU 
that terminates after November 9, 2023, but before the section 987 
regulations are generally applicable), the 2023 proposed regulations, 
as finalized, generally would apply immediately before the termination.
    A comment requested that the general applicability date be delayed 
until taxable years beginning after December 31, 2025, to allow 
additional time for taxpayers to build systems and processes to comply 
with the final regulations. Another comment requested a deferred 
applicability date no earlier than the taxable year beginning on or 
after one year after the first day of the first taxable year following 
the date on which the final regulations are published.
    One comment requested that the special rule for terminating QBUs be 
eliminated. The comment asserted that the existing deferral rules under 
Sec.  1.987-12 are sufficient to prevent abuse.
    Under Sec.  1.987-15, the final regulations generally apply to 
taxable years beginning after December 31, 2024, consistent with the 
2023 proposed regulations. See Sec.  1.987-15(a)(1). See also 
Sec. Sec.  1.861-9(g)(2)(v), 1.985-5(g), 1.988-1(i), 1.988-4(b)(2)(ii), 
1.989(a)-1(b)(4) and (d)(4), and 1.1502-13(l)(10). The 2016 final 
regulations originally were applicable to taxable years beginning on or 
after one year after the

[[Page 100160]]

first day of the first taxable year following December 7, 2016 (thus, 
they would have been applicable in 2018 for calendar year taxpayers). 
Although the applicability date of those regulations was subsequently 
deferred, taxpayers have been on notice for many years concerning the 
general framework of the section 987 regulations. Final regulations are 
necessary to provide guidance to taxpayers regarding the proper 
determination of section 987 taxable income or loss and section 987 
gain or loss and to provide a consistent set of rules applicable to all 
taxpayers. Accordingly, further deferral would not serve the interest 
of sound tax administration. The applicability date under Sec.  1.987-
15(a)(1) is consistent with the rule under section 7805(b) of the Code 
regarding retroactivity of regulations or rulings.
    In addition, the final regulations retain the special applicability 
date providing that the section 987 regulations apply to terminating 
QBUs immediately before the termination. See Sec.  1.987-15(a)(2). This 
rule is needed to prevent taxpayers from terminating a section 987 QBU 
before the section 987 regulations generally become applicable in order 
to avoid the rules of the section 987 regulations, including the loss 
suspension rules in Sec. Sec.  1.987-10, 1.987-11, and 1.987-13.

XIII. Comments and Changes to Proposed Sec.  1.1502-13: Intercompany 
Transactions

    The 2023 proposed regulations would provide a new rule applicable 
to certain intercompany transactions (as defined in Sec.  1.1502-
13(b)(1)(i)) involving section 987 QBUs. See proposed Sec.  1.1502-
13(j)(9).
    In general, Sec.  1.1502-13 provides rules to clearly reflect the 
taxable income and tax liability of a consolidated group as a whole by 
preventing intercompany transactions from creating, accelerating, 
avoiding, or deferring consolidated taxable income or consolidated tax 
liability. See Sec.  1.1502-13(a). Under Sec.  1.1502-13, the selling 
member (S) and the buying member (B) are treated as separate entities 
for some purposes but as divisions of a single corporation for other 
purposes. The matching rule in Sec.  1.1502-13(c) is one of the 
principal rules in Sec.  1.1502-13 that produces the effect of 
transactions between divisions of a single corporation (single entity 
treatment). See Sec.  1.1502-13(a)(6)(i).
    To address potential mismatches that make it difficult to apply the 
rules of Sec.  1.1502-13 to section 987 QBUs, the 2023 proposed 
regulations would apply a reattribution rule that treats all 
intercompany transactions involving a section 987 QBU as attributable 
to a member's home office rather than to any section 987 QBU. As a 
result, an intercompany transaction between one member of a 
consolidated group and a section 987 QBU of another member of the same 
group is treated as a combination of (i) an intercompany transaction 
between the consolidated group members (that is, S and B), and (ii) 
transfers between the section 987 QBU and its owner as necessary to 
account for the effect of the transaction on the assets and liabilities 
of the section 987 QBU. This approach would ensure that consolidated 
taxable income includes the same amount of section 987 gain or loss as 
would be recognized if the members were divisions of a single 
corporation.
    One comment requested that the proposed rule be removed, on the 
grounds that it would change the amount of currency gain or loss 
recognized by S and B with respect to intercompany transactions. For 
example, assume that S has a section 987 QBU with the euro as its 
functional currency, and the QBU makes a euro-denominated loan to B. 
The comment noted that, under the proposed rule, B's foreign currency 
exposure and S's foreign currency exposure offset for Federal income 
tax purposes (that is, if B recognizes any section 988 gain or loss on 
the interest payments, S will recognize an offsetting amount of section 
988 loss or gain). The comment indicated that, for financial accounting 
purposes, B's foreign currency exposure would result in net income (it 
would not be offset by S's foreign currency exposure). According to the 
comment, B would typically enter into a separate hedging transaction 
(for example, a foreign currency forward contract) to hedge this 
exposure. However, under the proposed rule, because the section 988 
gain or loss of B and S with respect to the loan will offset for tax 
purposes, the hedging transaction itself will generate net section 988 
gain or loss. Therefore, the comment asserted that the proposed rule 
may have the practical effect of giving rise to income or loss for tax 
purposes for consolidated groups with respect to hedging transactions.
    In other words, under the view expressed in the comment, if the 
taxpayer enters into a hedging transaction for U.S. GAAP purposes, B 
would have section 988 gain or loss on the loan absent the proposed 
rule, and such gain or loss would be offset by loss or gain on the 
hedging transaction; in contrast, under the proposed rule, B's section 
988 gain or loss on the loan would be offset by S's section 988 loss or 
gain, and loss or gain on the hedging transaction would not be offset.
    The comment appears to reflect the view that, in the absence of the 
reattribution rule in proposed Sec.  1.1502-13(j)(9), the matching rule 
of Sec.  1.1502-13(c) does not apply to transactions involving section 
987 QBUs, and as a result the tax treatment of S and B is determined 
independently. Therefore, the comment appears to assume that the 
Federal income tax treatment and the accounting treatment of 
transactions involving section 987 QBUs would be identical without the 
proposed rule.
    The Treasury Department and the IRS disagree with the comment. The 
intercompany transaction rules in Sec.  1.1502-13 apply to all 
intercompany transactions, including those that involve section 987 
QBUs, and taxpayers must apply those rules to achieve single entity 
treatment. The reattribution rule of proposed Sec.  1.1502-13(j)(9) 
merely reflects the application of the intercompany transaction rules 
to section 987 QBUs in a simpler and more administrable manner for 
taxpayers and the IRS. Therefore, removing the reattribution rule would 
not address the concerns expressed in the comment. Additionally, the 
approach discussed in the comment would be fundamentally inconsistent 
with the purposes of section 1502 and Sec.  1.1502-13: it would not 
clearly reflect the income tax liability of the consolidated group, 
because it would allow intercompany transactions to accelerate or defer 
currency gains and losses. The proposed reattribution rule is therefore 
finalized without change.
    Comments also requested clarification regarding Example 8 in 
proposed Sec.  1.1502-13(j)(10)(viii). In response, the final 
regulations include additional facts in Example 8 as well as two 
alternative fact patterns involving (i) a member's disposition of an 
intercompany loan before its satisfaction, and (ii) a member ceasing to 
be a member of the consolidated group while an intercompany loan 
remains outstanding. The final regulations also include formatting 
changes to the examples under Sec.  1.1502-13(j) that were proposed in 
REG-134420-10 (88 FR 52057).

XIV. Other Comments and Revisions

    A comment recommended that the Treasury Department and the IRS 
consider the impact of section 987 gain or loss on the corporate 
alternative minimum tax (``CAMT'') regime. The comment did not 
recommend specific rules to be implemented for this purpose. The final 
regulations do not address the application of the CAMT regime. 
Accordingly, this comment was

[[Page 100161]]

not adopted because it is outside the scope of the final regulations.
    Similarly, comments requested that information relating to section 
987 should continue to be reported on Form 8858, Schedule C-1, with 
modifications for taxpayers that do not make a current rate election. 
The development or modification of forms related to section 987 is 
outside the scope of the final regulations. Therefore, this comment was 
not adopted.
    A comment was received in response to the 2016 proposed regulations 
during the initial comment period for those proposed regulations. The 
comment requested that the 2016 final regulations and the 2016 
temporary regulations be reproposed with a deferred applicability date, 
which is consistent with the approach taken by the 2023 proposed 
regulations and these final regulations.
    In addition to the provisions described in parts I through XIII of 
this Summary of Comments and Explanation of Revisions, the final 
regulations include other wording changes, additions, deletions, and 
organizational changes to the 2023 proposed regulations for purposes of 
clarification. For example, the rules in Sec.  1.987-3(c)(3) relating 
to the adjustments required under the simplified inventory method have 
been clarified, and an example has been added to illustrate those 
rules. Similarly, the rules of Sec.  1.985-5 have been modified to 
update cross-references to the section 987 regulations and to clarify 
the example in Sec.  1.985-5(f).

Special Analyses

I. Regulatory Planning and Review-Economic Analysis

    Pursuant to the Memorandum of Agreement, Review of Treasury 
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory 
actions issued by the IRS are not subject to the requirements of 
section 6 of Executive Order 12866, as amended. Therefore, a regulatory 
impact assessment is not required.

II. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (PRA) 
requires that a Federal agency obtain the approval of the Office of 
Management and Budget (OMB) before collecting information from the 
public, whether such collection of information is mandatory, voluntary, 
or required to obtain or retain a benefit. 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 
OMB.
    The collections of information in the final regulations with 
respect to section 987 are in Sec. Sec.  1.987-1(g), 1.987-9, 1.987-
10(k), and 1.987-14(c). The likely respondents are individuals who file 
a Form 1040 and businesses that file a Form 1065 or Form 1120. The 
final regulations do not apply to trusts and estates. See part II.A.2 
of the Summary of Comments and Explanation of Revisions.
    The collection of information provided by Sec.  1.987-1(g) is 
required only when a taxpayer makes or revokes certain elections for 
purposes of calculating its section 987 taxable income or loss and 
section 987 gain or loss with respect to a section 987 QBU. In the 
first year in which the section 987 regulations apply to the taxpayer, 
or the taxpayer or a member of its consolidated group or section 987 
electing group is the owner of a section 987 QBU, the taxpayer may make 
any section 987 election. Thereafter, the taxpayer may make or revoke a 
current rate election, annual recognition election, or section 988 
mark-to-market election only every five years and may make or revoke 
other elections only with the consent of the Commissioner, which may be 
granted with a private letter ruling. When a taxpayer makes or revokes 
an election, the collection of information is mandatory. The collection 
of information required by Sec.  1.987-1(g) will be used by the IRS for 
tax compliance purposes.
    Section 1.987-9 is intended to specify how a taxpayer satisfies its 
recordkeeping obligations under section 6001 with respect to section 
987. The recordkeeping requirements under Sec.  1.987-9 are considered 
general tax records under Sec.  1.6001-1(e). For PRA purposes, general 
tax records are already approved by OMB under 1545-0074 for individuals 
and under 1545-0123 for business entities. The IRS intends that the 
information collection requirements pursuant to Sec.  1.987-9 will be 
satisfied by the taxpayer maintaining permanent books and records that 
are adequate to verify its section 987 gain or loss and section 987 
taxable income or loss with respect to its section 987 QBU.
    Specifically, with respect to each section 987 QBU, successor 
deferral QBU, and successor suspended loss QBU for a taxable year, as 
applicable, Sec.  1.987-9 requires taxpayers to maintain books and 
records related to the amount of the items of income, gain, deduction, 
or loss attributed to the section 987 QBU in the functional currency of 
the section 987 QBU and its owner; the adjusted balance sheet of the 
section 987 QBU in the functional currency of the section 987 QBU and 
its owner (or the information used to determine QBU net value under 
Sec.  1.987-4(e)(2)(iii), as explained in part V.A.1 of the Summary of 
Comments and Explanation of Revisions); the exchange rates used to 
translate items of income, gain, deduction, or loss of the section 987 
QBU into the owner's functional currency and, if a spot rate convention 
is used, the manner in which the convention is determined; the exchange 
rates used to translate the assets and liabilities of the section 987 
QBU into the owner's functional currency and, if a spot rate convention 
is used, the manner in which the convention is determined; the amount 
of assets and liabilities transferred by the section 987 QBU to the 
owner determined in the functional currency of the owner and the 
section 987 QBU; the amount of the unrecognized section 987 gain or 
loss for the taxable year; the amount of the net accumulated 
unrecognized section 987 gain or loss for the taxable year; the amount 
of the remittance and the remittance proportion for the taxable year; 
the computations required under Sec. Sec.  1.861-9(g) and 1.861-9T(g) 
for purposes of sourcing and characterizing section 987 gain or loss, 
deferred section 987 gain or loss, or suspended section 987 loss under 
Sec.  1.987-6; the cumulative suspended section 987 loss in each 
recognition grouping; the outstanding deferred section 987 gain or loss 
in each recognition grouping; the transition information required to be 
determined under Sec.  1.987-10(k); and the identification required 
under Sec.  1.987-14(c) with respect to a section 987 hedging 
transaction. These records are required for the IRS to validate that 
section 987 gain or loss and section 987 taxable income or loss have 
been properly determined.
    The Treasury Department and the IRS are adding a recordkeeping 
requirement under Sec.  1.987-14(c) based on a public comment on the 
substantive rules of the 2023 proposed regulations which requested 
implementation of a section 987 hedging election. See part V.B.1 of the 
Summary of Comments and Explanation of Revisions. Under Sec.  1.987-
14(c), the final regulations require an identification statement to be 
kept in the taxpayers' books and records with respect to a section 987 
hedging transaction described in Sec.  1.987-14(b)(1).
    The collection of information in Sec.  1.987-10(k) is mandatory. 
Specifically, Sec.  1.987-10(k) would require a taxpayer to file a 
``Section 987 Transition Information'' statement with its return for 
the taxable year beginning on the

[[Page 100162]]

transition date (as defined in Sec.  1.987-10(c)). The statement would 
contain information that is necessary for a taxpayer to transition to 
the final section 987 regulations. Specifically, the statement requires 
a taxpayer to provide information that is relevant to determining the 
taxpayer's pretransition gain or loss with respect to its section 987 
QBUs. The collection of information required by Sec.  1.987-10(k) will 
be used by the IRS for tax compliance purposes.
    The Treasury Department and the IRS intend that the information 
described in Sec.  1.987-1(g) will be collected by attaching a 
statement to a taxpayer's return (such as the appropriate Form 1040, 
Form 1120, Form 1065, or other appropriate form). With respect to Sec.  
1.987-10(k), the IRS also intends that the collection of information 
will be conducted by attaching a ``Section 987 Transition Information'' 
statement to a return. For purposes of the PRA, the reporting burden 
associated with those collections of information with respect to 
Sec. Sec.  1.987-1(g) and 1.987-10(k) will be reflected in the PRA 
submissions associated with those forms. The OMB Control Numbers for 
the forms will be approved under 1545-0074 for individuals and under 
1545-0123 for business entities.
    To the extent that a taxpayer makes or revokes an election by 
obtaining a private letter ruling, the reporting burden associated with 
those collections of information will be reflected in the PRA 
submissions associated with revenue procedures governing private letter 
rulings. The OMB Control Number for the collection of information for 
those revenue procedures is control number 1545-1522. The final 
regulations would only require taxpayers to follow the procedures under 
Revenue Procedure 2024-1, IRB 2024-1 (or future revenue procedure 
governing private letter rulings) and would not change the collection 
requirements of the Revenue Procedure.
    The attachment to a return used for making elections with respect 
to these final regulations will be used by those taxpayers making or 
revoking an election for the taxable year. The ``Section 987 Transition 
Information'' statement attached to a return will be used by all 
taxpayers, but generally only with respect to the taxable year in which 
the taxpayer transitions to these final regulations. In certain cases, 
if the taxpayer owns a QBU that terminates after November 9, 2023, and 
before the taxable year in which the taxpayer transitions to the final 
regulations, the ``Section 987 Transition Information'' statement must 
be filed for that taxable year too, but the statement would only 
contain information with respect to the terminating QBU. The burden 
will be accounted for in 1545-0074 for individuals and in 1545-0123 for 
businesses.
    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 
tax return information are confidential, as required by 26 U.S.C. 6103.

III. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that this rulemaking 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. The final 
regulations affect taxpayers with foreign branch operations and 
taxpayers that own an interest in a foreign partnership (or a 
partnership with a foreign branch).
    The number of small entities potentially affected by the final 
regulations is unknown; however, it is unlikely to be a substantial 
number because taxpayers with wholly owned foreign operations are 
typically larger businesses. The Treasury Department and the IRS 
estimate that the total number of corporations (other than S 
corporations) with a foreign branch subject to section 987 is 
approximately 2,000. This estimate is based on the number of 
corporations (other than S corporations) that filed a Form 8858 in 2022 
that showed that the filer: (1) owned at least one disregarded entity 
or branch with a functional currency different from the functional 
currency of the owner, and (2) indicated that the disregarded entity or 
branch was a section 989 QBU. As shown in the following table, only a 
small percentage of those filers are small entities.

------------------------------------------------------------------------
                                                           Percentage of
          Total receipts/positive income (2022)               filers
------------------------------------------------------------------------
Under $5 Million........................................               7
$5 Million to $10 Million...............................               2
$10 Million to $25 Million..............................               4
Over $25 Million........................................              87
------------------------------------------------------------------------

    The number of affected corporations (other than S corporations) 
with total receipts of less than $25 million represents 0.02% of all 
corporations (other than S corporations) with total receipts of less 
than $25 million.
    The Treasury Department and the IRS estimate that the total number 
of partnerships and S corporations with a foreign branch subject to 
section 987 is approximately 800. Approximately 50 percent of those 
filers have gross receipts of less than $25 million, but the data does 
not indicate whether these partnerships are part of larger enterprises. 
The number of affected partnerships and S corporations with total 
receipts of less than $25 million represents 0.004% of all partnerships 
and S corporations with total receipts of less than $25 million. Small 
entities may also own partnership interests.
    The primary rules that apply to partnerships (that is, the deferral 
rules in Sec.  1.987-12 and the suspended loss rules in Sec. Sec.  
1.987-11 and 1.987-13) apply only in the case of a remittance or 
termination that would result in the recognition of a significant 
amount of section 987 gain or loss. Small entities typically will not 
recognize section 987 gain or loss in excess of the applicable 
thresholds.
    These final regulations generally modify the rules that would 
otherwise apply under the 2016 final regulations by providing taxpayers 
with additional elections that reduce the compliance burden of applying 
section 987. Small entities generally would not be affected by these 
rules unless they choose to make one of the new elections in order to 
reduce their compliance burden. In addition, the final regulations 
contain several rules intended to limit their impact on small 
taxpayers. For example, the final regulations provide a de minimis rule 
under which section 987 loss is not suspended unless the amount of the 
loss exceeds the lesser of $3 million or two percent of gross income, 
as described in part X.A.1 of the Summary of Comments and Explanation 
of Revisions. In addition, for purposes of the transition rules, the 
final regulations provide an election under which small businesses can 
treat small QBUs as having no pretransition gain or loss. See part 
IX.A.2 of the Summary of Comments and Explanation of Revisions.
    A portion of the economic impact of the final regulations may 
derive from the collection of information requirements imposed under 
Sec. Sec.  1.987-1(g), 1.987-10(k), and 1.987-14(c). The Treasury 
Department and the IRS have determined that the average burden is 1.95 
hours per response. The IRS's Research, Applied Analytics, and 
Statistics division estimates that the appropriate wage rate for this 
set of taxpayers is $99.87 per hour. Thus, the annual burden per 
taxpayer from each collection of information requirement is $194.75. 
The requirements of Sec.  1.987-1(g) apply only if a taxpayer chooses 
to make or revoke an election (and only in the year of the election or 
revocation), the requirements of Sec.  1.987-10(k) apply

[[Page 100163]]

only in the first taxable year in which the final regulations apply, 
and the requirements of Sec.  1.987-14(c) apply only if a taxpayer 
identifies a hedge as a section 987 hedging transaction (which is 
unlikely to be relevant for small entities).
    Another portion of the economic impact of the final regulations may 
derive from the recordkeeping requirements of Sec.  1.987-9, which 
identify the records needed to satisfy the taxpayer's obligations under 
section 6001. The requirements of Sec.  1.987-9 generally will be less 
burdensome for small entities than the requirements of the 2016 final 
regulations due to the modifications described in part V.A.1 of the 
Summary of Comments and Explanation of Revisions (which permit QBU net 
value to be computed without preparing a tax basis balance sheet).

IV. Section 7805(f)

    Pursuant to section 7805(f) of the Code, the proposed regulations 
preceding these final regulations were submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on their 
impact on small business and no comments were received.

V. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other 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 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. The final regulations do not include any Federal mandate 
that may result in expenditures by State, local, or Tribal governments, 
or by the private sector in excess of that threshold.

VI. 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. The final regulations do not have 
federalism implications and do not impose substantial direct compliance 
costs on State and local governments or preempt State law within the 
meaning of the Executive order.

Statement of Availability of IRS Documents

    IRS Revenue Procedures, Revenue Rulings, Notices, and other 
guidance 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.

Drafting Information

    The principal authors of these final regulations are Adam G. 
Province and Raphael J. Cohen of the Office of Associate Chief Counsel 
(International); and Matthew N. Palucki and Jeremy Aron-Dine of the 
Office of Associate Chief Counsel (Corporate). However, other personnel 
from the Treasury Department and the IRS participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, the Treasury Department and the IRS amend 26 CFR part 
1 as follows:

PART 1--INCOME TAXES

0
Paragraph 1.The authority citation for part 1 is amended by:
0
a. Removing the entry for Sec. Sec.  1.861-9 and 1.861-9T and 
Sec. Sec.  1.861-8T through 1.861-14T;
0
b. Adding entries for Sec. Sec.  1.861-8T, 1.861-9, 1.861-9T through 
1.861-14T in numerical order;
0
c. Removing the entry for Sec. Sec.  1.985-0 through 1.985-5;
0
d. Adding entries for Sec. Sec.  1.985-0 through 1.985-5 in numerical 
order;
0
e. Removing the entry for Sec. Sec.  1.987-1 through 1.987-5;
0
f. Adding entries for Sec. Sec.  1.987-1 through 1.987-11 in numerical 
order;
0
g. Revising the entry for Sec.  1.987-12;
0
h. Adding entries for Sec. Sec.  1.987-13 through 1.987-15 in numerical 
order;
0
i. Removing the entry for Sec. Sec.  1.988-0 through 1.988-5;
0
j. Adding entries for Sec. Sec.  1.988-0 through 1.988-5 and 1.989(a)-1 
in numerical order; and
0
k. Revising the entry for Sec.  1.1502-13.
    The additions and revisions read as follows:

    Authority:  26 U.S.C. 7805 * * *
* * * * *
    Section 1.861-8T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
    Section 1.861-9 also issued under 26 U.S.C. 861, 863(a), 864(e), 
864(e)(7), 865(i), 987, and 989(c), and 7701(f).
    Section 1.861-9T also issued under 26 U.S.C. 861, 863(a), 
864(e), 864(e)(7), 865(i), and 7701(f).
* * * * *
    Section 1.861-10T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-11T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-12T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-13T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.861-14T also issued under 26 U.S.C. 863(a), 864(e), 
865(i), and 7701(f).
* * * * *
    Section 1.985-0 also issued under 26 U.S.C. 985.
    Section 1.985-1 also issued under 26 U.S.C. 985.
    Section 1.985-2 also issued under 26 U.S.C. 985.
    Section 1.985-3 also issued under 26 U.S.C. 985.
    Section 1.985-4 also issued under 26 U.S.C. 985.
    Section 1.985-5 also issued under 26 U.S.C. 985, 987, and 989.
* * * * *
    Section 1.987-1 also issued under 26 U.S.C. 987, 989, and 1502.
    Section 1.987-2 also issued under 26 U.S.C. 987, 989, and 1502.
    Section 1.987-3 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-4 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-5 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-6 also issued under 26 U.S.C. 904, 987, and 989.
    Section 1.987-7 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-8 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-9 also issued under 26 U.S.C. 987, 989, and 6001.
    Section 1.987-10 also issued under 26 U.S.C. 987, 989, and 6001.
    Section 1.987-11 also issued under 26 U.S.C. 987, 989, and 1502.
    Section 1.987-12 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-13 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-14 also issued under 26 U.S.C. 987 and 989.
    Section 1.987-15 also issued under 26 U.S.C. 987 and 989.
    Section 1.988-0 also issued under 26 U.S.C. 988.
    Section 1.988-1 also issued under 26 U.S.C. 988 and 989.
    Section 1.988-2 also issued under 26 U.S.C. 988.
    Section 1.988-3 also issued under 26 U.S.C. 988.
    Section 1.988-4 also issued under 26 U.S.C. 988 and 989.

[[Page 100164]]

    Section 1.988-5 also issued under 26 U.S.C. 988.
* * * * *
    Section 1.989(a)-1 also issued under 26 U.S.C. 989.
* * * * *
    Section 1.1502-13 also issued under 26 U.S.C. 250(c), 987, 989, 
and 1502.
* * * * *

0
Par. 2. Section 1.861-9 is amended by:
0
a. Revising paragraphs (g)(2)(ii)(A) introductory text, 
(g)(2)(ii)(A)(1), and (g)(2)(ii)(B); and
0
b. Adding paragraph (g)(2)(v).
    The revisions and addition read as follows:


Sec.  1.861-9  Allocation and apportionment of interest expense and 
rules for asset-based apportionment.

* * * * *
    (g) * * *
    (2) * * *
    (ii) * * *
    (A) Tax book value method. In the case of taxpayers using the tax 
book value method of apportionment, the following rules apply to 
determine the value of the assets of a qualified business unit (QBU) 
(as defined in section 989(a)) of a domestic corporation with a 
functional currency other than the dollar.
    (1) Section 987 QBU. In the case of a section 987 QBU (as defined 
in Sec.  1.987-1(b)(3)), the tax book value is determined by applying 
the rules of paragraph (g)(2)(i) of this section and Sec.  1.861-
9T(g)(3) to the beginning-of-year and end-of-year owner functional 
currency amount of assets. The beginning-of-year owner functional 
currency amount of assets is determined by reference to the owner 
functional currency amount of assets computed under Sec.  1.987-
4(d)(1)(i)(B) and (e) on the last day of the preceding taxable year. 
The end-of-year owner functional currency amount of assets is 
determined by reference to the owner functional currency amount of 
assets computed under Sec.  1.987-4(d)(1)(i)(A) and (e) on the last day 
of the current taxable year. The beginning-of-year and end-of-year 
owner functional currency amount of assets, as so determined within 
each grouping, are then averaged as provided in paragraph (g)(2)(i) of 
this section.
* * * * *
    (B) Fair market value method. In the case of taxpayers using the 
fair market value method of apportionment, the beginning-of-year and 
end-of-year fair market values of branch assets within each grouping 
are computed in dollars and averaged as provided in this paragraph 
(g)(2) and Sec.  1.861-9T(g)(2).
* * * * *
    (v) Applicability date. Generally, paragraph (g)(2)(ii)(A)(1) of 
this section applies to taxable years beginning after December 31, 
2024. However, if pursuant to Sec.  1.987-15(b), a taxpayer chooses to 
apply Sec. Sec.  1.987-1 through 1.987-15 to a taxable year before the 
first taxable year described in Sec.  1.987-15(a)(1), then paragraph 
(g)(2)(ii)(A)(1) of this section applies to that taxable year and 
subsequent years.
* * * * *


Sec.  1.861-9T  [Amended]

0
Par. 3. Section 1.861-9T is amended by removing and reserving paragraph 
(g)(2)(ii) and removing paragraph (g)(2)(vi).

0
Par. 4. Section 1.904-4 is amended by revising paragraph (c)(5)(iii)(B) 
to read as follows:


Sec.  1.904-4  Separate application of section 904 with respect to 
certain categories of income.

* * * * *
    (c) * * *
    (5) * * *
    (iii) * * *
    (B) Section 987. For special rules relating to the allocation and 
apportionment of foreign income taxes to section 987 items, see Sec.  
1.987-6(b)(3).
* * * * *

0
Par. 5. Add an undesignated center heading before Sec.  1.985-0 to read 
as follows:
* * * * *

Foreign Currency Transactions

* * * * *


Sec.  1.985-1  [Amended]

0
Par. 6. Section 1.985-1 is amended by:
0
a. In paragraph (f) designating Examples 1 through 12 as paragraphs 
(f)(1) through (12), respectively; and
0
b. Removing and reserving newly redesignated paragraphs (f)(9) through 
(11).

0
Par. 7. Section 1.985-5 is amended by:
0
a. In paragraph (a) removing the language ``Sec.  1.987-1(b)(2)'' and 
adding the language ``Sec.  1.987-1(b)(3)'' in its place;
0
b. In paragraph (d)(1)(i) removing the language ``1.987-11'' and adding 
the language ``1.987-15'' in its place;
0
c. Revising the last sentence of paragraph (d)(2);
0
d. Removing the second sentence of paragraph (e)(1);
0
e. Revising and republishing paragraphs (e)(4) and (f); and
0
f. Revising paragraph (g).
    The revisions read as follows:


Sec.  1.985-5  Adjustments required upon change in functional currency.

* * * * *
    (d) * * *
    (2) * * * See Sec. Sec.  1.987-5, 1.987-8, 1.987-12, and 1.987-13 
for the effect of a termination of a section 987 QBU that is subject to 
Sec. Sec.  1.987-1 through 1.987-15.
    (e) * * *
    (4) Adjustments to a section 987 QBU's balance sheet and 
unrecognized section 987 gain or loss when an owner changes functional 
currency--(i) Owner changing to a functional currency other than the 
section 987 QBU's functional currency. If an owner of a section 987 
QBU, subject to Sec. Sec.  1.987-1 through 1.987-15 pursuant to Sec.  
1.987-1(b)(1), changes to a functional currency other than the 
functional currency of the section 987 QBU, the adjustments described 
in paragraphs (e)(4)(i)(A) through (C) of this section are taken into 
account for purposes of section 987.
    (A) Determining new historic rates. The historic rate (as defined 
in Sec.  1.987-1(c)(3)) for the year of change and subsequent taxable 
years with respect to a historic item (as defined in Sec.  1.987-1(e)) 
reflected on the balance sheet of the section 987 QBU immediately 
before the year of change is equal to the historic rate before the year 
of change (that is, a rate that translates the section 987 QBU's 
functional currency into the owner's old functional currency) divided 
by the spot rate for translating an amount denominated in the owner's 
new functional currency into the owner's old functional currency on the 
last day of the last taxable year ending before the year of change. For 
example, if a taxpayer that owns a section 987 QBU with a British pound 
functional currency changes from a U.S. dollar functional currency to a 
euro functional currency, and the historic rate for translating a 
specific item of the section 987 QBU from GBP to USD is 1.50 and the 
spot rate for translating EUR to USD on the last day of the last 
taxable year before the change is 1.10, then the new historic rate for 
translating this historic item from GBP to EUR is 1.36 (1.50/1.10).
    (B) Determining the owner functional currency net value of the 
section 987 QBU on the last day of the last taxable year ending before 
the year of change under Sec.  1.987-4(d)(1)(i)(B). For purposes of 
determining the change in the owner functional currency net value of 
the section 987 QBU on the last day of the last taxable year preceding 
the year of change under Sec.  1.987-4(d)(1)(i)(B) and (e), the section 
987 QBU's marked items are translated into the owner's new functional 
currency at the spot rate on

[[Page 100165]]

the last day of the last taxable year ending before the year of change.
    (C) Translation of unrecognized section 987 gain or loss. Any net 
accumulated unrecognized section 987 gain or loss determined under 
Sec.  1.987-4(c), cumulative suspended section 987 loss determined 
under Sec.  1.987-11(b), or deferred section 987 gain or loss 
determined under Sec.  1.987-12 is translated from the owner's old 
functional currency into the owner's new functional currency using the 
spot rate for translating an amount denominated in the owner's old 
functional currency into the owner's new functional currency on the 
last day of the last taxable year ending before the year of change.
    (ii) Taxpayer with the same functional currency as its QBU changing 
to a different functional currency. If a taxpayer with the same 
functional currency as its QBU changes to a new functional currency and 
as a result the taxpayer becomes an owner of a section 987 QBU (see 
Sec.  1.987-1), the taxpayer and the section 987 QBU become subject to 
section 987 for the year of change and subsequent taxable years.
    (iii) Owner changing to the same functional currency as the section 
987 QBU. If an owner changes its functional currency to the functional 
currency of its section 987 QBU, the section 987 QBU is treated as if 
it terminated on the last day of the last taxable year ending before 
the year of change. See Sec. Sec.  1.987-5, 1.987-8, 1.987-12, and 
1.987-13 for the consequences of a termination of a section 987 QBU 
that is subject to Sec. Sec.  1.987-1 through 1.987-15.
    (f) Example. The provisions of this section are illustrated by the 
following example:
    (1) Facts. FC, a foreign corporation, is wholly owned by DC, a 
domestic corporation. The Commissioner granted permission to change 
FC's functional currency from the British pound to the euro beginning 
January 1, year 2. The EUR/GBP exchange rate on December 31, year 1, is 
[euro]1:[pound]0.50.
    (2) Analysis--(i) Determining new functional currency basis of 
property and liabilities. The following table shows how FC must convert 
the items on its balance sheet from the British pound to the euro on 
December 31, year 1.

  Table 1 to Paragraph (f)(2)(i) Conversion of FC's Balance Sheet Items
------------------------------------------------------------------------
                                           GBP                EUR
------------------------------------------------------------------------
Assets:
    Cash on hand..................      [pound]40,000       [euro]80,000
    Accounts Receivable...........             10,000             20,000
    Inventory.....................            100,000            200,000
    100,000 Euro Bond (100,000                 50,000            100,000
     historical basis)............
Fixed assets:
    Property......................            200,000            400,000
    Plant.........................            500,000          1,000,000
    Accumulated Depreciation......          (200,000)          (400,000)
    Equipment.....................          1,000,000          2,000,000
    Accumulated Depreciation......          (400,000)          (800,000)
                                   -------------------------------------
        Total Assets..............          1,300,000          2,600,000
Liabilities and Equity:
    Accounts Payable..............             50,000            100,000
    Long-term Liabilities.........            400,000            800,000
    Paid-in-Capital...............            800,000          1,600,000
    Retained Earnings.............             50,000            100,000
                                   -------------------------------------
        Total Liabilities and               1,300,000          2,600,000
         Equity...................
------------------------------------------------------------------------

    (ii) Exchange gain or loss on section 988 transactions. Under 
paragraph (b) of this section, FC will recognize a [pound]50,000 loss 
([pound]50,000 current value minus [pound]100,000 historical basis) on 
the Euro Bond resulting from the change in functional currency because, 
after the change, the Euro Bond will no longer be an asset denominated 
in a non-functional currency. The amount of FC's retained earnings on 
its December 31, year 1, balance sheet reflects the [pound]50,000 loss 
on the Euro Bond.
    (g) Applicability date. Generally, this section applies to taxable 
years beginning after December 31, 2024. However, if pursuant to Sec.  
1.987-15(b), a taxpayer chooses to apply Sec. Sec.  1.987-1 through 
1.987-15 to a taxable year before the first taxable year described in 
Sec.  1.987-15(a)(1), then this section applies to that taxable year 
and subsequent years.

0
Par. 8. Revise Sec. Sec.  1.987-0 through 1.987-12 and add Sec. Sec.  
1.987.13 through 1.987-15 to read as follows:

Foreign Currency Transactions

* * * * *
Sec.
1.987-0 Table of contents.
1.987-1 Scope, definitions and special rules.
1.987-2 Attribution of items to eligible QBUs; definition of a 
transfer and related rules.
1.987-3 Determination of section 987 taxable income or loss of an 
owner of a section 987 QBU.
1.987-4 Determination of net unrecognized section 987 gain or loss 
of a section 987 QBU.
1.987-5 Recognition of section 987 gain or loss.
1.987-6 Character and source of section 987 gain or loss.
1.987-7 Application of the section 987 regulations to partnerships 
and S corporations.
1.987-8 Termination of a section 987 QBU.
1.987-9 Recordkeeping requirements.
1.987-10 Transition rules.
1.987-11 Suspended section 987 loss relating to certain elections; 
loss-to-the-extent-of-gain rule.
1.987-12 Deferral of section 987 gain or loss.
1.987-13 Suspended section 987 loss upon terminations.
1.987-14 Section 987 hedging transactions.
1.987-15 Applicability date.
* * * * *


Sec.  1.987-0  Table of contents.

    This section lists the headings for Sec. Sec.  1.987-1 through 
1.987-15.

Sec.  1.987-1 Scope, definitions and special rules.

    (a) In general.

[[Page 100166]]

    (b) Scope of section 987 and certain rules relating to QBUs.
    (1) Persons subject to section 987.
    (i) In general.
    (ii) Inapplicability to certain entities.
    (2) Application of the section 987 regulations to earnings and 
profits.
    (i) In general.
    (ii) Timing.
    (3) Definition of a section 987 QBU.
    (i) In general.
    (ii) Section 987 QBU grouping election.
    (4) Definition of an eligible QBU.
    (i) In general.
    (ii) Qualified business unit.
    (5) Definition of an owner.
    (i) Direct ownership.
    (ii) [Reserved]
    (6) [Reserved]
    (7) Examples illustrating paragraph (b) of this section.
    (i) Example 1: Owner owns an eligible QBU and a DE holding 
company.
    (ii) Example 2: Owner owns eligible QBUs through DEs.
    (iii) Example 3: Section 987 grouping election.
    (c) Exchange rates.
    (1) Spot rate.
    (i) In general.
    (ii) Election to use a spot rate convention.
    (2) Yearly average exchange rate.
    (3) Historic rate.
    (i) In general.
    (ii) Date placed in service for depreciable or amortizable 
property.
    (iii) Changed functional currency.
    (d) Marked item.
    (1) In general.
    (2) Current rate election.
    (e) Historic item.
    (f) Example: Identification of marked and historic items.
    (1) Facts.
    (2) Analysis.
    (g) Elections.
    (1) Persons making the election.
    (i) United States persons.
    (ii) CFCs.
    (iii) Consolidated groups.
    (iv) Partnerships.
    (2) Consistency rules.
    (i) Consolidated groups.
    (ii) CFCs and foreign partnerships.
    (iii) Section 381(a) transactions.
    (3) Manner of making or revoking elections.
    (i) Statement must be attached to a return.
    (ii) Election requirements.
    (iii) Elections made under the 2016 and 2019 section 987 
regulations.
    (4) No change in method of accounting.
    (5) Principles of Sec.  1.964-1(c)(3) applicable to section 987 
elections.
    (h) Definitions.

Sec.  1.987-2 Attribution of items to eligible QBUs; definition of a 
transfer and related rules.

    (a) In general.
    (b) Attribution of items to an eligible QBU.
    (1) General rules.
    (2) Exceptions for non-portfolio stock, interests in 
partnerships, and certain acquisition indebtedness.
    (i) In general.
    (ii) Separate account assets.
    (3) Adjustments to items reflected on the books and records.
    (i) General rule.
    (ii) Factors indicating no tax avoidance.
    (iii) Factors indicating tax avoidance.
    (iv) Section 988 transactions.
    (c) Transfers to and from section 987 QBUs.
    (1) In general.
    (2) Disregarded transactions.
    (i) General rule.
    (ii) Definition of a disregarded transaction.
    (iii) Items derived from disregarded transactions ignored.
    (3) through (6) [Reserved]
    (7) Application of general tax law principles.
    (8) Interaction with Sec.  1.988-1(a)(10).
    (9) Certain disregarded transactions not treated as transfers.
    (i) Combinations of section 987 QBUs.
    (ii) Change in functional currency from a combination.
    (iii) Separation of section 987 QBUs.
    (iv) Special rules for successor suspended loss QBUs.
    (10) Examples.
    (i) Example 1: Loan to a section 987 QBU.
    (ii) Example 2: Transfer between section 987 QBUs.
    (iii) Example 3: Sale of property between two section 987 QBUs.
    (iv) through (ix) [Reserved]
    (x) Example 10: Contribution of a section 987 QBU's assets to a 
corporation.
    (xi) Example 11: Circular transfers.
    (xii) Example 12: Transfers without substance.
    (xiii) Example 13: Offsetting positions in section 987 QBUs
    (xiv) Example 14: Offsetting positions with respect to a section 
987 QBU and a section 988 transaction.
    (xv) Example 15: Offsetting positions with respect to a section 
987 QBU and a section 988 transaction.
    (xvi) Example 16: Borrowing by section 987 QBU followed by 
immediate distribution to owner.
    (xvii) Example 17: Payment of interest by section 987 QBU on 
obligation of owner.
    (xviii) Example 18: Sale of the interests in a DE.
    (d) Translation of items transferred to a section 987 QBU.
    (1) Marked items.
    (2) Historic items.
    (e) Cross-reference.

Sec.  1.987-3 Determination of section 987 taxable income or loss of 
an owner of a section 987 QBU.

    (a) In general.
    (b) Determination of each item of income, gain, deduction, or 
loss in the section 987 QBU's functional currency.
    (1) In general.
    (2) Translation of items of income, gain, deduction, or loss 
that are denominated in a nonfunctional currency.
    (3) [Reserved]
    (4) Section 988 transactions.
    (i) In general.
    (ii) Section 988 mark-to-market election.
    (c) Translation of items of income, gain, deduction, or loss of 
a section 987 QBU into the owner's functional currency.
    (1) In general.
    (2) Exceptions.
    (i) Recovery of basis with respect to historic assets.
    (ii) through (iii) [Reserved]
    (iv) Cost of goods sold computation.
    (v) Translation of income to account for certain foreign income 
tax claimed as a credit.
    (3) Adjustments to COGS required under the simplified inventory 
method.
    (i) In general.
    (ii) Adjustment for cost recovery deductions included in 
inventoriable costs.
    (iii) Adjustment for beginning inventory for non-LIFO inventory.
    (iv) Adjustment for year of LIFO liquidation.
    (d) [Reserved]
    (e) Examples.
    (1) Example 1: Item of income denominated in nonfunctional 
currency.
    (2) Example 2: Asset sold for nonfunctional currency.
    (3) Example 3: Historic inventory method.
    (i) Facts.
    (ii) Analysis.
    (4) Example 4: Simplified inventory method.
    (i) Facts.
    (ii) Analysis.
    (5) Example 5: Depreciation expense that is not an inventoriable 
cost.
    (6) Example 6: Translation of depreciation expense that is an 
inventoriable cost (historic inventory method).
    (7) Example 7: Sale of land.
    (8) Example 8: Current rate election.
    (9) through (12) [Reserved]
    (13) Example 13: Section 988 transaction.
    (i) Facts.
    (ii) Analysis.
    (14) Example 14: Payment of foreign income tax.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-4 Determination of net unrecognized section 987 gain or 
loss of a section 987 QBU.

    (a) In general.
    (b) Calculation of net unrecognized section 987 gain or loss.
    (c) Net accumulated unrecognized section 987 gain or loss for 
all prior taxable years.
    (1) In general.
    (2) Additional adjustments for certain taxable years beginning 
on or before December 31, 2024.
    (d) Calculation of unrecognized section 987 gain or loss for a 
taxable year.
    (1) Step 1: Determine the change in the owner functional 
currency net value of the section 987 QBU for the taxable year.
    (i) In general.
    (ii) Year section 987 QBU is terminated.
    (iii) First taxable year of a section 987 QBU.
    (iv) First year in which an election is in effect or ceases to 
be in effect.
    (2) Step 2: Increase the amount determined in step 1 by the 
amount of assets transferred from the section 987 QBU to the owner.
    (i) In general.
    (ii) Assets transferred from the section 987 QBU to the owner 
during the taxable year.
    (3) Step 3: Decrease the amount determined in steps 1 and 2 by 
the amount

[[Page 100167]]

of assets transferred from the owner to the section 987 QBU.
    (i) In general.
    (ii) Assets transferred from the owner to the section 987 QBU 
during the taxable year.
    (4) Step 4: Decrease the amount determined in steps 1 through 3 
by the amount of liabilities transferred from the section 987 QBU to 
the owner.
    (i) In general.
    (ii) Liabilities transferred from the owner to the section 987 
QBU during the taxable year.
    (5) Step 5: Increase the amount determined in steps 1 through 4 
by the amount of liabilities transferred from the owner to the 
section 987 QBU.
    (6) Step 6: Decrease or increase the amount determined in steps 
1 through 5 by the section 987 taxable income or loss, respectively, 
of the section 987 QBU for the taxable year.
    (7) Step 7: Increase the amount determined in steps 1 through 6 
by certain expenses or losses that are not deductible in computing 
the section 987 taxable income or loss of the section 987 QBU for 
the taxable year.
    (8) Step 8: Decrease the amount determined in steps 1 through 7 
by the amount of certain income or gain that is not included in 
taxable income in computing the section 987 taxable income or loss 
of the section 987 QBU for the taxable year.
    (9) Step 9: Increase or decrease the amount determined in steps 
1 through 8 by any income or gain, or any deduction or loss, 
respectively, that does not impact the adjusted balance sheet.
    (10) Step 10: Decrease or increase the amount determined in 
steps 1 through 9 by any increase or decrease, respectively, to the 
section 987 QBU's net assets that is not previously taken into 
account under steps 2 through 9.
    (i) In general.
    (ii) Determining the residual increase or decrease to net 
assets.
    (iii) Modifications for taxable years to which a current rate 
election or an annual recognition election applies.
    (e) Determination of the owner functional currency net value of 
a section 987 QBU.
    (1) In general.
    (i) Marked item.
    (ii) Historic item.
    (2) Current rate election.
    (i) In general.
    (ii) QBU net value.
    (iii) Alternative calculation of QBU net value.
    (f) Combinations and separations.
    (1) Combinations.
    (2) Separations.
    (3) Examples.
    (i) Example 1: Combination of two section 987 QBUs that have the 
same owner.
    (ii) Example 2: Separation of two section 987 QBUs that have the 
same owner.
    (g) Examples.
    (1) Example 1: Determination of net unrecognized section 987 
gain or loss.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Determination of net unrecognized section 987 
gain or loss if a current rate election in effect.
    (i) Facts.
    (ii) Analysis.
    (iii) Alternative computation of QBU net value.
    (3) Example 3: Determination of net unrecognized section 987 
gain or loss when a current rate election is revoked.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-5 Recognition of section 987 gain or loss.

    (a) Recognition of section 987 gain or loss by the owner of a 
section 987 QBU.
    (b) Remittance proportion.
    (1) In general.
    (2) Annual recognition election.
    (c) Remittance.
    (1) Definition.
    (2) Alternative calculation.
    (i) Step 1: Determine the change in QBU net value.
    (ii) Step 2: Adjust the amount determined in step 1 for income 
or loss of the section 987 QBU.
    (iii) Step 3: Multiply the amount determined in step 2 by 
negative one.
    (3) Day when a remittance is determined.
    (4) Termination.
    (d) Aggregate of all amounts transferred from the section 987 
QBU to the owner for the taxable year.
    (e) Aggregate of all amounts transferred from the owner to the 
section 987 QBU for the taxable year.
    (f) Determination of owner's adjusted basis in transferred 
assets and amount of transferred liabilities.
    (1) In general.
    (2) Marked items.
    (3) Historic items.
    (g) Example--Calculation of section 987 gain or loss recognized.
    (1) Facts.
    (i) In general.
    (ii) Year 1 balance sheet.
    (iii) Transfers and income in year 2.
    (iv) Year 2 balance sheet.
    (2) Analysis.
    (i) Computation of amount of remittance.
    (ii) Alternative computation of remittance amount.
    (iii) Computation of section 987 QBU gross assets plus 
remittance.
    (iv) Computation of remittance proportion.
    (v) Computation of section 987 gain or loss.
    (3) Annual recognition election.

Sec.  1.987-6 Character and source of section 987 gain or loss.

    (a) Ordinary income or loss.
    (b) Character and source of section 987 gain or loss.
    (1) Timing of source and character determination.
    (2) Method for determining the character and source section 987 
gain or loss.
    (i) Initial assignment
    (ii) Reassignment of section 987 gain or loss.
    (iii) Special rule for the application of the GILTI high-tax 
exclusion to section 987 gain or loss.
    (3) Allocation and apportionment of foreign income tax to 
section 987 items under section 861.
    (i) The foreign gross income is an item of foreign currency gain 
or loss.
    (ii) The same event or events give rise to both the foreign 
gross income and the section 987 gain or loss.
    (c) Examples.
    (1) Example 1: Initial assignment and reassignment of section 
987 gain or loss.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Effect of GILTI high-tax exclusion.
    (i) Facts.
    (ii) Analysis.
    (3) Example 3: Section 987 gain or loss treated as attributable 
to section 988 transactions.
    (i) Facts.
    (ii) Analysis.
    (4) Example 4: Section 987 gain or loss assigned to passive 
foreign personal holding company income.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-7 Application of the section 987 regulations to 
partnerships and S corporations.

    (a) Overview.
    (b) Section 987 regulations generally do not apply to 
partnerships.
    (c) Provisions of the section 987 regulations that apply to 
partnerships.
    (1) In general.
    (i) Eligible QBU.
    (ii) Partnership.
    (2) Applicable provisions.
    (i) In general.
    (ii) Annual recognition election.
    (iii) Section 988 mark-to-market election.
    (3) Modifications to applicable provisions.
    (i) In general.
    (ii) Controlled group.
    (4) Terminating QBUs.
    (d) Suspended section 987 loss.
    (1) In general.
    (i) Rules of Sec.  1.987-11(c) and (d)(2) do not apply.
    (ii) Suspension of section 987 loss.
    (2) Exceptions.
    (i) Method under which historic items do not give rise to 
section 987 gain or loss.
    (ii) Annual recognition election.
    (iii) De minimis rule.
    (3) Recognition of suspended section 987 loss.
    (i) In general.
    (ii) Partnership that is not engaged in a trade or business.
    (iii) Application of the loss-to-the-extent-of-gain rule.
    (e) Adjustments to the basis of a partner's interest in the 
partnership.
    (f) S corporations treated as partnerships.
    (g) Examples.
    (1) Example 1: Aggregate approach to section 987.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Entity approach to section 987.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-8 Termination of a section 987 QBU.

    (a) Scope.
    (b) In general.
    (1) Trade or business ceases.

[[Page 100168]]

    (2) Substantially all assets transferred.
    (3) Owner no longer a CFC.
    (4) Owner ceases to exist.
    (5) Section 987 QBU ceases to be an eligible QBU with a 
functional currency different from its owner.
    (6) Change in form of ownership.
    (c) Transactions described in section 381(a).
    (1) Liquidations.
    (2) Reorganizations.
    (d) [Reserved]
    (e) Effect of terminations.
    (f) Examples.
    (1) Example 1: Cessation of operations.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Transfer of a section 987 QBU to a member of a 
consolidated group.
    (i) Facts.
    (ii) Analysis.
    (3) Example 3: Cessation of controlled foreign corporation 
status.
    (i) Facts.
    (ii) Analysis.
    (4) Example 4: Section 332 liquidation.
    (i) Facts.
    (ii) Analysis.
    (5) [Reserved]
    (6) Example 6: Deemed transfers to a CFC upon a check-the-box 
election.
    (i) Facts.
    (ii) Analysis.
    (7) Example 7: Sale of a section 987 QBU to a member of a 
consolidated group.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-9 Recordkeeping requirements.

    (a) In general.
    (b) Supplemental information.
    (c) Retention of records.
    (d) Information on a dedicated section 987 form.

Sec.  1.987-10 Transition rules.

    (a) Overview.
    (1) In general.
    (2) Terms defined under prior Sec.  1.987-12.
    (b) Scope.
    (1) Owner of a section 987 QBU.
    (2) Deferral QBU owner and owner of outbound loss QBU.
    (c) Transition date.
    (1) In general.
    (2) Terminating QBU.
    (i) In general.
    (ii) Ordering rule.
    (d) Application of the section 987 regulations after the 
transition date.
    (1) Owner functional currency net value on the last day of the 
preceding taxable year.
    (2) Determination of historic rate.
    (3) Transition exchange rate.
    (i) In general.
    (ii) Earnings only method.
    (e) Pretransition gain or loss.
    (1) In general.
    (2) Amount of pretransition gain or loss for an owner that 
applied an eligible pretransition method.
    (i) Owner of a section 987 QBU
    (ii) Deferral QBU owner.
    (iii) Owner of an outbound loss QBU.
    (3) Amount of pretransition gain or loss for an owner that did 
not apply an eligible pretransition method.
    (i) In general.
    (ii) Computation of pretransition gain or loss.
    (iii) Annual unrecognized section 987 gain or loss.
    (iv) Deferral QBU owner.
    (v) Owner of an outbound loss QBU.
    (4) Eligible pretransition method.
    (i) Earnings and capital method.
    (ii) Other reasonable methods.
    (iii) Other earnings only methods.
    (iv) Error in the application of a section 987 method.
    (v) Certain consistent practices not treated as errors.
    (vi) Deferral of section 987 gain or loss until termination is 
not reasonable.
    (vii) Anti-abuse rule.
    (5) Recognition of pretransition gain or loss.
    (i) In general.
    (ii) Election to recognize pretransition section 987 gain or 
loss ratably over the transition period.
    (6) Predecessor of an owner.
    (i) In general.
    (ii) Predecessor.
    (7) Small business election.
    (i) Scope.
    (ii) Owner threshold.
    (iii) QBU threshold.
    (iv) Small business election.
    (f) QBUs to which the fresh start transition method was applied.
    (1) In general.
    (2) Application of the section 987 regulations after the 
transition date.
    (i) Owner functional currency net value on the last day of the 
preceding taxable year.
    (ii) Determination of historic rate.
    (iii) Unrecognized section 987 gain or loss.
    (3) Taxpayers that are required to transition using the fresh 
start transition method.
    (g) [Reserved]
    (h) Determination of source and character.
    (1) In general.
    (2) Deferral QBU or outbound loss QBU.
    (i) [Reserved]
    (j) Adjustments to avoid double counting or omissions.
    (k) Reporting.
    (1) In general.
    (2) QBUs for which reporting is required.
    (i) In general.
    (ii) QBUs to which the fresh start transition method was 
applied.
    (3) Attachments not required where information is reported on a 
form.
    (4) No change in method of accounting.
    (l) Examples.
    (1) Example 1: Earnings and capital method.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Earnings only method described in paragraph 
(e)(4)(ii) of this section.
    (i) Facts.
    (ii) Analysis.
    (3) Example 3: Earnings only method described in paragraph 
(e)(4)(iii) of this section.
    (i) Facts.
    (ii) Analysis.
    (4) Example 4: Owner did not apply section 987(3).
    (i) Facts.
    (ii) Analysis.
    (5) Example 5: Error in application of method.
    (i) Facts.
    (ii) Analysis.
    (6) Example 6: Consistent practice not treated as an error.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-11 Suspended section 987 loss relating to certain 
elections; loss to the extent of gain rule.

    (a) In general.
    (b) Cumulative suspended section 987 loss in a recognition 
grouping.
    (1) In general.
    (2) Combined QBU.
    (3) Separated QBU.
    (c) Suspension of section 987 loss for taxable years in which a 
current rate election is in effect and an annual recognition 
election is not in effect.
    (1) In general.
    (2) De minimis rule.
    (3) Taxable year of controlled group members.
    (i) In general.
    (ii) Owner is a CFC.
    (d) Suspension of net unrecognized section 987 loss upon making 
or revoking certain elections.
    (1) Making an annual recognition election.
    (2) Revoking a current rate election.
    (e) Loss-to-the-extent of gain rule.
    (1) In general.
    (2) Separate determination for each recognition grouping.
    (3) Amount of suspended section 987 loss recognized.
    (i) Current year gain amount.
    (ii) Lookback gain amount.
    (iii) Suspended section 987 loss not taken into account.
    (iv) Lookback period.
    (v) Anti-abuse rule.
    (4) Suspended section 987 loss recognized with respect to each 
section 987 QBU and suspended section 987 loss QBU.
    (5) Section 381(a) transactions.
    (i) In general.
    (ii) Limitation for inbound section 381(a) transactions.
    (6) Consolidated group members.
    (i) In general.
    (ii) Suspended section 987 losses arising in separate return 
limitation years.
    (f) Recognition groupings.
    (1) Sourcing and section 904 category.
    (2) Statutory and residual groupings for CFC owners.
    (g) Examples.
    (1) Example 1: Suspension of section 987 loss and recognition of 
suspended section 987 loss.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Recognition of suspended section 987 loss by 
reason of gain recognized during the lookback period.
    (i) Facts.
    (ii) Analysis.
    (iii) Alternative facts.
    (iv) Analysis of alternative facts.
    (3) Example 3: Suspension of section 987 loss when a current 
rate election is revoked.

[[Page 100169]]

    (i) Facts.
    (ii) Analysis.

Sec.  1.987-12 Deferral of section 987 gain or loss.

    (a) Overview.
    (1) Scope.
    (2) Exceptions.
    (i) Annual recognition election.
    (ii) De minimis rule.
    (b) Treatment of section 987 gain and loss in connection with a 
deferral event.
    (1) Gain or loss recognized (or suspended) in the taxable year 
of a deferral event.
    (2) Deferred section 987 gain or loss.
    (i) In general.
    (ii) Deferred section 987 gain or loss attributable to a 
successor deferral QBU.
    (c) Recognition (or suspension) of deferred section 987 gain or 
loss following a deferral event.
    (1) Recognition upon a subsequent remittance.
    (i) In general.
    (ii) Amount.
    (iii) Deemed remittance by a successor deferral QBU.
    (2) Deferral events and outbound loss events with respect to a 
successor deferral QBU.
    (d) Successor deferral QBU becomes a successor suspended loss 
QBU.
    (e) Anti-abuse rule.
    (f) Combinations and separations of successor deferral QBUs.
    (1) Combined QBU.
    (2) Separated QBU.
    (g) Definitions.
    (1) Deferral event.
    (i) Events.
    (ii) Assets on books of successor deferral QBU.
    (2) Successor deferral QBU.
    (3) Original deferral QBU owner.
    (4) Qualified successor.
    (h) Examples.
    (1) Example 1: Contribution of a section 987 QBU with net 
unrecognized section 987 gain to a member of the controlled group.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Contribution of a section 987 QBU with net 
unrecognized section 987 loss to a member of the controlled group 
when a current rate election is in effect.
    (i) Facts.
    (ii) Analysis.
    (3) Example 3: Election to be classified as a corporation.
    (i) Facts.
    (ii) Analysis.
    (4) Example 4: Partial recognition of deferred gain or loss.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-13 Suspended section 987 loss upon terminations.

    (a) Overview.
    (1) In general.
    (2) Ordering rule.
    (b) Termination of a section 987 QBU with suspended loss.
    (1) Suspended section 987 loss becomes suspended section 987 
loss with respect to a successor suspended loss QBU.
    (i) Successor suspended loss QBU.
    (ii) Attribution of suspended section 987 loss to successor 
suspended loss QBU.
    (2) Recognition of suspended section 987 loss.
    (c) Termination of a successor suspended loss QBU.
    (1) Successor to the successor suspended loss QBU.
    (i) Successor suspended loss QBU.
    (ii) Attribution of suspended section 987 loss to successor 
suspended loss QBU.
    (2) Recognition of suspended section 987 loss.
    (d) Transfer of successor suspended loss QBU owner.
    (e) Transfer of original suspended loss QBU owner.
    (f) Owner ceases to exist.
    (g) Inbound nonrecognition transactions-no carryover of 
suspended section 987 loss.
    (h) Outbound transactions-recognition or suspension of net 
unrecognized section 987 loss.
    (1) In general.
    (2) Outbound loss event.
    (3) Loss recognition upon an outbound loss event
    (4) Loss suspension upon outbound loss event.
    (i) [Reserved]
    (j) Termination of a successor suspended loss QBU.
    (k) Anti-abuse.
    (l) Definitions.
    (1) Original suspended loss QBU owner.
    (i) In general.
    (ii) Successors.
    (2) Successor suspended loss QBU.
    (3) Successor suspended loss QBU owner.
    (4) Ownership interests.
    (5) Significant portion.
    (m) Examples.
    (1) Example 1: Trade or business of a section 987 QBU ceases.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Trade or business of a section 987 QBU is sold to 
a third party.
    (i) Facts.
    (ii) Analysis.
    (3) Example 3: Outbound loss event.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-14 Section 987 hedging transactions.

    (a) Overview.
    (b) Section 987 hedging transaction.
    (1) In general.
    (2) Requirements.
    (i) Identification.
    (ii) Current rate election.
    (iii) Mark-to-market method of accounting.
    (iv) Treatment under U.S. generally accepted accounting 
principles.
    (v) Hedge entered into by owner of the hedged QBU.
    (3) Anti-abuse rule.
    (4) Partial termination of a section 987 hedging transaction.
    (c) Identification requirements.
    (1) In general.
    (2) Inadvertent error.
    (d) Taxation of section 987 hedging transactions.
    (1) Hedging gain or loss with respect to a hedged QBU.
    (2) Adjustment to unrecognized section 987 gain or loss for the 
taxable year.
    (i) Hedging loss.
    (ii) Hedging gain.
    (3) Termination of a hedged QBU.
    (e) Examples.
    (1) Example 1: Section 987 hedging transaction.
    (i) Facts.
    (ii) Analysis.
    (2) Example 2: Excess hedging gain from a section 987 hedging 
transaction.
    (i) Facts.
    (ii) Analysis.

Sec.  1.987-15 Applicability date.

    (a) Applicability date of section 987 regulations.
    (1) In general.
    (2) Applicability date for a terminating QBU.
    (b) Application of the section 987 regulations to taxable years 
beginning on or before December 31, 2024, and ending after November 
9, 2023.
    (c) Application of the 2016 and 2019 section 987 regulations.
    (1) In general.
    (2) Application to section 987 QBUs not owned on the transition 
date.
    (3) Modifications of defined terms for purposes of this 
paragraph (c).
    (i) Application of Sec.  1.987-10 in lieu of prior Sec.  1.987-
10.
    (ii) Partnerships not included in section 987 electing group.
    (iii) Transition date.
    (d) Prior Sec.  1.987-12.


Sec.  1.987-1  Scope, definitions, and special rules.

    (a) In general. Sections 1.987-1 through 1.987-15 (the section 987 
regulations) provide rules for determining the taxable income or loss 
and earnings and profits of a taxpayer with respect to a qualified 
business unit (QBU) that is subject to section 987. Further, the 
section 987 regulations provide rules for determining the timing, 
amount, character, and source of section 987 gain or loss recognized 
with respect to a section 987 QBU. This section addresses the scope of 
the section 987 regulations and provides certain definitions, special 
rules, and procedures for making elections. Section 1.987-2 provides 
rules for attributing assets and liabilities and items of income, gain, 
deduction, and loss to an eligible QBU. It also provides rules 
regarding the translation of items transferred to a section 987 QBU. 
Section 1.987-3 provides rules for determining and translating the 
taxable income or loss of a taxpayer with respect to a section 987 QBU. 
Section 1.987-4 provides rules for determining net unrecognized section 
987 gain or loss. Section 1.987-5 provides rules regarding the 
recognition of section 987 gain or loss. It also provides rules 
regarding the translation of items

[[Page 100170]]

transferred from a section 987 QBU to its owner. Section 1.987-6 
provides rules regarding the character and source of section 987 gain 
or loss. Section 1.987-7 provides rules relating to the application of 
the section 987 regulations with respect to a partnership or S 
corporation. Section 1.987-8 provides rules regarding the termination 
of a section 987 QBU. Section 1.987-9 provides rules regarding the 
recordkeeping required under section 987. Section 1.987-10 provides 
transition rules. Section 1.987-11 provides rules relating to suspended 
losses in connection with certain elections and the loss-to-the-extent-
of-gain rule. Section 1.987-12 provides rules regarding when section 
987 gain or loss is deferred, as well as when such deferred amounts are 
recognized. Section 1.987-13 provides rules relating to suspended 
section 987 loss of an owner with respect to a section 987 QBU that 
terminates. Section 1.987-14 provides rules relating to section 987 
hedging transactions. Section 1.987-15 provides the applicability date 
of the section 987 regulations.
    (b) Scope of section 987 and certain rules relating to QBUs--(1) 
Persons subject to section 987--(i) In general. Except as provided in 
paragraphs (b)(1)(ii) and (b)(6) of this section, any individual or 
corporation is subject to the section 987 regulations. See Sec.  1.987-
7 for rules relating to the application of the section 987 regulations 
in the case of a partnership or S corporation.
    (ii) Inapplicability to certain entities. Section 987(3) and the 
section 987 regulations do not apply to individuals who are not United 
States persons and foreign corporations that either are not controlled 
foreign corporations or that are controlled foreign corporations in 
which no United States shareholders own (within the meaning of section 
958(a)) stock.
    (2) Application of the section 987 regulations to earnings and 
profits--(i) In general. The rules and principles of the section 987 
regulations also apply to the determination of earnings and profits, 
and any elections that apply pursuant to the section 987 regulations 
also apply for purposes of determining earnings and profits.
    (ii) Timing. Earnings and profits are increased when section 987 
gain is recognized and decreased when section 987 loss is recognized. 
As a result, converting net unrecognized section 987 gain or loss to 
deferred section 987 gain or loss or suspended section 987 loss does 
not affect earnings and profits because the amounts have not yet been 
recognized.
    (3) Definition of a section 987 QBU--(i) In general. For purposes 
of section 987, a section 987 QBU is an eligible QBU that has a 
functional currency different from its owner. A section 987 QBU will 
continue to be treated as a section 987 QBU of the owner until a sale 
or other termination of the section 987 QBU as described in Sec.  
1.987-8(b) and (c). See Sec.  1.985-1 for rules determining the 
functional currency of an eligible QBU.
    (ii) Section 987 QBU grouping election--(A) In general. Solely for 
purposes of section 987, an owner may elect to treat all section 987 
QBUs with the same functional currency as a single section 987 QBU 
except to the extent provided in paragraph (b)(2)(ii)(B) of this 
section. However, a QBU described in Sec.  1.987-7(c)(1) may not be 
treated as part of the same QBU as a section 987 QBU that is not 
described in Sec.  1.987-7(c)(1).
    (B) [Reserved]
    (4) Definition of an eligible QBU--(i) In general. For purposes of 
section 987, an eligible QBU means a qualified business unit that is 
not subject to the United States dollar approximate separate 
transactions method rules of Sec.  1.985-3.
    (ii) Qualified business unit. For purposes of this paragraph 
(b)(4), a qualified business unit is defined in Sec.  1.989(a)-1(b), 
except that a corporation, partnership, trust, estate, or disregarded 
entity is not itself a qualified business unit, but the activities of 
such entity may be a qualified business unit if they meet the 
requirements of Sec.  1.989(a)-1(b)(1) and (b)(2)(ii). For example, if 
a corporation is solely engaged in activities that constitute a trade 
or business, and the corporation maintains only one set of books and 
records, the activities (but not the corporation) are a qualified 
business unit.
    (5) Definition of an owner. For purposes of section 987, an owner 
is any person having direct ownership in an eligible QBU (including 
ownership through DEs). The term owner does not include an eligible 
QBU. For example, a section 987 QBU (QBU1) is not an owner of another 
section 987 QBU (QBU2) even if QBU1 wholly owns the DE that owns QBU2. 
A person that is not subject to the section 987 regulations under 
paragraph (b)(1)(ii) of this section can meet the definition of an 
owner under this paragraph (b)(5) for purposes of applying the section 
987 regulations to other persons.
    (i) Direct ownership. A person is a direct owner of an eligible QBU 
if the person is the owner for Federal income tax purposes of the 
assets and liabilities of the eligible QBU.
    (ii) [Reserved]
    (6) [Reserved]
    (7) Examples illustrating paragraph (b) of this section. The 
following examples illustrate the principles of this paragraph (b). The 
following facts are assumed for purposes of the examples. U.S. Corp is 
a domestic corporation, has the U.S. dollar as its functional currency, 
and uses the calendar year as its taxable year. Except as otherwise 
provided: Business A and Business B are eligible QBUs and have the euro 
and the Japanese yen, respectively, as their functional currencies; and 
DE1 and DE2 are DEs, have no assets or liabilities, and conduct no 
activities.
    (i) Example 1: Owner owns an eligible QBU and a DE holding 
company--(A) Facts. U.S. Corp owns Business A and all of the interests 
in DE1. DE1 maintains a separate set of books and records that are kept 
in British pounds. DE1 owns pounds and all of the stock of a foreign 
corporation, FC. DE1 is liable to a lender on a pound-denominated 
obligation that was incurred to acquire the stock of FC. The FC stock, 
the pounds, and the liability incurred to acquire the FC stock are 
recorded on DE1's separate books and records. DE1 has no other assets 
or liabilities and conducts no activities (other than holding the FC 
stock and pounds and servicing its liability).
    (B) Analysis--(1) Pursuant to paragraph (b)(5) of this section, 
U.S. Corp is the owner of Business A because it has direct ownership of 
Business A, an eligible QBU. Because Business A is an eligible QBU with 
a functional currency that is different from the functional currency of 
its owner, U.S. Corp, Business A is a section 987 QBU under paragraph 
(b)(3)(i) of this section. As a result, U.S. Corp and its section 987 
QBU, Business A, are subject to section 987.
    (2) Holding the stock of FC and pounds and servicing a liability 
does not constitute a trade or business within the meaning of Sec.  
1.989(a)-1(c). Because the activities of DE1 do not constitute a trade 
or business within the meaning of Sec.  1.989(a)-1(c), such activities 
are not an eligible QBU. In addition, pursuant to paragraph (b)(4)(ii) 
of this section, DE1 itself is not an eligible QBU. As a result, 
neither DE1 nor its activities qualify as a section 987 QBU of U.S. 
Corp. Therefore, neither the activities of DE1 nor DE1 itself is 
subject to section 987. For the foreign currency treatment of payments 
on DE1's pound-denominated liability, see Sec.  1.988-2(b).
    (ii) Example 2: Owner owns eligible QBUs through DEs--(A) Facts. 
U.S.

[[Page 100171]]

Corp owns all of the interests in DE1. DE1 owns Business A and all of 
the interests in DE2. The only activities of DE1 are Business A 
activities and holding the interests in DE2. DE2 owns Business B and 
Business C. For purposes of this example, Business B does not maintain 
books and records that are separate from DE2. Instead, the activities 
of Business B are reflected on the books and records of DE2, which are 
maintained in Japanese yen. In addition, Business C has the U.S. dollar 
as its functional currency, maintains books and records that are 
separate from the books and records of DE2, and is an eligible QBU.
    (B) Analysis--(1) Pursuant to paragraph (b)(4)(ii) of this section, 
DE1 and DE2 are not eligible QBUs. Moreover, pursuant to paragraph 
(b)(5) of this section, DE1 is not the owner of the Business A, 
Business B, or Business C eligible QBUs, and neither Business A nor DE2 
is the owner of the Business B or Business C eligible QBUs. Instead, 
pursuant to paragraph (b)(5) of this section, U.S. Corp is the owner of 
the Business A, Business B, and Business C eligible QBUs.
    (2) Because Business A and Business B are eligible QBUs with 
functional currencies that are different than the functional currency 
of U.S. Corp, Business A and Business B are section 987 QBUs under 
paragraph (b)(3)(i) of this section.
    (3) The Business C eligible QBU has the same functional currency as 
U.S. Corp, the U.S. dollar. Therefore, the Business C eligible QBU is 
not a section 987 QBU under paragraph (b)(3)(i) of this section.
    (iii) Example 3: Section 987 grouping election--(A) Facts. U.S. 
Corp owns all of the interests in DE1. DE1 owns Business A and Business 
B. For purposes of this example, assume Business B has the euro as its 
functional currency.
    (B) Analysis--(1) Pursuant to paragraph (b)(4)(ii) of this section, 
DE1 is not an eligible QBU. Moreover, pursuant to paragraph (b)(5) of 
this section, DE1 is not the owner of the Business A or Business B 
eligible QBUs. Instead, pursuant to paragraph (b)(5) of this section, 
U.S. Corp is the owner of the Business A and Business B eligible QBUs.
    (2) Business A and Business B constitute two separate eligible 
QBUs, each with the euro as its functional currency. Accordingly, 
Business A and Business B are section 987 QBUs of U.S. Corp under 
paragraph (b)(3)(i) of this section. U.S. Corp may elect to treat 
Business A and Business B as a single section 987 QBU pursuant to 
paragraph (b)(3)(ii) of this section. If such election is made, 
pursuant to paragraph (b)(5) of this section, U.S. Corp would be the 
owner of the Business AB section 987 QBU that would include the 
activities of both the Business A section 987 QBU and the Business B 
section 987 QBU. In addition, pursuant to paragraph (b)(5) of this 
section, DE1 would not be treated as the owner of the Business AB 
section 987 QBU.
    (c) Exchange rates. Solely for purposes of section 987, the spot 
rate, the yearly average exchange rate, and the historic rate are 
determined as provided in paragraphs (c)(1) through (3) of this 
section.
    (1) Spot rate--(i) In general. Except as otherwise provided in this 
section, the spot rate means the rate determined under the rules of 
Sec.  1.988-1(d)(1), (2), and (4) on the relevant date.
    (ii) Election to use a spot rate convention. An owner may elect to 
use a spot rate convention that reasonably approximates the spot rate 
determined in paragraph (c)(1)(i) of this section. A spot rate 
convention may be based on the spot rate at the beginning of a 
reasonable period, the spot rate at the end of a reasonable period, the 
average of spot rates for a reasonable period, or spot and forward 
rates for a reasonable period. For this purpose, a reasonable period 
may not exceed three months. For example, in lieu of the spot rate 
determined in paragraph (c)(1)(i) of this section, the spot rate for 
all transactions during a monthly period may be determined pursuant to 
one of the following conventions: the spot rate at the beginning of the 
current month or at the end of the preceding month; the monthly average 
of daily spot rates for the current or preceding month; or an average 
of the beginning and ending spot rates for the current or preceding 
month. Similarly, in lieu of the spot rate determined in paragraph 
(c)(1)(i) of this section, the spot rate may be determined pursuant to 
an average of the spot rate and the 30-day forward rate on a day of the 
preceding month. Use of a spot rate convention that is consistent with 
the convention used for financial accounting purposes is generally 
presumed to reasonably approximate the rate in paragraph (c)(1)(i) of 
this section. However, the Commissioner may prescribe the spot rate as 
determined in paragraph (c)(1)(i) of this section or an appropriate 
spot rate pursuant to this paragraph (c)(1)(ii) if the Commissioner 
determines that the use of the convention would not clearly reflect 
income based on the facts and circumstances available at the time of 
the election. The election or revocation of a spot rate convention does 
not change the spot rate with respect to any day of a taxable year 
before the election or revocation becomes effective. See paragraph (g) 
of this section for rules relating to section 987 elections.
    (2) Yearly average exchange rate. For purposes of section 987, the 
yearly average exchange rate is a rate that represents an average 
exchange rate for the taxable year (or, if the section 987 QBU existed 
for less than the full taxable year, the portion of the year during 
which the section 987 QBU existed) computed under any reasonable 
method. For example, an owner may determine the yearly average exchange 
rate based on a daily, monthly, or quarterly averaging convention, 
whether weighted or unweighted, and may take into account forward rates 
for a period not to exceed three months. Use of an averaging convention 
that is consistent with the convention used for financial accounting 
purposes is generally presumed to be a reasonable method. However, the 
Commissioner may prescribe an appropriate yearly average exchange rate 
if the Commissioner determines that the use of the convention would not 
have been expected to clearly reflect income based on the facts and 
circumstances available at the time of the election.
    (3) Historic rate--(i) In general. Except as otherwise provided in 
the section 987 regulations, the historic rate is determined as 
described in paragraphs (c)(3)(i)(A) through (E) of this section.
    (A) Assets generally. In the case of an asset other than inventory 
that is acquired by a section 987 QBU (or otherwise becomes 
attributable to a section 987 QBU, including through a transfer), the 
historic rate is the yearly average exchange rate applicable to the 
year of acquisition (or the year in which the asset otherwise becomes 
attributable to the section 987 QBU).
    (B) Inventory under the simplified inventory method. If a taxpayer 
has not elected under Sec.  1.987-3(c)(2)(iv)(B) to use the historic 
inventory method, the historic rate for inventory is determined under 
this paragraph (c)(3)(i)(B).
    (1) LIFO inventory. The historic rate for LIFO inventory is the 
yearly average exchange rate applicable to the year in which the 
inventory's LIFO layer arose.
    (2) Non-LIFO inventory. The historic rate for non-LIFO inventory is 
the yearly average exchange rate for the relevant taxable year. For 
example, in determining the owner functional currency net value of a 
section 987 QBU on the last day of the current taxable year under Sec.  
1.987-4(d)(1)(i)(A), the historic rate for non-LIFO inventory is the 
yearly average exchange rate for the

[[Page 100172]]

current taxable year. In determining the owner functional currency net 
value of a section 987 QBU on the last day of the preceding taxable 
year under Sec.  1.987-4(d)(1)(i)(B), the historic rate for non-LIFO 
inventory is the yearly average exchange rate for the preceding taxable 
year.
    (C) Inventory under the historic inventory method. If a taxpayer 
has elected under Sec.  1.987-3(c)(2)(iv)(B) to use the historic 
inventory method, each inventoriable cost with respect to a section 987 
QBU's inventory may have a different historic rate. The historic rate 
for each inventoriable cost is the exchange rate at which the cost 
would be translated under Sec.  1.987-3 if it were not an inventoriable 
cost.
    (D) Liabilities generally. In the case of a liability that is 
incurred or assumed by a section 987 QBU, the historic rate is the 
yearly average exchange rate applicable to the year the liability is 
incurred or assumed.
    (E) Determination of historic rates after revocation of current 
rate election. If a current rate election is revoked or otherwise 
ceases to be in effect, the historic rate of all historic items (other 
than non-LIFO inventory subject to the simplified inventory method) 
that were attributable to a section 987 QBU on the last day of the last 
taxable year in which the current rate election was in effect is the 
spot rate applicable to that day. Similarly, except as provided in 
paragraph (c)(3)(i)(B)(2) of this section, if a marked item becomes a 
historic item (such as when an asset of an insurance company ceases to 
be a separate account asset), the historic rate for the historic item 
is equal to the spot rate applicable to the last day of the last 
taxable year in which it was treated as a marked item.
    (ii) Date placed in service for depreciable or amortizable 
property. In the case of depreciable or amortizable property, an owner 
may determine the historic rate by reference to the date such property 
is placed in service by the section 987 QBU rather than the date the 
property was acquired, provided that this convention is consistently 
applied for all such property attributable to that section 987 QBU.
    (iii) Changed functional currency. In the case of a section 987 QBU 
or an owner of a section 987 QBU that previously changed its functional 
currency, Sec.  1.985-5(d)(1)(ii)(A) and (e)(4)(i)(A), respectively, 
are taken into account in determining the historic rate for an item 
reflected on the balance sheet of the section 987 QBU immediately 
before the year of change.
    (d) Marked item--(1) In general. Except as provided in paragraph 
(d)(2) of this section, a marked item is an asset (marked asset) or 
liability (marked liability) that is attributable to a section 987 QBU 
under Sec.  1.987-2(b) and that--
    (i) Is denominated in, or determined by reference to, the 
functional currency of the section 987 QBU and would be a section 988 
transaction if such item were held or entered into directly by the 
owner of the section 987 QBU;
    (ii) Is a prepaid expense or a liability for an advance payment of 
unearned income, in either case having an original term of one year or 
less on the date the prepaid expense or liability for an advance 
payment of unearned income arises;
    (iii) Is a section 988 transaction of the section 987 QBU;
    (iv) Is an insurance reserve; or
    (v) Is a separate account asset.
    (2) Current rate election. A taxpayer may elect to treat all assets 
and liabilities that are attributable to a section 987 QBU under Sec.  
1.987-2(b) as marked items (a current rate election). See Sec.  1.987-
11(c) for rules suspending section 987 loss if a current rate election 
is in effect.
    (e) Historic item. A historic item is an asset (historic asset) or 
liability (historic liability) that is attributable to a section 987 
QBU under Sec.  1.987-2(b) and that is not a marked item.
    (f) Example: Identification of marked and historic items. The 
following example illustrates the application of paragraphs (d) and (e) 
of this section.
    (1) Facts. U.S. Corp is a domestic corporation with the U.S. dollar 
as its functional currency and is the owner of Business A, a section 
987 QBU that has the pound as its functional currency. Items reflected 
on Business A's balance sheet include [pound]10,000, $1,000, a building 
with a basis of [pound]100,000, a light general purpose truck with a 
basis of [pound]30,000, a computer with a basis of [pound]1,000, a 60-
day receivable for [yen]15,000, an account payable of [pound]5,000, and 
a foreign currency contract within the meaning of section 1256(g)(2) 
that requires Business A to exchange [pound]100 for $125 in 90 days.
    (2) Analysis. Under paragraph (d) of this section, the 
[pound]10,000, the $1,000, the [yen]15,000 receivable, the [pound]5,000 
account payable, and the [pound]/$ section 1256 foreign currency 
contract are marked items. The other items are historic items under 
paragraph (e) of this section.
    (g) Elections. This paragraph (g) provides rules for making and 
revoking elections under the section 987 regulations (the section 987 
elections). A section 987 election is made for the owner and for a 
taxable year and applies to every section 987 QBU owned by the owner 
while the election is in effect. Once made, a section 987 election 
remains in effect until revoked.
    (1) Persons making the election. A section 987 election is made or 
revoked by the authorized person. The authorized person is described in 
paragraph (g)(1)(i), (ii), (iii), or (iv) of this section. If there are 
multiple controlling domestic shareholders, references to ``the 
authorized person'' refer to all authorized persons acting in concert.
    (i) United States persons. Except as provided in paragraph 
(g)(1)(iii) or (iv) of this section, if the owner of a section 987 QBU 
is a United States person, the owner is the authorized person.
    (ii) CFCs. If the owner of a section 987 QBU is a controlled 
foreign corporation, the controlling domestic shareholders (determined 
under Sec.  1.964-1(c)(5)(i)) of the controlled foreign corporation are 
treated as the authorized person.
    (iii) Consolidated groups. If the owner is a member of a 
consolidated group, see Sec.  1.1502-77.
    (iv) Partnerships. If the owner of a section 987 QBU is a 
partnership, the election is made or revoked by the partnership. For a 
partnership that is not otherwise required to file a partnership 
return, see Sec.  1.6031(a)-1(b)(5) for elections that can only be made 
by a partnership under section 703.
    (2) Consistency rules--(i) Consolidated groups. A section 987 
election is made or revoked by a consolidated group and applies to all 
members of the group. Therefore, the same section 987 elections will be 
in effect for all members of a consolidated group at all times. If a 
corporation becomes a member of a consolidated group, it is deemed to 
make or revoke any section 987 election as necessary to be consistent 
with the consolidated group. If a corporation ceases to be a member of 
a consolidated group and does not join another group, its section 987 
elections are unaffected by its departure from the group. All members 
of a consolidated group are treated as a single United States person 
for purposes of applying paragraph (g)(2)(ii) of this section.
    (ii) CFCs and foreign partnerships. If the authorized person makes 
or revokes an election on behalf of any person (including the 
authorized person) described in paragraphs (g)(2)(ii)(A) through (C) of 
this section (the section 987 electing group), then the election must 
be made or revoked on behalf of all members of the section 987 electing 
group for the first taxable year of each entity that ends with or 
within the taxable year of the United States person described in 
paragraph (g)(2)(ii)(A) of

[[Page 100173]]

this section in which the election or revocation became effective. If 
an entity that was not previously a member of the section 987 electing 
group becomes a member (for example, upon formation or acquisition), it 
is deemed to make or revoke any section 987 election as necessary to be 
consistent with the other members (without regard to the requirements 
of paragraph (g)(3)(ii) of this section). The following persons are 
described in this paragraph (g)(2)(ii):
    (A) A United States person (the relevant United States person).
    (B) Each controlled foreign corporation in which the relevant 
United States person owns (within the meaning of section 958(a)) more 
than fifty percent of the stock (by vote or value).
    (C) In the case of an election that can be made by or for a 
partnership, each foreign partnership in which the relevant United 
States person owns (directly or indirectly) more than fifty percent of 
the capital and profits interest.
    (iii) Section 381(a) transactions. If a corporation (acquiring 
corporation) acquires the assets of another corporation in a 
transaction described in section 381(a), the acquiring corporation's 
election status applies to all section 987 QBUs owned by the acquiring 
corporation after the transaction.
    (3) Manner of making or revoking elections. The section 987 
elections must be made in accordance with this paragraph (g)(3), except 
as provided in forms and instructions or other guidance as provided by 
the Secretary.
    (i) Statement must be attached to a return. An authorized person 
that makes or revokes a section 987 election in accordance with this 
paragraph (g) must attach to its return the statement described in this 
paragraph (g)(3)(i) (or must provide the information described in this 
paragraph (g)(3)(i) in the manner prescribed in forms or instructions 
or other guidance). Each statement must include an identification of 
the election that is made or revoked (including the section and 
paragraph of the regulations under which the election is made); the 
name, address, and functional currency of each owner (or if the owner 
is a member of a consolidated group, the common parent of the 
consolidated group) for which the election is made or revoked; and the 
name, address, functional currency, and owner of each section 987 QBU 
to which the election applies. The elections provided in Sec.  1.987-10 
are made by reporting the election on the statement described in Sec.  
1.987-10(k). An election to use a spot rate convention under paragraph 
(c)(1)(ii) of this section must describe the convention.
    (ii) Election requirements--(A) Consent required. Except as 
provided in paragraph (g)(3)(ii)(B) or (C) of this section, a section 
987 election may not be made or revoked without the consent of the 
Commissioner. A copy of the consent must be attached to the statement 
described in paragraph (g)(3)(i) of this section. For purposes of this 
paragraph (g)(3)(ii), the Commissioner's consent may be obtained only 
with a ruling or administrative pronouncement. See Revenue Procedure 
2024-1, I.R.B. 2024-1 (or superseding guidance).
    (B) Current rate election, annual recognition election, and section 
988 mark-to-market election. Except as provided in paragraph 
(g)(3)(ii)(C) of this section, the authorized person may make a current 
rate election, an annual recognition election, or a section 988 mark-
to-market election without the Commissioner's consent by filing the 
statement prescribed in paragraph (g)(3)(i) of this section with the 
Internal Revenue Service in accordance with the prescribed form or its 
instructions (or other guidance) on or before the first day of the 
taxable year to which the election applies, and attaching a copy of the 
statement to its return. Once made, a current rate election, annual 
recognition election, or section 988 mark-to-market election may not be 
revoked without the Commissioner's consent for any taxable year 
beginning within 60 months of the first day of the taxable year for 
which it was made. Once revoked, a new current rate election, annual 
recognition election, or section 988 mark-to-market election may not be 
made without the Commissioner's consent for any taxable year beginning 
within 60 months of the first day of the taxable year for which it was 
revoked.
    (C) First year to which the section 987 regulations apply. The 
authorized person may make a section 987 election without the consent 
of the Commissioner on its original, timely filed (including 
extensions) return for the first taxable year of an owner in which 
both--
    (1) The section 987 regulations apply (other than by applying 
solely to one or more terminating QBUs pursuant to Sec.  1.987-
15(a)(2)); and
    (2) Either the owner or any member of its consolidated group or 
section 987 electing group is the owner of a section 987 QBU.
    (iii) Elections made under the 2016 and 2019 section 987 
regulations. Each section 987 election must be made by the authorized 
person under the rules of this section without regard to whether the 
election was in effect under the 2016 and 2019 final regulations or 
under prior Sec.  1.987-8T. In the first taxable year in which the 
section 987 regulations apply, any elections made under the 2016 and 
2019 final regulations cease to be effective.
    (4) No change in method of accounting. An election under section 
987 is not treated as a change in method of accounting for purposes of 
sections 446 and 481.
    (5) Principles of Sec.  1.964-1(c)(3) applicable to section 987 
elections. Except as otherwise provided in this paragraph (g), if the 
authorized person makes or revokes a section 987 election on behalf of 
a controlled foreign corporation, the authorized person must make or 
revoke the section 987 election in accordance with the rules and 
principles of Sec.  1.964-1(c)(3).
    (h) Definitions. The definitions in this paragraph (h) apply for 
purposes of the section 987 regulations.
    1991 proposed regulations. 1991 proposed regulations means proposed 
Sec. Sec.  1.987-1 through 1.987-3 as contained in 56 FR 48457-01 
(September 25, 1991).
    2006 proposed regulations. 2006 proposed regulations means: 
proposed Sec. Sec.  1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5; 
1.987-1 through 1.987-11; 1.988-1(a)(3) and (4), (a)(10)(ii), and (i); 
1.988-4(b)(2); and 1.989(a)-1(b)(2)(i), and (b)(4) as contained in 71 
FR 52876-01 (September 7, 2006).
    2016 and 2019 section 987 regulations. 2016 and 2019 section 987 
regulations means the following regulations:
    (i) Sections 1.861-9T(g)(2)(ii)(A)(1) and (g)(2)(vi); 1.985-5; 
1.987-1 through 1.987-10; 1.988-1(a)(4), (a)(10)(ii), and (i); 1.988-
4(b)(2); and 1.989(a)-1(b)(2)(i), (b)(4), (d)(3) and (4), as contained 
in 26 CFR in part 1 in effect on April 1, 2017.
    (ii) Sections 1.987-2T(c)(9), 1.987-4T(c)(2) and (f), and 1.987-7T, 
as contained in 26 CFR in part 1 in effect on April 1, 2017 (until they 
were revoked on May 13, 2019).
    (iii) Sections 1.987-2(c)(9) and 1.987-4(c)(2) and (f), as 
contained in 26 CFR in part 1 in effect on April 1, 2020 (beginning on 
May 13, 2019).
    (iv) Sections 1.987-1T (other than Sec. Sec.  1.987-1T(g)(2)(i)(B) 
and (g)(3)(i)(H)), 1.987-3T, 1.987-6T, 1.988-1T, and 1.988-2T(i), as 
contained in 26 CFR in part 1 in effect on April 1, 2017 (until they 
expired on December 6, 2019).
    Adjusted balance sheet. Adjusted balance sheet means a tax basis 
balance sheet in the functional currency of the eligible QBU, 
determined by--

[[Page 100174]]

    (i) Preparing a balance sheet for the relevant date from the 
section 987 QBU's books and records (within the meaning of Sec.  
1.989(a)-1(d)) recorded in the section 987 QBU's functional currency 
and showing all assets and liabilities attributable to the section 987 
QBU under Sec.  1.987-2(b) (the preliminary balance sheet); and
    (ii) Making adjustments necessary to conform the items reflected on 
the preliminary balance sheet to United States tax accounting 
principles (including adjustments to reflect items that were not 
reflected on the preliminary balance sheet but should be reflected 
under United States tax accounting principles, and adjustments to 
eliminate items that are reflected on the preliminary balance sheet but 
should not be reflected under United States tax accounting principles).
    Annual recognition election. Annual recognition election has the 
meaning provided in Sec.  1.987-5(b)(2).
    Authorized person. Authorized person has the meaning provided in 
paragraph (g)(1) of this section.
    Combination. Combination has the meaning provided in Sec.  1.987-
2(c)(9)(i).
    Combined QBU. Combined QBU has the meaning provided in Sec.  1.987-
2(c)(9)(i).
    Combining QBU. Combining QBU has the meaning provided in Sec.  
1.987-2(c)(9)(i).
    Consolidated group. Consolidated group has the meaning provided in 
Sec.  1.1502-1(h).
    Controlled foreign corporation. Controlled foreign corporation (or 
CFC) has the meaning provided in section 957 (or, if applicable, 
section 953(c)(1)(B)).
    Controlled group. A controlled group means all persons with the 
relationships to each other specified in section 267(b) or section 
707(b).
    Cumulative suspended section 987 loss. Cumulative suspended section 
987 loss has the meaning provided in Sec.  1.987-11(b).
    Current rate election. Current rate election has the meaning 
provided in paragraph (d)(2) of this section.
    Current year gain amount. Current year gain amount has the meaning 
provided in Sec.  1.987-11(e)(3)(i).
    Deferral event. Deferral event has the meaning provided in Sec.  
1.987-12(g)(1).
    Deferred section 987 gain or loss. Deferred section 987 gain or 
loss has the meaning provided in Sec.  1.987-12(b)(2). Deferred section 
987 gain or loss does not include net unrecognized section 987 gain or 
loss or suspended section 987 loss.
    Disregarded entity. Disregarded entity (or DE) means an entity 
disregarded as an entity separate from its owner for Federal income tax 
purposes, including an entity described in Sec.  301.7701-2(c)(2) of 
this chapter, a qualified subchapter S subsidiary under section 
1361(b)(3), a qualified REIT subsidiary within the meaning of section 
856(i)(2), and a trust all of which is treated (under subpart E of part 
I of subchapter J of Chapter 1 of the Code) as owned by the grantor or 
another person.
    Disregarded transactions. Disregarded transactions has the meaning 
provided in Sec.  1.987-2(c)(2)(ii).
    Earnings only method. Earnings only method means a method of 
applying section 987 before the transition date under which gain or 
loss under section 987(3) is determined only with respect to the 
earnings of a section 987 QBU.
    ECI. ECI means income that is effectively connected with the 
conduct of a trade or business within the United States.
    Eligible pretransition method. Eligible pretransition method has 
the meaning provided in Sec.  1.987-10(e)(4).
    Eligible QBU. Eligible QBU has the meaning provided in paragraph 
(b)(4) of this section.
    Financial instrument. Financial instrument has the meaning provided 
in Sec.  1.1275-6(b)(3). It includes a financial instrument entered 
into between related parties or unrelated parties.
    Foreign source income. Foreign source income means income from 
sources without the United States.
    Generally accepted accounting principles. Generally accepted 
accounting principles means United States generally accepted accounting 
principles described in standards established and made effective by the 
Financial Accounting Standards Board.
    Hedge. Hedge has the meaning provided in Sec.  1.987-14(b)(1).
    Hedged QBU. Hedged QBU has the meaning provided in Sec.  1.987-
14(b)(1).
    Hedging gain or loss. Hedging gain or loss has the meaning provided 
in Sec.  1.987-14(d)(1).
    Historic asset. Historic asset has the meaning provided in 
paragraph (e) of this section.
    Historic item. Historic item has the meaning provided in paragraph 
(e) of this section.
    Historic liability. Historic liability has the meaning provided in 
paragraph (e) of this section.
    Historic rate. Historic rate has the meaning provided in paragraph 
(c)(3) of this section.
    Insurance reserve. Insurance reserve means an item that is a 
reserve under section 807(c) or section 953(b) (as applicable).
    LIFO. LIFO means the last-in, first-out inventory method (as 
described in section 472).
    LIFO inventory. LIFO inventory means inventory accounted for under 
the LIFO inventory method.
    Liability. Liability means the amount of a liability on the 
adjusted balance sheet (or the amount that would be on the adjusted 
balance sheet if an adjusted balance sheet were prepared for that day).
    Lookback gain amount. Lookback gain amount has the meaning provided 
in Sec.  1.987-11(e)(3)(ii).
    Lookback period. Lookback period has the meaning provided in Sec.  
1.987-11(e)(3)(iv).
    Loss-to-the-extent-of-gain rule. Loss-to-the-extent-of-gain rule 
has the meaning provided in Sec.  1.987-11(e)(1).
    Marked asset. Marked asset has the meaning provided in paragraph 
(d) of this section.
    Marked item. Marked item has the meaning provided in paragraph (d) 
of this section.
    Marked liability. Marked liability has the meaning provided in 
paragraph (d) of this section.
    Net accumulated unrecognized section 987 gain or loss. Net 
accumulated unrecognized section 987 gain or loss has the meaning 
provided in Sec.  1.987-4(c).
    Net unrecognized section 987 gain or loss. Net unrecognized section 
987 gain or loss has the meaning provided in Sec.  1.987-4(b). Net 
unrecognized section 987 gain or loss does not include deferred section 
987 gain or loss or suspended section 987 loss.
    Non-LIFO inventory. Non-LIFO inventory means inventory that is not 
accounted for under the LIFO inventory method.
    Original deferral QBU. Original deferral QBU has the meaning 
provided in Sec.  1.987-12(b).
    Original deferral QBU owner. Original deferral QBU owner has the 
meaning provided in Sec.  1.987-12(g)(3).
    Original suspended loss QBU owner. Original suspended loss QBU 
owner has the meaning provided in Sec.  1.987-13(l)(1).
    Outbound loss event. Outbound loss event has the meaning provided 
in Sec.  1.987-13(h)(2).
    Outbound loss QBU. Outbound loss QBU has the meaning provided in 
Sec.  1.987-13(h)(1).
    Outbound section 987 loss. Outbound section 987 loss has the 
meaning provided in Sec.  1.987-13(h)(4).
    Owner. Owner has the meaning provided in paragraph (b)(5) of this 
section.
    Prior Sec.  1.987-1. Prior Sec.  1.987-1 means Sec.  1.987-1, as 
contained in 26 CFR in part 1 in effect on April 1, 2017.

[[Page 100175]]

    Prior Sec.  1.987-4. Prior Sec.  1.987-4 means Sec.  1.987-4, as 
contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-5. Prior Sec.  1.987-5 means Sec.  1.987-5, as 
contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-8T. Prior Sec.  1.987-8T means Sec.  1.987-8T, as 
contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-10. Prior Sec.  1.987-10 means Sec.  1.987-10, as 
contained in 26 CFR in part 1 in effect on April 1, 2017.
    Prior Sec.  1.987-12. Prior Sec.  1.987-12 means Sec.  1.987-12, as 
contained in 26 CFR in part 1 in effect on April 1, 2020.
    Prior Sec.  1.987-12T. Prior Sec.  1.987-12T means Sec.  1.987-12T, 
as contained in 26 CFR in part 1 in effect on April 1, 2017.
    QBU net value. QBU net value has the meaning provided in Sec.  
1.987-4(e)(2)(ii).
    Recognition grouping. Recognition grouping has the meaning provided 
in Sec.  1.987-11(f).
    Remittance. Remittance has the meaning provided in Sec.  1.987-
5(c).
    S corporation. S corporation has the meaning provided in section 
1361(a)(1).
    Section 904 category. Section 904 category means a separate 
category of income described in Sec.  1.904-5(a)(4)(v).
    Section 987 electing group. Section 987 electing group has the 
meaning provided in paragraph (g)(2)(ii) of this section.
    Section 987 elections. Section 987 elections has the meaning 
provided in paragraph (g) of this section.
    Section 987 gain or loss. Section 987 gain or loss means gain or 
loss that is recognized under Sec.  1.987-5, deferred section 987 gain 
or loss, suspended section 987 loss, and pretransition gain or loss 
that is recognized under Sec.  1.987-10(e)(5)(ii).
    Section 987 hedging transaction. Section 987 hedging transaction 
has the meaning provided in Sec.  1.987-14(b).
    Section 987 QBU. Section 987 QBU has the meaning provided in 
paragraph (b)(3) of this section.
    Section 987 regulations. Section 987 regulations has the meaning 
provided in paragraph (a) of this section.
    Section 987 taxable income or loss. Section 987 taxable income or 
loss has the meaning provided in Sec.  1.987-3(a).
    Section 988 mark-to-market election. Section 988 mark-to-market 
election has the meaning provided in Sec.  1.987-3(b)(4)(ii).
    Separate account. Separate account means a separate set of 
financial records maintained with respect to an insurance contract or 
group of contracts to report assets and liabilities for specific 
products that are separated from the insurer's general account, 
provided the following requirements are met--
    (i) Any liability of the separate account is the liability only of 
that account and not the liability of any other separate account or the 
general account;
    (ii) The separate account is not part of the company's general 
account and is protected from the general creditors of the company; and
    (iii) The value of each contract supported by the separate account 
is supported proportionately by each of the assets in such account.
    Separate account asset. Separate account asset means an asset that 
is reflected on the books and records of an eligible QBU and held in a 
separate account with respect to a separate account insurance contract. 
A separate account asset does not include an asset held in the general 
account.
    Separate account insurance contract. Separate account insurance 
contract means a contract that would be treated as an insurance 
contract for Federal income tax purposes (except to the extent provided 
in this definition with respect to the requirements in section 72(s), 
101(f), 817(h), or 7702) for which some or all of the assets supporting 
the insurance reserves are required to be held in a separate account 
under the insurance regulatory rules of the jurisdiction in which the 
contract is issued, and either--
    (i) The contract qualifies as a variable contract under section 
817(d) (treating foreign law as a State law or regulation); or
    (ii) The contract would qualify as a variable contract under 
section 817(d) (treating foreign law as a State law or regulation) but 
for its failure to meet one or more of the requirements in section 
72(s), 101(f), 817(h), or 7702, provided that the following 
requirements are met--
    (A) The contract is regulated as a life insurance or annuity 
contract in the foreign jurisdiction in which it is issued;
    (B) The contract reserves are computed or estimated on the basis of 
recognized mortality or morbidity tables and assumed rates of interest. 
For this purpose, the reflection of the investment return and the 
market value of assets in the separate account is considered an assumed 
rate of interest; and
    (C) No policyholder, annuitant, insured, or beneficiary under the 
contract is a United States person.
    Separated QBU. Separated QBU has the meaning provided in Sec.  
1.987-2(c)(9)(iii).
    Separating QBU. Separating QBU has the meaning provided in Sec.  
1.987-2(c)(9)(iii).
    Separation. Separation has the meaning provided in Sec.  1.987-
2(c)(9)(iii).
    Separation fraction. In the case of a separated QBU, separation 
fraction means a fraction, the numerator of which is the aggregate 
adjusted basis of the gross assets attributable to the separated QBU 
immediately after the separation, and the denominator of which is the 
aggregate adjusted basis of the gross assets attributable to all 
separated QBUs immediately after the separation.
    Spot rate. Spot rate has the meaning provided in paragraph (c)(1) 
of this section.
    SRLY section 987 losses. SRLY section 987 losses has the meaning 
provided in Sec.  1.987-11(e)(6)(ii).
    Successor deferral QBU. Successor deferral QBU has the meaning 
provided in Sec.  1.987-12(g)(2).
    Successor deferral QBU owner. Successor deferral QBU owner has the 
meaning provided in Sec.  1.987-12(c)(1).
    Successor suspended loss QBU. Successor suspended loss QBU has the 
meaning provided in Sec.  1.987-13(l)(2).
    Successor suspended loss QBU owner. Successor suspended loss QBU 
owner has the meaning provided in Sec.  1.987-13(l)(3).
    Suspended section 987 loss. Suspended section 987 loss means 
section 987 loss that is subject to the limitations on recognition 
described in Sec.  1.987-11(e). See Sec. Sec.  1.987-10(e)(5), 1.987-
11(c) and (d), 1.987-12(c), and 1.987-13(h) for rules regarding when 
net unrecognized section 987 loss or deferred section 987 loss becomes 
suspended section 987 loss. Suspended section 987 loss does not include 
net unrecognized section 987 loss or deferred section 987 loss.
    Tentative tested income group. Tentative tested income group has 
the meaning provided in Sec.  1.987-6(b)(2)(i)(D)(1).
    Terminating QBU. Terminating QBU means a section 987 QBU, if both--
    (i) The section 987 QBU terminates on any date on or after November 
9, 2023, or the section 987 QBU terminates as a result of an entity 
classification election made under Sec.  301.7701-3 of this chapter 
that is filed on or after November 9, 2023, and that is effective 
before November 9, 2023; and
    (ii) When the section 987 QBU terminates, neither the section 987 
regulations nor the 2016 and 2019 section 987 regulations would apply 
with respect to the section 987 QBU but for Sec.  1.987-15(a)(2).
    Termination. With respect to a section 987 QBU, termination has the 
meaning provided in Sec.  1.987-8(b) and (c). With respect to a 
successor suspended loss QBU, the term termination has the meaning 
provided in Sec.  1.987-13(j).

[[Page 100176]]

    Trade or business. Trade or business has the meaning provided in 
Sec.  1.989(a)-1(c).
    Transfer. Transfer has the meaning provided in Sec.  1.987-2(c).
    Transition date. Transition date has the meaning provided in Sec.  
1.987-10(c).
    United States person. United States person (or U.S. person) has the 
meaning provided in section 7701(a)(30).
    United States shareholder. United States shareholder (or U.S. 
shareholder) has the meaning provided in section 951(b) (or, if 
applicable, section 953(c)(1)(A)).
    U.S. source income. U.S. source income means income from sources 
within the United States.
    Yearly average exchange rate. Yearly average exchange rate has the 
meaning provided in paragraph (c)(2) of this section.


Sec.  1.987-2  Attribution of items to eligible QBUs; definition of a 
transfer and related rules.

    (a) In general. This section provides rules regarding when items 
are attributed to eligible QBUs and when they are treated as 
transferred to or from section 987 QBUs. Paragraph (b) of this section 
provides rules for attributing assets and liabilities, and items of 
income, gain, deduction, and loss, to an eligible QBU. Paragraph (c) of 
this section defines a transfer to or from a section 987 QBU. Paragraph 
(d) of this section provides translation rules for transfers to a 
section 987 QBU. Paragraph (e) of this section provides a cross-
reference relating to the treatment of section 987 QBUs owned by 
consolidated groups.
    (b) Attribution of items to an eligible QBU--(1) General rules. 
Except as provided in paragraphs (b)(2) and (3) of this section, items 
are attributable to an eligible QBU to the extent they are reflected on 
the separate set of books and records, as defined in Sec.  1.989(a)-
1(d)(1) and (2), of the eligible QBU. For purposes of this section, the 
term item refers to any asset or liability, and any item of income, 
gain, deduction, or loss. Items that are attributed to an eligible QBU 
pursuant to this section must be adjusted to conform to Federal income 
tax principles. An item that is not taken into account for financial 
accounting purposes, and therefore is not reflected on the separate set 
of books and records of an eligible QBU, is treated as reflected on the 
separate set of books and records of an eligible QBU to the extent it 
would have been so reflected if the item were taken into account for 
financial accounting purposes. Except as provided in Sec.  1.989(a)-
1(d)(3), these attribution rules apply solely for purposes of section 
987. For example, the allocation and apportionment of interest expense 
under section 864(e) is independent of these rules.
    (2) Exceptions for non-portfolio stock, interests in partnerships, 
and certain acquisition indebtedness. (i) In general. Except as 
provided in paragraph (b)(2)(ii) of this section, the following items 
are not considered to be on the books and records of an eligible QBU:
    (A) Stock of a corporation (whether domestic or foreign), other 
than stock of a corporation if the owner of the eligible QBU owns less 
than 10 percent of the total combined voting power of all classes of 
stock entitled to vote and less than 10 percent of the total value of 
all classes of stock of such corporation. For this purpose, section 958 
(other than section 958(b)(1)) applies in determining ownership of a 
controlled foreign corporation and section 318(a) applies in 
determining ownership of other corporations, except that in applying 
section 318(a)(2)(C), the phrase ``10 percent'' is used instead of the 
phrase ``50 percent.''
    (B) An interest in a partnership (whether domestic or foreign).
    (C) A liability that was incurred to acquire stock described in 
paragraph (b)(2)(i)(A) of this section or that was incurred to acquire 
a partnership interest described in paragraph (b)(2)(i)(B) of this 
section.
    (D) Income, gain, deduction, or loss arising from the items 
described in paragraphs (b)(2)(i)(A) through (C) of this section. For 
example, if a dividend is received with respect to stock of a 
corporation described in paragraph (b)(2)(i)(A) of this section, the 
dividend is excluded from the income of the eligible QBU. See also 
paragraph (c)(2)(ii) of this section, treating the payment as received 
by the owner and contributed to the eligible QBU.
    (ii) Separate account assets. Paragraph (b)(2)(i) of this section 
does not apply to separate account assets, liabilities related to 
separate account assets, or income, gain, deduction, or loss arising 
from those assets and liabilities.
    (3) Adjustments to items reflected on the books and records--(i) 
General rule. If a principal purpose of recording (or not recording) an 
item on the books and records of an eligible QBU is the avoidance of 
Federal income tax under, or through the use of, section 987, the item 
must be allocated between or among the eligible QBU, the owner of such 
eligible QBU, and any other persons, entities (including DEs), or other 
QBUs within the meaning of Sec.  1.989(a)-1(b) (including eligible 
QBUs) in a manner that reflects the substance of the transaction. For 
purposes of this paragraph (b)(3)(i), relevant factors for determining 
whether such Federal income tax avoidance is a principal purpose of 
recording (or not recording) an item on the books and records of an 
eligible QBU include the factors set forth in paragraphs (b)(3)(ii) and 
(iii) of this section. The presence or absence of any factor or factors 
is not determinative. The weight given to any factor (whether or not 
set forth in paragraphs (b)(3)(ii) and (iii) of this section) depends 
on the facts and circumstances.
    (ii) Factors indicating no tax avoidance. For purposes of paragraph 
(b)(3)(i) of this section, factors that may indicate that recording (or 
not recording) an item on the books and records of an eligible QBU did 
not have as a principal purpose the avoidance of Federal income tax 
under, or through the use of, section 987 include the recording (or not 
recording) of an item:
    (A) For a significant and bona fide business purpose;
    (B) In a manner that is consistent with the economics of the 
underlying transaction;
    (C) In accordance with generally accepted accounting principles (or 
a similar comprehensive accounting standard);
    (D) In a manner that is consistent with the treatment of similar 
items from year to year;
    (E) In accordance with accepted conditions or practices in the 
particular trade or business of the eligible QBU;
    (F) In a manner that is consistent with an explanation of existing 
internal accounting policies that is evidenced by documentation 
contemporaneous with the timely filing of a return for the taxable 
year; and
    (G) As a result of a transaction between legal entities (for 
example, the transfer of an asset or the assumption of a liability), 
even if such transaction is not regarded for Federal income tax 
purposes (for example, a transaction between a DE and its owner).
    (iii) Factors indicating tax avoidance. For purposes of paragraph 
(b)(3)(i) of this section, factors that may indicate that a principal 
purpose of recording (or not recording) an item on the books and 
records of an eligible QBU is the avoidance of Federal income tax 
under, or through the use of, section 987 include:
    (A) The presence or absence of an item on the books and records 
that is the result of one or more transactions that are transitory, for 
example, due to a circular flow of cash or other property;
    (B) The presence or absence of an item on the books and records 
that is the

[[Page 100177]]

result of one or more transactions that do not have substance; and
    (C) The presence or absence of an item on the books and records 
that results in the taxpayer (or a person related to the taxpayer 
within the meaning of section 267(b) or section 707(b)) having 
offsetting positions with respect to the functional currency of a 
section 987 QBU.
    (iv) Section 988 transactions. A section 988 transaction that is 
reflected on the books and records of an eligible QBU is not 
attributable to an eligible QBU if the transaction was entered into or 
was reflected on the eligible QBU's books and records with a principal 
purpose of generating fully or partially offsetting amounts of section 
988 gain or loss and section 987 gain or loss (or if the taxpayer chose 
to denominate the section 988 transaction in a nonfunctional currency 
with such a principal purpose).
    (c) Transfers to and from section 987 QBUs--(1) In general. The 
following rules apply for purposes of determining whether there is a 
transfer of an asset or a liability from an owner to a section 987 QBU, 
or from a section 987 QBU to an owner. These rules apply solely for 
purposes of section 987.
    (2) Disregarded transactions--(i) General rule. An asset or 
liability is treated as transferred to a section 987 QBU from its owner 
if, as a result of a disregarded transaction, such asset or liability 
is reflected on the books and records of (or otherwise becomes 
attributable to) the section 987 QBU within the meaning of paragraph 
(b) of this section. Similarly, an asset or liability is treated as 
transferred from a section 987 QBU to its owner if, as a result of a 
disregarded transaction, such asset or liability is no longer reflected 
on the books and records of (or otherwise ceases to be attributable to) 
the section 987 QBU within the meaning of paragraph (b) of this 
section.
    (ii) Definition of a disregarded transaction. For purposes of this 
section, a disregarded transaction means a transaction that is not 
regarded for Federal income tax purposes (for example, any transaction 
between separate section 987 QBUs of the same owner). For purposes of 
this paragraph (c), a disregarded transaction is treated as including 
events described in paragraphs (c)(2)(ii)(A) through (F) of this 
section.
    (A) If the recording (or not recording) of an asset or liability on 
the books and records of a section 987 QBU of an owner is the result of 
such asset or liability being removed from (or included on) the books 
and records of the owner or another eligible QBU of the owner, the 
asset or liability is treated as transferred to (or from) the section 
987 QBU in a disregarded transaction.
    (B) If an asset or liability that was previously attributable to a 
section 987 QBU of an owner begins to be attributable to the owner (or 
another eligible QBU of the owner) as a result of the application of 
paragraph (b)(2) or (3) of this section, the asset or liability is 
treated as having been transferred by the section 987 QBU in a 
disregarded transaction. If an asset or liability that was previously 
attributable to the owner (or another eligible QBU of the owner) begins 
to be attributable to the section 987 QBU as a result of the 
application of paragraph (b)(2) or (3) of this section, the asset or 
liability is treated as transferred to the section 987 QBU in a 
disregarded transaction.
    (C) If an asset or liability that is attributable to a section 987 
QBU is sold or exchanged (including in a nonrecognition transaction, 
such as an exchange under section 351) for an asset or liability that 
is not attributable to the section 987 QBU immediately after the sale 
or exchange, the sold or exchanged asset or liability that was 
attributable to the section 987 QBU immediately before the transaction 
is treated as transferred from the section 987 QBU to its owner in a 
disregarded transaction immediately before the sale or exchange for 
purposes of section 987 (including for purposes of recognizing section 
987 gain or loss under Sec.  1.987-5) and subsequently sold or 
exchanged by the owner.
    (D) If an asset or liability of an owner of a section 987 QBU that 
is not attributable to a section 987 QBU is sold or exchanged 
(including in a nonrecognition transaction, such as an exchange under 
section 351) for an asset or liability that is attributable to the 
section 987 QBU immediately after the sale or exchange, the asset or 
liability that is attributable to the section 987 QBU immediately after 
the transaction is treated as received or assumed by the owner and 
transferred from the owner to the section 987 QBU in a disregarded 
transaction immediately after the sale or exchange for purposes of 
section 987 (including for purposes of recognizing section 987 gain or 
loss under Sec.  1.987-5).
    (E) If an asset or liability that is attributable to a section 987 
QBU was received, transferred, assumed, or accrued in a regarded 
transaction (including the making or receiving of a payment) in which 
the related item of income, gain, deduction, or loss is not 
attributable to the section 987 QBU, the asset or liability is treated 
as though it was received, transferred, assumed, or accrued by the 
owner or another eligible QBU and transferred to or from the section 
987 QBU in a disregarded transaction. Similarly, if an asset or 
liability that is not attributable to a section 987 QBU was received, 
transferred, assumed, or accrued in a regarded transaction (including 
the making or receiving of a payment) in which the related item of 
income, gain, deduction, or loss is attributable to the section 987 
QBU, the asset or liability is treated as though it was received, 
transferred, assumed, or accrued by the section 987 QBU and transferred 
to or from the section 987 QBU in a disregarded transaction. For 
example, if a section 987 QBU receives a dividend on an interest in 
stock that would be attributable to the section 987 QBU but for 
paragraph (b)(2)(i)(A) of this section, the owner is treated as 
receiving the dividend and transferring to the section 987 QBU the 
amount of the dividend in a disregarded transaction. Similarly, if a 
section 987 QBU pays interest on a liability that would be attributable 
to the section 987 QBU but for paragraph (b)(2)(i)(C) of this section, 
the section 987 QBU is treated as transferring to the owner the amount 
of the interest expense and the owner is treated as paying the interest 
expense in a disregarded transaction. See also paragraph (c)(7) of this 
section (application of general tax law principles).
    (F) In the first taxable year in which an eligible QBU is treated 
as a section 987 QBU, all assets and liabilities attributable to the 
eligible QBU are treated as transferred from the owner to the section 
987 QBU in a disregarded transaction on the first day on which the 
eligible QBU is treated as a section 987 QBU.
    (iii) Items derived from disregarded transactions ignored. For 
purposes of section 987, disregarded transactions do not give rise to 
items of income, gain, deduction, or loss that are taken into account 
in determining section 987 taxable income or loss under Sec.  1.987-3.
    (3) through (6) [Reserved]
    (7) Application of general tax law principles. General tax law 
principles, including the circular cash flow, step-transaction, 
economic substance, and substance-over-form doctrines, apply for 
purposes of determining whether there is a transfer of an asset or 
liability under this paragraph (c), including a transfer of an asset or 
liability pursuant to a disregarded transaction.
    (8) Interaction with Sec.  1.988-1(a)(10). See Sec.  1.988-1(a)(10) 
for rules regarding the treatment of an intra-taxpayer transfer of a 
section 988 transaction.

[[Page 100178]]

    (9) Certain disregarded transactions not treated as transfers--(i) 
Combinations of section 987 QBUs. The combination (a combination) of 
two or more separate section 987 QBUs (combining QBUs) that are 
directly owned by the same owner into one section 987 QBU (combined 
QBU) does not give rise to a transfer of any combining QBU's assets or 
liabilities to the owner under this paragraph (c). In addition, 
transactions between the combining QBUs occurring in the taxable year 
of the combination do not result in a transfer of the combining QBUs' 
assets or liabilities to the owner under this paragraph (c). For this 
purpose, a combination occurs when the assets and liabilities that were 
attributable to two or more combining QBUs begin to be attributable to 
a combined QBU and the separate existence of the combining QBUs ceases. 
A combination may result from any transaction or series of transactions 
in which the combining QBUs become a combined QBU. A combination may 
also result when an owner of two or more section 987 QBUs with the same 
functional currency becomes subject to a grouping election under Sec.  
1.987-1(b)(3)(ii) or when a section 987 QBU of an owner subject to a 
grouping election changes its functional currency to that of another 
section 987 QBU of the same owner. For purposes of determining net 
unrecognized section 987 gain or loss, deferred section 987 gain or 
loss, and cumulative suspended section 987 loss of a combined QBU, the 
combining QBUs are treated as having combined immediately before the 
beginning of the taxable year of combination. See Sec. Sec.  1.987-
4(f)(1), 1.987-11(b)(2), and 1.987-12(f)(1).
    (ii) Change in functional currency from a combination. If, 
following a combination of section 987 QBUs described in paragraph 
(c)(9)(i) of this section, the combined section 987 QBU has a different 
functional currency than one or more of the combining section 987 QBUs, 
any such combining section 987 QBU is treated as changing its 
functional currency, and the owner of the combined section 987 QBU must 
comply with the regulations under section 985 regarding the change in 
functional currency. See Sec. Sec.  1.985-1(c)(6) and 1.985-5.
    (iii) Separation of section 987 QBUs. The separation (a separation) 
of a section 987 QBU (separating QBU) into two or more section 987 QBUs 
(separated QBUs) that, after the separation, are directly owned by the 
same owner does not result in a transfer of the separating QBU's assets 
or liabilities to the owner under this paragraph (c). Additionally, 
transactions that occurred between the separating QBUs in the taxable 
year of the separation before the completion of the separation do not 
result in transfers for purposes of section 987. For this purpose, a 
separation occurs when the assets and liabilities that were 
attributable to a separating QBU begin to be attributable to two or 
more separated QBUs and each of the separated QBUs continues to perform 
a significant portion of the separating QBU's activities immediately 
after the separation. A separation may result from any transaction or 
series of transactions in which a separating QBU becomes two or more 
separated QBUs described in the preceding sentence. A separation may 
also result when a section 987 QBU that is subject to a grouping 
election under Sec.  1.987-1(b)(3)(ii) changes its functional currency 
or when the grouping election is revoked. For purposes of determining 
net unrecognized section 987 gain or loss, deferred section 987 gain or 
loss, or cumulative suspended section 987 loss of a separated QBU, the 
separating QBU is treated as having separated immediately before the 
beginning of the taxable year of separation. See Sec. Sec.  1.987-
4(f)(2), 1.987-11(b)(3), and 1.987-12(f)(2).
    (iv) Special rules for successor suspended loss QBUs. For purposes 
of determining whether a combination or separation has occurred with 
respect to a successor suspended loss QBU, the rules of paragraphs 
(c)(9)(i) and (iii) of this section are applied without regard to 
whether any of the combining QBUs, the combined QBU, the separating 
QBU, or the separated QBUs are section 987 QBUs. A combined QBU is a 
successor suspended loss QBU if either combining QBU was a successor 
suspended loss QBU, and a separated QBU is a successor suspended loss 
QBU if the separating QBU was a successor suspended loss QBU.
    (10) Examples. The following examples illustrate the principles of 
this paragraph (c). For purposes of the examples, X and Y are domestic 
corporations, have the U.S. dollar as their functional currencies, and 
use the calendar year as their taxable years. Furthermore, except as 
otherwise provided, Business A and Business B are eligible QBUs that 
have the euro and the Japanese yen, respectively, as their functional 
currencies, and DE1 and DE2 are DEs. For purposes of determining 
whether any of the transfers in these examples result in remittances, 
see Sec.  1.987-5.
    (i) Example 1: Loan to a section 987 QBU--(A) Facts. X owns all of 
the interests in DE1. DE1 owns Business A, which is a section 987 QBU 
of X. X owns [euro]100 that are not reflected on the books and records 
of Business A. Business A is in need of additional capital and, as a 
result, X lends the [euro]100 to DE1 for use in Business A in exchange 
for a note.
    (B) Analysis--(1) The loan from X to DE1 is not regarded for 
Federal income tax purposes (because it is an interbranch transaction) 
and therefore is a disregarded transaction (as defined in paragraph 
(c)(2)(ii) of this section). Because DE1 is a DE, the DE1 note held by 
X and the liability of DE1 under the note are not taken into account 
under this section.
    (2) As a result of the disregarded transaction, the [euro]100 is 
reflected on the books and records of Business A and is attributable to 
Business A under paragraph (b) of this section. Therefore, X is treated 
as transferring [euro]100 to its Business A section 987 QBU for 
purposes of section 987. This transfer is taken into account in 
determining the amount of any remittance for the taxable year under 
Sec.  1.987-5(c). See Sec.  1.988-1(a)(10)(ii) for the application of 
section 988 to X as a result of the transfer of nonfunctional currency 
to its section 987 QBU.
    (ii) Example 2: Transfer between section 987 QBUs--(A) Facts. X 
owns Business A and Business B, both of which are section 987 QBUs of 
X. X owns equipment that is used in Business A and is reflected on the 
books and records of Business A. Because Business A has excess 
manufacturing capacity and X intends to expand the manufacturing 
capacity of Business B, the equipment formerly used in Business A is 
transferred to Business B for use by Business B. As a result of the 
transfer, the equipment is removed from the books and records of 
Business A and is recorded on the books and records of Business B.
    (B) Analysis. The transfer of the equipment from the books and 
records of Business A to the books and records of Business B is not 
regarded for Federal income tax purposes (because it is an interbranch 
transaction) and therefore is a disregarded transaction (as defined in 
paragraph (c)(2)(ii) of this section). Therefore, for purposes of 
section 987, the Business A section 987 QBU is treated as transferring 
the equipment to X, and X is subsequently treated as transferring the 
equipment to the Business B section 987 QBU. These transfers are taken 
into account in determining the amount of any remittance for the 
taxable year under Sec.  1.987-5(c).

[[Page 100179]]

    (iii) Example 3: Sale of property between two section 987 QBUs--(A) 
Facts. X owns all of the interests in DE1 and DE2. DE1 and DE2 own 
Business A and Business B, respectively, both of which are section 987 
QBUs of X. DE1 owns equipment that is used in Business A and is 
reflected on the books and records of Business A. For business reasons, 
DE1 sells a portion of the equipment used in Business A to DE2 in 
exchange for a fair market value amount of Japanese yen. The yen used 
by DE2 to acquire the equipment was generated by Business B and was 
reflected on Business B's books and records. Following the sale, the 
yen and the equipment will be used in Business A and Business B, 
respectively. As a result of such sale, the equipment is removed from 
the books and records of Business A and is recorded on the books and 
records of Business B. Similarly, as a result of the sale, the yen is 
removed from the books and records of Business B and is recorded on the 
books and records of Business A.
    (B) Analysis--(1) The sale of equipment between DE1 and DE2 is a 
transaction that is not regarded for Federal income tax purposes 
(because it is an interbranch transaction) and therefore the 
transaction is a disregarded transaction (as defined in paragraph 
(c)(2)(ii) of this section). Pursuant to paragraph (c)(2)(iii) of this 
section, the sale does not give rise to an item of income, gain, 
deduction, or loss for purposes of determining section 987 taxable 
income or loss under Sec.  1.987-3. However, the yen and equipment 
exchanged by DE1 and DE2 in connection with the sale must be taken into 
account as a transfer under paragraph (c)(2)(i) of this section.
    (2) As a result of the disregarded transaction, the equipment 
ceases to be reflected on the books and records of Business A and 
becomes reflected on the books and records of Business B. Therefore, 
the Business A section 987 QBU is treated as transferring the equipment 
to X, and X is subsequently treated as transferring the equipment to 
the Business B section 987 QBU.
    (3) Additionally, as a result of the disregarded transaction, the 
yen currency ceases to be reflected on the books and records of 
Business B and becomes reflected on the books and records of Business 
A. Therefore, the Business B section 987 QBU is treated as transferring 
the yen to X, and X is subsequently treated as transferring the yen 
from X to the Business A section 987 QBU. The transfers among Business 
A, Business B and X are taken into account in determining the amount of 
any remittance for the taxable year under Sec.  1.987-5(c).
    (iv) through (ix) [Reserved]
    (x) Example 10: Contribution of a section 987 QBU's assets to a 
corporation--(A) Facts. X owns Business A. X forms Z, a domestic 
corporation, contributing 50 percent of its Business A assets and 
liabilities to Z in exchange for all of the stock of Z. X and Z do not 
file a consolidated tax return.
    (B) Analysis. Pursuant to paragraph (b)(2) of this section, the Z 
stock received in exchange for 50 percent of Business A's assets and 
liabilities is not reflected on the books and records of, and therefore 
is not attributable to, Business A for purposes of section 987 
immediately after the exchange. As a result, pursuant to paragraphs 
(c)(2)(i) and (ii) of this section, 50 percent of the assets and 
liabilities of Business A are treated as transferred from Business A to 
X in a disregarded transaction immediately before the exchange. See 
Sec.  1.1502-13(j)(9) if X and Z file a consolidated return.
    (xi) Example 11: Circular transfers--(A) Facts. X owns Business A. 
On December 30, year 1, Business A purports to transfer [euro]100 to X. 
On January 2, year 2, X purports to transfer [euro]50 to Business A. On 
January 4, year 2, X purports to transfer another [euro]50 to Business 
A. As of the end of year 1, X has net unrecognized section 987 loss 
with respect to Business A, such that a remittance, if respected, would 
result in recognition of a foreign currency loss under section 987.
    (B) Analysis. Because the transfer by Business A to X is offset by 
the transfers from X to Business A that occurred in close temporal 
proximity, the purported transfers to and from Business A may be 
disregarded for purposes of section 987 pursuant to general tax 
principles under paragraph (c)(7) of this section.
    (xii) Example 12: Transfers without substance--(A) Facts. X owns 
Business A and Business B. On January 1, year 1, Business A purports to 
transfer [euro]100 to X. On January 4, year 1, X purports to transfer 
[euro]100 to Business B. The account in which Business B deposited the 
[euro]100 is used to pay the operating expenses and other costs of 
Business A. As of the end of year 1, X has net unrecognized section 987 
loss with respect to Business A, such that a remittance, if respected, 
would result in recognition of a foreign currency loss under section 
987.
    (B) Analysis. Because Business A continues to have use of the 
transferred property, the [euro]100 purported transfer from Business A 
to X may be disregarded for purposes of section 987 pursuant to general 
tax principles under paragraph (c)(7) of this section.
    (xiii) Example 13: Offsetting positions in section 987 QBUs--(A) 
Facts. X owns Business A and Business B. Business A and Business B each 
have the euro as their functional currency. X has not made a grouping 
election under Sec.  1.987-1(b)(3)(ii). On January 1, year 1, X borrows 
[euro]1,000 from a third-party lender, records the liability with 
respect to the borrowing on the books and records of Business A, and 
records the borrowed [euro]1,000 on the books and records of Business 
B. On December 31, year 2, when Business A has $100 of net unrecognized 
section 987 loss and Business B has $100 of net unrecognized section 
987 gain resulting from the change in exchange rates with respect to 
the liability and the [euro]1,000, X terminates the Business A section 
987 QBU.
    (B) Analysis. Under paragraph (b)(3) of this section, the fact that 
Business A and Business B have offsetting positions in the euro is a 
factor indicating that a principal purpose of recording the euro-
denominated liability on the books and records of Business A and the 
borrowed euros on the books and records of Business B was the avoidance 
of tax under section 987. If such a principal purpose is present, the 
items must be reallocated (that is, the euros and the euro-denominated 
liability) between Business A, Business B, and X under paragraph (b)(3) 
of this section to reflect the substance of the transaction.
    (xiv) Example 14: Offsetting positions with respect to a section 
987 QBU and a section 988 transaction--(A) Facts. X owns all of the 
interests in DE1, and DE1 owns Business A. On January 1, year 1, X 
borrows [euro]1,000 from a third-party lender and records the liability 
with respect to the borrowing on its books and records. X contributes 
the [euro]1,000 loan proceeds to DE1 and the [euro]1,000 are reflected 
on the books and records of Business A. On December 31, year 2, when 
Business A has $100 of net unrecognized section 987 loss resulting from 
the change in exchange rates with respect to the [euro]1,000 received 
from the borrowing, and when the euro-denominated borrowing, if repaid, 
would result in $100 of gain under section 988, X terminates the 
Business A section 987 QBU.
    (B) Analysis. Under paragraph (b)(3) of this section, the fact that 
X and Business A have offsetting positions in the euro is a factor 
indicating that a principal purpose of recording the borrowed euros on 
the books and records of Business A, or not recording the corresponding 
euro-denominated liability on the books and records of

[[Page 100180]]

Business A, was the avoidance of tax under section 987. If such a 
principal purpose is present, the items (that is, the euros and the 
euro-denominated liability) must be reallocated between Business A and 
X under paragraph (b)(3) of this section to reflect the substance of 
the transaction.
    (xv) Example 15: Offsetting positions with respect to a section 987 
QBU and a section 988 transaction--(A) Facts. X owns all of the stock 
of Y and all of the interests in DE1. DE1 owns Business A. X and Y do 
not file a consolidated return. On January 1, year 1, DE1 lends 
[euro]1,000 to Y. X records the receivable with respect to the loan on 
Business A's books and records. On December 31, year 2, when Business A 
has $100 of net unrecognized section 987 gain resulting from the loan, 
Y repays the [euro]1,000 liability. The repayment of the euro-
denominated borrowing results in $100 of loss to Y under section 988. 
Business A does not make any remittances to X in year 2, so the 
offsetting gain with respect to the loan receivable has not been 
recognized by X.
    (B) Analysis. Under paragraph (b)(3) of this section, the fact that 
Y (a related party to X) and Business A have offsetting positions in 
the euro is a factor indicating that a principal purpose of recording 
the euro-denominated receivable on the books and records of Business A, 
rather than on the books and records of X, was to avoid Federal income 
tax under, or through the use of, section 987. If such a principal 
purpose is present, the euro-denominated receivable must be reallocated 
between Business A and X under paragraph (b)(3) of this section to 
reflect the substance of the transaction. Other provisions (for 
example, section 267) may also apply to defer or disallow the loss. See 
Sec.  1.1502-13(j)(9) if X and Y file a consolidated return.
    (xvi) Example 16: Borrowing by section 987 QBU followed by 
immediate distribution to owner--(A) Facts. X owns all of the interests 
in DE1. DE1 owns Business A. On January 1, year 1, Business A borrows 
[euro]1,000 from a bank. On January 2, year 1, Business A distributes 
the [euro]1,000 it received from the bank to X. There are no other 
transfers between X and Business A during the year. At the end of the 
year, X has net unrecognized section 987 loss with respect to Business 
A such that a remittance would result in the recognition of foreign 
currency loss under section 987.
    (B) Analysis. Under paragraph (b)(3) of this section, if a 
principal purpose of recording of the loan on the books and records of 
Business A, rather than on the books and records of X, was to avoid 
Federal income tax under, or through the use of, section 987, the items 
must be reallocated to reflect the substance of the transaction (for 
example, by moving the loan onto the books of X, resulting in the 
transfer not being taken into account for purposes of section 987).
    (xvii) Example 17: Payment of interest by section 987 QBU on 
obligation of owner--(A) Facts. X owns all of the interests in DE1. DE1 
owns Business A. On January 1, X borrows [euro]1,000 from a bank. On 
July 1, DE1 pays [euro]20 in interest on X's [euro]1,000 obligation to 
the bank, which is treated as a payment by Business A.
    (B) Analysis. Under general tax law principles as provided in 
paragraph (c)(7) of this section, on July 1, year 1, Business A is 
treated for purposes of section 987 as making a transfer of [euro]20 to 
X, and X is treated as making a [euro]20 interest payment to the bank. 
See also paragraph (c)(2)(ii)(E) of this section for interest payments 
on loans that are not attributable to a section 987 QBU pursuant to 
paragraph (b)(2) or (3) of this section.
    (xviii) Example 18: Sale of the interests in a DE--(A) Facts. X 
owns all of the interests in DE1, a disregarded entity. DE1 owns 
Business A, which is a section 987 QBU of X. X has made a current rate 
election under Sec.  1.987-1(d)(2) but not an annual recognition 
election under Sec.  1.987-5(b)(2). On December 31, year 1, X sells all 
of the interests in DE1 to FC, an unrelated foreign corporation, for 
$150,000, when the exchange rate is [euro]1 = $1.2. The sale proceeds 
are reflected on X's books and records after the sale. At the time of 
the sale, all of DE1's assets are used in Business A and are reflected 
on the books and records of Business A. The assets have a basis of 
[euro]100,000 and Business A has no liabilities. In year 1, X has net 
unrecognized section 987 gain with respect to Business A of $20,000.
    (B) Analysis--(1) Under paragraph (c)(2)(ii)(C) of this section, if 
an asset that is attributable to a section 987 QBU is sold or exchanged 
for an asset that is not attributable to the section 987 QBU 
immediately after the sale or exchange, the sold or exchanged asset is 
treated as transferred from the section 987 QBU to its owner in a 
disregarded transaction immediately before the sale or exchange and 
subsequently sold or exchanged by the owner. The sale of DE1 is treated 
as a sale of the assets of Business A in exchange for cash that is not 
reflected on the books and records of the Business A section 987 QBU. 
Therefore, the assets of Business A are treated as transferred from the 
Business A section 987 QBU to X, and X is treated as selling the assets 
to FC.
    (2) The deemed transfer of all of Business A's assets to X results 
in a termination of the Business A section 987 QBU under Sec.  1.987-
8(b)(2) (substantially all assets transferred). Under Sec.  1.987-
5(c)(3) and Sec.  1.987-8(e), a termination of a section 987 QBU is 
treated as a remittance of all the gross assets of the section 987 QBU 
to the owner on the date of the termination. Therefore, the owner's 
remittance proportion is one, and X recognizes all of its net 
unrecognized section 987 gain with respect to Business A, or $20,000.
    (3) Because a current rate election was in effect, all of the 
assets of Business A are marked items. Therefore, under Sec.  1.987-
5(f)(2), X's basis in the assets transferred from Business A is 
determined by translating Business A's functional currency basis in the 
assets into X's functional currency at the spot rate applicable to the 
date of the transfer, [euro]1 = $1.2. Consequently, immediately before 
the sale of the interests in DE1, X's functional currency basis in 
Business A's assets (which Business A held with a basis of 
[euro]100,000) is $120,000. X recognizes $30,000 of gain under section 
1001(a) on the sale of DE1.
    (d) Translation of items transferred to a section 987 QBU--(1) 
Marked items. The adjusted basis of a marked asset, or the amount of a 
marked liability, transferred to a section 987 QBU is translated into 
the section 987 QBU's functional currency at the spot rate applicable 
to the date of transfer. If, and to the extent that, exchange gain or 
loss is recognized on the asset or liability transferred under Sec.  
1.988-1(a)(10)(ii), the adjusted basis of the marked asset, or the 
amount of the marked liability, is adjusted to take into account the 
exchange gain or loss recognized.
    (2) Historic items. The adjusted basis of a historic asset, or the 
amount of a historic liability, transferred to a section 987 QBU is 
translated into the section 987 QBU's functional currency at the rate 
provided in Sec.  1.987-1(c)(3).
    (e) Cross-reference. See also Sec.  1.1502-13(j)(9) regarding the 
treatment of intercompany transactions involving section 987 QBUs owned 
by a member of a consolidated group.


Sec.  1.987-3  Determination of section 987 taxable income or loss of 
an owner of a section 987 QBU.

    (a) In general. This section provides rules for determining the 
taxable income or loss of an owner of a section 987 QBU (section 987 
taxable income or loss). Paragraph (b) of this section provides rules 
for determining items of income, gain, deduction, and loss in the 
section 987 QBU's functional currency.

[[Page 100181]]

Paragraph (c) of this section provides rules for translating each item 
determined under paragraph (b) of this section into the functional 
currency of the owner of the section 987 QBU. Paragraph (d) of this 
section is reserved. Paragraph (e) of this section provides examples 
illustrating the application of the rules of this section.
    (b) Determination of each item of income, gain, deduction, or loss 
in the section 987 QBU's functional currency--(1) In general. The owner 
of a section 987 QBU must determine each item of income, gain, 
deduction, or loss attributable to the section 987 QBU in the section 
987 QBU's functional currency under Federal income tax principles.
    (2) Translation of items of income, gain, deduction, or loss that 
are denominated in a nonfunctional currency. Except as otherwise 
provided in paragraph (b)(4) of this section, an item of income, gain, 
deduction, or loss (or the item's components and related items, such as 
gross receipts and amount realized) that is denominated in (or 
determined by reference to) a nonfunctional currency (including the 
functional currency of the owner) is translated into the section 987 
QBU's functional currency at the spot rate on the date such item is 
properly taken into account. Paragraphs (e)(1) and (2) of this section 
(Examples 1 and 2) illustrate the application of this paragraph (b)(2).
    (3) [Reserved]
    (4) Section 988 transactions--(i) In general. Section 988 and the 
regulations under section 988 apply to section 988 transactions of a 
section 987 QBU. The determination of whether an asset or liability of 
a section 987 QBU is a section 988 transaction is determined by 
reference to the functional currency of the section 987 QBU. Section 
988 gain or loss is determined in, and by reference to, the functional 
currency of the section 987 QBU. The amount of section 988 gain or loss 
determined under this paragraph (b)(4)(i) is translated into the 
owner's functional currency under paragraph (c) of this section.
    (ii) Section 988 mark-to-market election--(A) In general. A 
taxpayer may elect to apply the section 988 mark-to-market method of 
accounting described in this paragraph (b)(4)(ii) with respect to all 
section 988 transactions that are properly attributable to a section 
987 QBU and that are not otherwise accounted for under a mark-to-market 
method of accounting under section 475 or section 1256 (other than a 
section 988 transaction described in paragraph (b)(4)(ii)(B) of this 
section). Under the section 988 mark-to-market method of accounting, 
the timing of section 988 gain or loss on section 988 transactions 
described in the preceding sentence is determined under the principles 
of section 1256. Only section 988 gain or loss is taken into account 
under the foreign currency mark-to-market method of accounting. 
Appropriate adjustments must be made to prevent the section 988 gain or 
loss from being taken into account again after it is recognized under 
this paragraph (b)(4)(ii). A section 988 transaction subject to the 
foreign currency mark-to-market method of accounting is not subject to 
the netting rule of section 988(b) and Sec.  1.988-2(b)(8) (under which 
exchange gain or loss is limited to overall gain or loss realized in a 
transaction) in taxable years before the taxable year in which section 
988 gain or loss would be recognized with respect to the section 988 
transaction but for this election.
    (B) Built-in loss transactions contributed to a section 987 QBU. 
Paragraph (b)(4)(ii)(A) of this section does not apply to a section 988 
transaction if--
    (1) The transaction was transferred to the section 987 QBU from its 
owner (or from another eligible QBU of the owner);
    (2) Immediately before the transfer, the transaction was a section 
988 transaction in the hands of the owner (or other eligible QBU of the 
owner) and was not subject to a mark-to-market method of accounting;
    (3) If the owner (or other eligible QBU) had disposed of the 
section 988 transaction immediately before the transfer (and Sec.  
1.988-2(b)(8) did not apply), the owner would have recognized section 
988 loss; and
    (4) Section 988 loss was not recognized in connection with the 
transfer under Sec.  1.988-1(a)(10).
    (c) Translation of items of income, gain, deduction, or loss of a 
section 987 QBU into the owner's functional currency--(1) In general. 
Except as otherwise provided in this section, the exchange rate to be 
used by an owner in translating an item of income, gain, deduction, or 
loss attributable to a section 987 QBU (or the item's components and 
related items, such as gross receipts, amount realized, basis, and cost 
of goods sold) into the owner's functional currency, if necessary, is 
the yearly average exchange rate for the taxable year.
    (2) Exceptions. Except as otherwise provided in paragraph (c)(2)(v) 
of this section, this paragraph (c)(2) applies only to taxable years 
for which neither the annual recognition election nor the current rate 
election is in effect.
    (i) Recovery of basis with respect to historic assets. Except as 
otherwise provided in this paragraph (c)(2), the exchange rate to be 
used by the owner in translating any recovery of basis (whether through 
a sale or exchange; deemed sale or exchange; cost recovery deduction 
such as depreciation, depletion or amortization; or otherwise) with 
respect to a historic asset is the historic rate for the property to 
which such recovery of basis is attributable.
    (ii) through (iii) [Reserved]
    (iv) Cost of goods sold computation--(A) General rule--simplified 
inventory method. Except as otherwise provided in paragraph 
(c)(2)(iv)(B) of this section, cost of goods sold (COGS) for a taxable 
year is translated into the functional currency of the owner at the 
yearly average exchange rate for the taxable year in which the sale of 
inventory occurs (or the COGS is otherwise taken into account in 
computing taxable income) and adjusted as provided in paragraph (c)(3) 
of this section.
    (B) Election to use the historic inventory method. In lieu of using 
the simplified inventory method described in paragraph (c)(2)(iv)(A) of 
this section, the owner of a section 987 QBU may elect under this 
paragraph (c)(2)(iv)(B) to translate inventoriable costs (including 
current-year inventoriable costs and costs that were capitalized into 
inventory in prior years) that are included in COGS at the historic 
rate for each such cost.
    (v) Translation of income to account for certain foreign income tax 
claimed as a credit. The owner of a section 987 QBU claiming a credit 
under section 901 for foreign income taxes, other than foreign income 
taxes deemed paid under section 960, that are properly reflected on the 
books and records of the section 987 QBU (the creditable tax amount) 
must determine section 987 taxable income or loss attributable to the 
section 987 QBU by reducing the amount of section 987 taxable income or 
loss that otherwise would be determined under this section by an amount 
equal to the creditable tax amount, translated into U.S. dollars using 
the yearly average exchange rate for the taxable year in which the 
creditable tax is accrued, and by increasing the resulting amount by an 
amount equal to the creditable tax amount, translated using the same 
exchange rate that is used to translate the creditable taxes into U.S. 
dollars under section 986(a). This paragraph (c)(2)(v) applies whether 
or not a current rate election or an annual recognition election is in 
effect. See paragraph (e)(14) of this section (Example 14) for an 
illustration of this rule.

[[Page 100182]]

    (3) Adjustments to COGS required under the simplified inventory 
method. This paragraph (c)(3) applies only to taxable years for which 
neither the annual recognition election nor the current rate election 
is in effect.
    (i) In general. An owner of a section 987 QBU that uses the 
simplified inventory method described in paragraph (c)(2)(iv)(A) of 
this section must make the adjustment described in paragraph (c)(3)(ii) 
of this section. In addition, the owner must make the adjustment 
described in paragraph (c)(3)(iii) of this section with respect to any 
inventory for which the section 987 QBU does not use the LIFO inventory 
method and must make the adjustment described in paragraph (c)(3)(iv) 
of this section with respect to any inventory for which the section 987 
QBU uses the LIFO inventory method. An owner of a section 987 QBU that 
uses the simplified inventory method must make all of the applicable 
adjustments described in paragraphs (c)(3)(ii) through (iv) of this 
section with respect to the section 987 QBU even in taxable years in 
which the amount of COGS is zero.
    (ii) Adjustment for cost recovery deductions included in 
inventoriable costs--(A) In general. The translated COGS amount 
computed under paragraph (c)(2)(iv)(A) of this section is increased or 
decreased (as appropriate) by the amount described in paragraph 
(c)(3)(ii)(B) of this section. The adjustment is included as an 
adjustment to translated COGS computed under paragraph (c)(2)(iv)(A) of 
this section in full in the year to which the adjustment relates and is 
not allocated between COGS and ending inventory.
    (B) Amount of adjustment. With respect to each cost recovery 
deduction attributable to a historic asset that is included in 
inventoriable costs for a taxable year, the adjustment is equal to--
    (1) The amount of the cost recovery deduction included in 
inventoriable costs, translated at the historic rate for the property 
to which the deduction is attributable; less
    (2) The amount of the cost recovery deduction included in 
inventoriable costs, translated at the yearly average exchange rate for 
the current taxable year.
    (iii) Adjustment for beginning inventory for non-LIFO inventory--
(A) In general. In the case of non-LIFO inventory, the translated COGS 
amount computed under paragraph (c)(2)(iv)(A) of this section is 
increased or decreased (as appropriate) by the amount described in 
paragraph (c)(3)(iii)(B) of this section.
    (B) Amount of adjustment. The adjustment is equal to--
    (1) The ending non-LIFO inventory included on the closing balance 
sheet for the preceding taxable year, translated at the exchange rate 
described in paragraph (c)(3)(iii)(C) of this section (which is 
generally the yearly average exchange rate for the preceding taxable 
year); less
    (2) The ending non-LIFO inventory included on the closing balance 
sheet for the preceding taxable year, translated at the yearly average 
exchange rate for the current taxable year.
    (C) Exchange rate--(1) In general. Except as provided in paragraph 
(c)(3)(iii)(C)(2) of this section, the exchange rate used to translate 
non-LIFO inventory under paragraph (c)(3)(iii)(B)(1) of this section is 
the yearly average exchange rate for the preceding taxable year.
    (2) Revocation of current rate election or taxable year beginning 
on the transition date. In the first taxable year in which a current 
rate election is revoked or otherwise ceases to be in effect (or in the 
taxable year beginning on the transition date), the exchange rate used 
to translate non-LIFO inventory under paragraph (c)(3)(iii)(B)(1) of 
this section is the spot rate applicable to the last day of the 
preceding taxable year.
    (iv) Adjustment for year of LIFO liquidation--(A) In general. In 
the case of inventory with respect to which a section 987 QBU uses the 
LIFO inventory method, the translated COGS amount computed under 
paragraph (c)(2)(iv)(A) of this section is increased or decreased (as 
appropriate) by the amount described in paragraph (c)(3)(iv)(B) of this 
section.
    (B) Amount of adjustment. With respect to each LIFO layer 
liquidated in whole or in part during the taxable year, the adjustment 
is equal to:
    (1) The amount of the LIFO layer liquidated during the taxable 
year, translated at the historic rate that is used for translating the 
LIFO layer (which is generally the yearly average exchange rate for the 
year the LIFO layer arose); less
    (2) The amount of the LIFO layer liquidated during the taxable 
year, translated at the yearly average exchange rate for the taxable 
year.
    (d) [Reserved]
    (e) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, U.S. Corp is a domestic 
corporation that uses the calendar year as its taxable year and has the 
U.S. dollar as its functional currency. Except as otherwise indicated, 
U.S. Corp is the owner of Business A, a section 987 QBU with the euro 
as its functional currency, and U.S. Corp elects under paragraph 
(c)(2)(iv)(B) of this section to use the historic inventory method with 
respect to Business A but does not make any other elections.
    (1) Example 1: Item of income denominated in nonfunctional 
currency. Business A accrues [pound]100 of income from the provision of 
services. Under paragraph (b)(2) of this section, the [pound]100 is 
translated into [euro]90 at the spot rate on the date of accrual, 
without the use of a spot rate convention. In determining U.S. Corp's 
taxable income, the [euro]90 of income is translated into dollars at 
the yearly average exchange rate under paragraph (c)(1) of this 
section.
    (2) Example 2: Asset sold for nonfunctional currency. Business A 
sells a historic asset consisting of non-inventory property for 
[pound]100. Under paragraph (b)(2) of this section, the [pound]100 
amount realized is translated into [euro]85 at the spot rate on the 
sale date without the use of a spot rate convention. In determining 
U.S. Corp's taxable income, the [euro]85 is translated into dollars at 
the yearly average exchange rate under paragraph (c)(1) of this 
section. The euro basis of the property is translated into dollars at 
the historic rate under paragraph (c)(2)(i) of this section.
    (3) Example 3: Historic inventory method--(i) Facts. Business A 
uses a first-in, first-out (FIFO) method of accounting for inventory. 
Business A sells 1,200 units of inventory in year 2 for [euro]3 per 
unit. The yearly average exchange rate is [euro]1 = $1.02 for year 1 
and [euro]1 = $1.05 for year 2.
    (ii) Analysis--(A) Gross sales. Business A's gross sales are 
translated under paragraph (c)(1) of this section at the yearly average 
exchange rate for the year of the sale. Business A's dollar gross sales 
will be computed as follows:

[[Page 100183]]



                                 Table 1 to Paragraph (e)(3)(ii)(A)--Gross Sales
                                                    [Year 2]
----------------------------------------------------------------------------------------------------------------
                                                                                     [euro]/$
                      Month                          Number of       Amount in    yearly average    Amount in $
                                                       units          [euro]           rate
----------------------------------------------------------------------------------------------------------------
Jan.............................................             100      [euro] 300       [euro]1 =         $315.00
                                                                                           $1.05
Feb.............................................             200             600       [euro]1 =          630.00
                                                                                           $1.05
March...........................................               0               0       [euro]1 =            0.00
                                                                                           $1.05
April...........................................             200             600       [euro]1 =          630.00
                                                                                           $1.05
May.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
June............................................               0               0       [euro]1 =            0.00
                                                                                           $1.05
July............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Aug.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Sept............................................               0               0       [euro]1 =            0.00
                                                                                           $1.05
Oct.............................................               0               0       [euro]1 =            0.00
                                                                                           $1.05
Nov.............................................             100             300       [euro]1 =          315.00
                                                                                           $1.05
Dec.............................................             300             900       [euro]1 =          945.00
                                                                                           $1.05
                                                 ---------------------------------------------------------------
                                                           1,200  ..............  ..............        3,780.00
----------------------------------------------------------------------------------------------------------------

    (B) Translated basis of inventory. The purchase price for each 
inventory unit was [euro]1.50. Under Sec.  1.987-1(c)(3)(i) and 
paragraph (c)(2)(iv)(B) of this section, the basis of each item of 
inventory is translated into dollars at the yearly average exchange 
rate for the year the inventory was acquired.

                       Table 2 to Paragraph (e)(3)(ii)(B)--Opening Inventory and Purchases
                                                    [Year 2]
----------------------------------------------------------------------------------------------------------------
                                                                                     [euro]/$
                      Month                          Number of       Amount in    yearly average    Amount in $
                                                       units          [euro]           rate
----------------------------------------------------------------------------------------------------------------
Opening inventory (purchased in Dec. year 1)
                                                             100       [euro]150       [euro]1 =         $153.00
                                                                                           $1.02
Purchases in year 2
    Jan.........................................             300      [euro] 450       [euro]1 =         $472.50
                                                                                           $1.05
    Feb.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    March.......................................               0               0       [euro]1 =               0
                                                                                           $1.05
    April.......................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    May.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    June........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    July........................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    Aug.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Sept........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Oct.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
    Nov.........................................             300             450       [euro]1 =          472.50
                                                                                           $1.05
    Dec.........................................               0               0       [euro]1 =               0
                                                                                           $1.05
                                                 ---------------------------------------------------------------
                                                           1,200  ..............  ..............        1,890.00
----------------------------------------------------------------------------------------------------------------

    (C) COGS. Because Business A uses a FIFO method for inventory, 
Business A is considered to have sold in year 2 the 100 units of 
opening inventory purchased in year 1 ($153.00), the 300 units 
purchased in January year 2 ($472.50), the 300 units purchased in April 
year 2 ($472.50), the 300 units purchased in July year 2 ($472.50), and 
200 of the 300 units purchased in November year 2 ($315.00). 
Accordingly, Business A's translated dollar COGS for year 2 is 
$1,885.50. Business A's opening inventory for year 3 is 100 units of 
inventory with a translated dollar basis of $157.50.
    (D) Gross sales income. Accordingly, for purposes of section 987, 
Business A has gross income in dollars of $1,894.50 ($3,780.00-
$1,885.50) from the sale of inventory in year 2.
    (4) Example 4: Simplified inventory method--(i) Facts. The facts 
are the same as in paragraph (e)(3) of this section (Example 3), except 
that U.S. Corp does not elect to use the historic inventory method with 
respect to Business A.
    (ii) Analysis. Because U.S. Corp does not elect to use the historic 
inventory method, the simplified inventory method under paragraph 
(c)(2)(iv)(A) of this section applies.
    (A) Gross sales. Business A's dollar gross sales will be computed 
as described in paragraph (e)(3)(ii)(A) of this section (Example 3). 
Therefore, Business A has gross sales of $3,780.
    (B) COGS. Business A sold 1,200 units of inventory in year 2, and 
the purchase price for each unit was [euro]1.50. The total purchase 
price for the inventory sold in year 2 was [euro]1,800. Under the 
simplified inventory method provided in paragraph (c)(2)(iv)(A) of this 
section, COGS for a taxable year is translated into the functional 
currency of the owner at the yearly average exchange rate for the 
taxable year in which the sale of inventory occurs. Therefore, before 
making the adjustments required under paragraph (c)(3) of this section, 
Business A's dollar COGS for year 2 is equal to $1,890 (the purchase 
price for the inventory sold in year 2 ([euro]1,800), translated at the 
yearly average exchange rate of [euro]1 = $1.05).

[[Page 100184]]

    (C) Adjustments required. Because the simplified inventory method 
applies, Business A's COGS must be adjusted under paragraph (c)(3) of 
this section. No adjustment is required under paragraph (c)(3)(ii) of 
this section because no cost recovery deduction attributable to a 
historic asset is included in inventoriable costs for year 2. However, 
an adjustment for beginning inventory is required under paragraph 
(c)(3)(iii)(A) of this section because Business A uses a FIFO method of 
accounting for inventory.
    (D) Adjustment for beginning inventory. The adjustment required 
under paragraph (c)(3)(iii)(A) of this section is equal to: the ending 
non-LIFO inventory included on Business A's closing balance sheet for 
the preceding taxable year ([euro]150), translated at the yearly 
average exchange rate for year 1 ([euro]1 = $1.02), which is $153; less 
the ending non-LIFO inventory included on Business A's closing balance 
sheet for the preceding taxable year ([euro]150), translated at the 
yearly average exchange rate for year 2 ([euro]1 = $1.05), which is 
$157.50. Therefore, there is a negative adjustment to COGS of $4.50. 
Business A's COGS for year 2 is reduced from $1,890 to $1,885.50.
    (E) Gross sales income. Accordingly, for purposes of section 987, 
Business A has gross income in dollars of $1,894.50 ($3,780.00-
$1,885.50) from the sale of inventory in year 2.
    (5) Example 5: Depreciation expense that is not an inventoriable 
cost. The facts are the same as in paragraph (e)(3) of this section 
(Example 3) except that during year 2, Business A incurred [euro]100 of 
depreciation expense with respect to a truck. No portion of the 
depreciation expense is an inventoriable cost. The truck was purchased 
on January 15, year 1. The yearly average exchange rate for year 1 was 
[euro]1 = $1.02. Under paragraph (c)(2)(i) of this section, the 
[euro]100 of depreciation is translated into dollars at the historic 
rate. The historic rate is the yearly average exchange rate for year 1. 
Accordingly, U.S. Corp takes into account depreciation of $102 with 
respect to Business A in year 2.
    (6) Example 6: Translation of depreciation expense that is an 
inventoriable cost (historic inventory method). The facts are the same 
as in paragraph (e)(5) of this section (Example 5) except that the 
[euro]100 of depreciation expense incurred during year 2 with respect 
to the truck is an inventoriable cost. As a result, the depreciation 
expense is capitalized into the 1,200 units of inventory purchased by 
Business A in year 2. Of those 1,200 units, 1,100 units are sold during 
the year, and 100 units become ending inventory. The portion of 
depreciation expense capitalized into inventory that is sold during 
year 2 is reflected in Business A's euro COGS and is translated at the 
[euro]1 = $1.02 yearly average exchange rate for year 1, the year in 
which the truck was purchased. The portion of the depreciation expense 
capitalized into the 100 units of ending inventory is not taken into 
account in year 2 but rather, will be taken into account in the year 
the ending inventory is sold, translated at the [euro]1 = $1.02 yearly 
average exchange rate for year 1.
    (7) Example 7: Sale of land. Business A purchased raw land on 
October 16, year 1, for [euro]8,000 and sold the land on November 1, 
year 2, for [euro]10,000. The yearly average exchange rate was [euro]1 
= $1.02 for year 1 and [euro]1 = $1.05 for year 2. Under paragraph 
(c)(1) of this section, the amount realized is translated into dollars 
at the yearly average exchange rate for year 2 ([euro]10,000 x $1.05 = 
$10,500). Under paragraph (c)(2)(i) of this section, the basis is 
translated at the historic rate for year 1, which is the yearly average 
exchange rate under section Sec.  1.987-1(c)(3)(i) ([euro]8,000 x $1.02 
= $8,160). Accordingly, the amount of gain reported by U.S. Corp on the 
sale of the land is $2,340 ($10,500-$8,160).
    (8) Example 8: Current rate election. The facts are the same as in 
paragraph (e)(7) of this section (Example 7), except that U.S. Corp 
makes a current rate election under Sec.  1.987-1(d)(2). Under 
paragraph (c)(2) of this section, the exceptions to paragraph (c)(1) of 
this section generally do not apply in a taxable year for which an 
annual recognition election or a current rate election is in effect. As 
a result, all items of income, gain, deduction, and loss with respect 
to Business A are translated into U.S Corp's functional currency at the 
yearly average exchange rate under paragraph (c)(1) of this section. 
Business A's gain on the sale of the land is determined in its 
functional currency and is equal to [euro]2,000 (amount realized of 
[euro]10,000 less basis of [euro]8,000). This gain is translated at the 
yearly average exchange rate for year 2 of [euro]1 = $1.05, and the 
amount of gain reported by U.S. Corp on the sale of the land is $2,100. 
The result would be the same if U.S. Corp made an annual recognition 
election under Sec.  1.987-5(b)(2) (and did not make a current rate 
election).
    (9) through (12) [Reserved]
    (13) Example 13: Section 988 transaction--(i) Facts. Business A 
receives and accrues $100 of income from the provision of services on 
January 1, 2021. Business A continues to hold the $100 as a U.S. 
dollar-denominated demand deposit at a bank on December 31, 2021. U.S. 
Corp has made a section 988 mark-to-market election under paragraph 
(b)(4)(ii) of this section. The euro-dollar spot rate without the use 
of a spot rate convention is [euro]1 = $1 on January 1, 2021, and 
[euro]1 = $2 on December 31, 2021, and the yearly average exchange rate 
for 2021 is [euro]1 = $1.50.
    (ii) Analysis--(A) Under paragraph (b)(2) of this section, the $100 
earned by Business A is translated into [euro]100 at the spot rate on 
January 1, 2021, as defined in Sec.  1.987-1(c)(1) without the use of a 
spot rate convention. In determining U.S. Corp's taxable income, the 
[euro]100 of services income is translated into $150 at the yearly 
average exchange rate for 2021, as provided in paragraph (c)(1) of this 
section.
    (B) Under paragraph (b)(4)(i) of this section, section 988 gain or 
loss for Business A's section 988 transactions is determined in, and by 
reference to, the euro, the functional currency of Business A. 
Accordingly, section 988 gain or loss must be determined on Business 
A's holding of the $100 demand deposit in, and by reference to, the 
euro. Under Sec.  1.988-2(a)(2), Business A is treated as having an 
amount realized of [euro]50 when the $100 is marked to market at the 
end of 2021 under paragraph (b)(4)(ii) of this section. Marking the 
dollars to market gives rise to a section 988 loss of [euro]50 
([euro]50 amount realized, less Business A's [euro]100 basis in the 
$100). In determining U.S. Corp's taxable income, that [euro]50 loss is 
translated into a $75 loss at the yearly average exchange rate for 
2021, as provided in paragraph (c)(1) of this section.
    (14) Example 14: Payment of foreign income tax--(i) Facts. Business 
A earns [euro]100 of revenue from the provision of services and incurs 
[euro]30 of general expenses and [euro]10 of depreciation expense 
during 2021. Except as otherwise provided, U.S. Corp uses the yearly 
average exchange rate described in Sec.  1.987-1(c)(2) to translate 
items of income, gain, deduction, and loss of Business A. Business A is 
subject to income tax in Country X at a 25 percent rate. U.S. Corp 
claims a credit with respect to Business A's foreign income taxes and 
elects under section 986(a)(1)(D) to translate the foreign income taxes 
at the spot rate on the date the taxes were paid. The yearly average 
exchange rate for 2021 is [euro]1 = $1.50. The historic rate used to 
translate the depreciation expense is [euro]1 = $1.00. The spot rate on 
the date that Business A paid its foreign income taxes was [euro]1 = 
$1.60.
    (ii) Analysis. Because U.S. Corp has elected to translate foreign 
income taxes

[[Page 100185]]

at the spot rate on the date such taxes were paid rather than at the 
yearly average exchange rate, U.S. Corp must make the adjustments 
described in paragraph (c)(2)(v) of this section. Accordingly, U.S. 
Corp determines its section 987 taxable income or loss by reducing the 
section 987 taxable income or loss that otherwise would be determined 
under this section by [euro]15, translated into U.S. dollars at the 
yearly average exchange rate ([euro]1 = $1.50), and increasing the 
resulting amount by [euro]15, translated using the same exchange rate 
that is used to translate the creditable taxes into U.S. dollars under 
section 986(a) ([euro]1 = $1.60). Following these adjustments, Business 
A's section 987 taxable income for 2021 is $96.50, computed as follows:

                                        Table 3 to Paragraph (e)(14)(ii)
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                    [euro]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Revenue.......................................       [euro]100  [euro]1 = $1.50.................         $150.00
General Expenses..............................            (30)  [euro]1 = $1.50.................         (45.00)
Depreciation..................................            (10)  [euro]1 = $1.00.................         (10.00)
Tentative section 987 taxable income..........        [euro]60  ................................          $95.00
Adjustments under paragraph (c)(2)(v) of this
 section:
    Decrease by [euro]15 tax translated at      ..............  ................................        ($22.50)
     yearly average exchange rate ([euro]1 =
     $1.50).
    Increase by [euro]15 tax translated at      ..............  ................................           24.00
     spot rate on payment date ([euro]1 =
     $1.60).
        Section 987 taxable income............  ..............  ................................          $96.50
----------------------------------------------------------------------------------------------------------------

Sec.  1.987-4  Determination of net unrecognized section 987 gain or 
loss of a section 987 QBU.

    (a) In general. The net unrecognized section 987 gain or loss of a 
section 987 QBU is determined by the owner annually as provided in 
paragraph (b) of this section in the owner's functional currency. Only 
assets and liabilities attributable to the section 987 QBU are taken 
into account.
    (b) Calculation of net unrecognized section 987 gain or loss. Net 
unrecognized section 987 gain or loss of a section 987 QBU for a 
taxable year equals the sum of:
    (1) The section 987 QBU's net accumulated unrecognized section 987 
gain or loss for all prior taxable years as determined in paragraph (c) 
of this section; and
    (2) The section 987 QBU's unrecognized section 987 gain or loss for 
the current taxable year as determined in paragraph (d) of this section 
and Sec.  1.987-14.
    (c) Net accumulated unrecognized section 987 gain or loss for all 
prior taxable years--(1) In general. A section 987 QBU's net 
accumulated unrecognized section 987 gain or loss for all prior taxable 
years is the aggregate of the amounts determined under paragraph (d) of 
this section for all prior taxable years to which this section applies, 
reduced by amounts recognized under Sec.  1.987-5(a), amounts treated 
as deferred section 987 gain or loss, and amounts treated as suspended 
section 987 loss for all prior taxable years to which this section 
applies. Accordingly, net accumulated unrecognized section 987 gain or 
loss is not reduced under this paragraph (c)(1) when deferred section 
987 gain or loss is recognized (or suspended) under Sec.  1.987-12 or 
when suspended section 987 loss is recognized under Sec.  1.987-11 or 
Sec.  1.987-13.
    (2) Additional adjustments for certain taxable years beginning on 
or before December 31, 2024. For any section 987 QBU in existence 
before the transition date, see Sec.  1.987-10(e)(5) and (f)(2) for 
additional adjustments to the section 987 QBU's net accumulated 
unrecognized section 987 gain or loss.
    (d) Calculation of unrecognized section 987 gain or loss for a 
taxable year. The unrecognized section 987 gain or loss of a section 
987 QBU for a taxable year is generally determined under paragraphs 
(d)(1) through (10) of this section. However, for taxable years in 
which a current rate election or an annual recognition election is in 
effect, the unrecognized section 987 gain or loss of a section 987 QBU 
for a taxable year is determined by applying only paragraphs (d)(1) 
through (5) and (10) of this section. See Sec.  1.987-14 for additional 
adjustments that must be made to the unrecognized section 987 gain or 
loss of a section 987 QBU for a taxable year in connection with a 
section 987 hedging transaction.
    (1) Step 1: Determine the change in the owner functional currency 
net value of the section 987 QBU for the taxable year--(i) In general. 
The change in the owner functional currency net value of the section 
987 QBU for the taxable year equals--
    (A) The owner functional currency net value of the section 987 QBU, 
determined in the functional currency of the owner under paragraph (e) 
of this section, on the last day of the taxable year; less
    (B) The owner functional currency net value of the section 987 QBU, 
determined in the functional currency of the owner under paragraph (e) 
of this section, on the last day of the preceding taxable year.
    (ii) Year section 987 QBU is terminated. If a section 987 QBU is 
terminated within the meaning of Sec.  1.987-8 during an owner's 
taxable year, the termination date is treated as the last day of the 
taxable year for purposes of this section.
    (iii) First taxable year of a section 987 QBU. If the owner's 
taxable year is the first taxable year of a section 987 QBU, the owner 
functional currency net value of the section 987 QBU described in 
paragraph (d)(1)(i)(B) of this section is zero.
    (iv) First year in which an election is in effect or ceases to be 
in effect. Except as otherwise provided, the owner functional currency 
net value of the section 987 QBU described in paragraph (d)(1)(i)(B) of 
this section is determined based on the elections that were (or were 
not) in effect on the last day of the preceding taxable year.
    (2) Step 2: Increase the amount determined in step 1 by the amount 
of assets transferred from the section 987 QBU to the owner--(i) In 
general. The amount determined in paragraph (d)(1) of this section is 
increased by the total amount of assets transferred from the section 
987 QBU to the owner during the taxable year translated into the 
functional currency of the owner as provided in paragraph (d)(2)(ii) of 
this section.
    (ii) Assets transferred from the section 987 QBU to the owner 
during the taxable year. The total amount of assets transferred from 
the section 987 QBU to the owner for the taxable year translated into 
the functional currency of the owner equals the sum of:

[[Page 100186]]

    (A) The amount of the functional currency of the section 987 QBU 
and the aggregate adjusted basis of all other marked assets, after 
taking into account Sec.  1.988-1(a)(10), transferred to the owner 
during the taxable year determined in the functional currency of the 
section 987 QBU and translated into the functional currency of the 
owner at the spot rate applicable to the date of transfer; and
    (B) The aggregate adjusted basis of all historic assets transferred 
to the owner during the taxable year determined in the functional 
currency of the section 987 QBU and translated into the functional 
currency of the owner at the historic rate for each such asset.
    (3) Step 3: Decrease the amount determined in steps 1 and 2 by the 
amount of assets transferred from the owner to the section 987 QBU--(i) 
In general. The aggregate amount determined in paragraphs (d)(1) and 
(2) of this section is decreased by the total amount of assets 
transferred from the owner to the section 987 QBU during the taxable 
year determined in the functional currency of the owner as provided in 
paragraph (d)(3)(ii) of this section.
    (ii) Assets transferred from the owner to the section 987 QBU 
during the taxable year. The total amount of assets transferred from 
the owner to the section 987 QBU for the taxable year equals the sum 
of:
    (A) The amount of functional currency of the owner transferred to 
the section 987 QBU during the taxable year; and
    (B) The aggregate adjusted basis of all other assets, after taking 
into account Sec.  1.988-1(a)(10), transferred to the section 987 QBU 
during the taxable year determined in the functional currency of the 
owner immediately before the transfer.
    (4) Step 4: Decrease the amount determined in steps 1 through 3 by 
the amount of liabilities transferred from the section 987 QBU to the 
owner--(i) In general. The aggregate amount determined in paragraphs 
(d)(1) through (3) of this section is decreased by the total amount of 
liabilities transferred from the section 987 QBU to the owner during 
the taxable year translated into the functional currency of the owner 
as provided in paragraph (d)(4)(ii) of this section.
    (ii) Liabilities transferred from the section 987 QBU to the owner 
during the taxable year. The total amount of liabilities transferred 
from the section 987 QBU to the owner for the taxable year equals the 
sum of:
    (A) The amount of marked liabilities, after taking into account 
Sec.  1.988-1(a)(10), transferred to the owner during the taxable year 
determined in the functional currency of the section 987 QBU and 
translated into the functional currency of the owner at the spot rate 
applicable to the date of transfer; and
    (B) The amount of historic liabilities transferred to the owner 
during the taxable year determined in the functional currency of the 
section 987 QBU and translated into the functional currency of the 
owner at the historic rate for each such liability.
    (5) Step 5: Increase the amount determined in steps 1 through 4 by 
the amount of liabilities transferred from the owner to the section 987 
QBU. The aggregate amount determined in paragraphs (d)(1) through (4) 
of this section is increased by the total amount of liabilities, after 
taking into account Sec.  1.988-1(a)(10), transferred from the owner to 
the section 987 QBU during the taxable year determined in the 
functional currency of the owner immediately before the transfer.
    (6) Step 6: Decrease or increase the amount determined in steps 1 
through 5 by the section 987 taxable income or loss, respectively, of 
the section 987 QBU for the taxable year. The aggregate amount 
determined in paragraphs (d)(1) through (5) of this section is 
decreased or increased by the section 987 taxable income or loss, 
respectively, computed under Sec.  1.987-3 for the taxable year.
    (7) Step 7: Increase the amount determined in steps 1 through 6 by 
certain expenses or losses that are not deductible in computing the 
section 987 taxable income or loss of the section 987 QBU for the 
taxable year. The aggregate amount determined under paragraphs (d)(1) 
through (6) of this section is increased by the amount of any expense 
or loss that reduces the basis of assets or increases the amount of 
liabilities attributable to the section 987 QBU for the taxable year 
but is not deductible in computing the section 987 QBU's taxable income 
or loss for the taxable year (such as business interest expense that is 
not deductible under section 163(j)). Items of expense or loss 
described in the preceding sentence are translated into the functional 
currency of the owner using the exchange rate that would apply under 
Sec.  1.987-3(c) if they were deductible in computing the section 987 
QBU's taxable income or loss for the taxable year. However, any foreign 
income taxes incurred by the section 987 QBU with respect to which the 
owner claims a credit are translated at the same rate at which such 
taxes were translated under section 986(a).
    (8) Step 8: Decrease the amount determined in steps 1 through 7 by 
the amount of certain income or gain that is not included in taxable 
income in computing the section 987 taxable income or loss of the 
section 987 QBU for the taxable year. The aggregate amount determined 
under paragraphs (d)(1) through (7) of this section is decreased by the 
amount of any income or gain that increases the basis of assets or 
reduces the amount of liabilities attributable to the section 987 QBU 
for the taxable year but is not included in taxable income in computing 
the section 987 QBU's taxable income or loss for the taxable year. 
Items of income or gain described in the preceding sentence are 
translated into the functional currency of the owner using the exchange 
rate that would apply under Sec.  1.987-3(c) if they were included in 
taxable income in computing the section 987 QBU's taxable income or 
loss for the taxable year.
    (9) Step 9: Increase or decrease the amount determined in steps 1 
through 8 by any income or gain, or any deduction or loss, 
respectively, that does not impact the adjusted balance sheet. The 
aggregate amount determined under paragraphs (d)(1) through (8) of this 
section is increased by any items of income or gain taken into account 
in paragraph (d)(6) of this section (step 6) that do not increase the 
basis of assets or reduce the amount of liabilities attributable to the 
section 987 QBU for the taxable year, and decreased by any items of 
deduction or loss taken into account in paragraph (d)(6) of this 
section (step 6) that do not reduce the basis of assets or increase the 
amount of liabilities attributable to the section 987 QBU for the 
taxable year. Items of income, gain, deduction, or loss described in 
the preceding sentence are translated into the functional currency of 
the owner using the exchange rate that applied under Sec.  1.987-3(c) 
in computing the section 987 QBU's taxable income or loss for the 
taxable year.
    (10) Step 10: Decrease or increase the amount determined in steps 1 
through 9 by any increase or decrease, respectively, to the section 987 
QBU's net assets that is not previously taken into account under steps 
2 through 9--(i) In general. Except as provided in paragraph 
(d)(10)(iii) of this section, the aggregate amount determined under 
paragraphs (d)(1) through (9) of this section is--
    (A) Decreased by the residual increase to net assets (as defined in 
paragraph (d)(10)(ii) of this section), translated into the owner's 
functional currency at the yearly average exchange rate for the taxable 
year; or
    (B) Increased by the residual decrease to net assets (as defined in 
paragraph

[[Page 100187]]

(d)(10)(ii) of this section), translated into the owner's functional 
currency at the yearly average exchange rate for the taxable year.
    (ii) Determining the residual increase or decrease to net assets--
(A) In general. The residual increase to net assets is the positive 
amount, if any, that would be determined under paragraphs (d)(1) 
through (9) of this section in the functional currency of the section 
987 QBU if such amounts were determined in the functional currency of 
the section 987 QBU. The residual decrease to net assets is the 
negative amount, if any, that would be determined under paragraphs 
(d)(1) through (9) of this section in the functional currency of the 
section 987 QBU if such amounts were determined in the functional 
currency of the section 987 QBU.
    (B) Application of step 1 in the functional currency of the section 
987 QBU if a current rate election is in effect. In a taxable year in 
which a current rate election is in effect, for purposes of applying 
step 1 (paragraph (d)(1) of this section) in the functional currency of 
the section 987 QBU, the change in the net value of the section 987 QBU 
is determined by reference to the QBU net value described in paragraph 
(e)(2)(ii) of this section.
    (C) Application of steps 3 and 5 in the functional currency of the 
section 987 QBU. For purposes of applying steps 3 and 5 (paragraphs 
(d)(3) and (5) of this section) in the functional currency of the 
section 987 QBU, the amount of assets and liabilities transferred from 
an owner to a section 987 QBU is determined by translating the basis of 
the assets and the amount of the liabilities under Sec.  1.987-2(d).
    (iii) Modifications for taxable years to which a current rate 
election or an annual recognition election applies. For any taxable 
year to which a current rate election or an annual recognition election 
applies, paragraphs (d)(10)(i) and (ii) of this section are applied by 
replacing ``paragraphs (d)(1) through (9) of this section'' with 
``paragraphs (d)(1) through (5) of this section.''
    (e) Determination of the owner functional currency net value of a 
section 987 QBU--(1) In general. Except as provided in paragraph (e)(2) 
of this section, the owner functional currency net value of a section 
987 QBU on the last day of a taxable year is equal to the aggregate 
amount of functional currency and the adjusted basis of each other 
asset on the section 987 QBU's adjusted balance sheet on that day, less 
the aggregate amount of each liability on the section 987 QBU's 
adjusted balance sheet on that day, in each case translated into the 
owner's functional currency as provided in paragraphs (e)(1)(i) and 
(ii) of this section.
    (i) Marked item. A marked item is translated into the owner's 
functional currency at the spot rate applicable to the last day of the 
relevant taxable year.
    (ii) Historic item. A historic item is translated into the owner's 
functional currency at the historic rate.
    (2) Current rate election--(i) In general. If a current rate 
election is in effect, the owner functional currency net value of a 
section 987 QBU on the last day of a taxable year is equal to the QBU 
net value described in paragraph (e)(2)(ii) of this section, translated 
into the owner's functional currency at the spot rate applicable to 
that day.
    (ii) QBU net value. The QBU net value of a section 987 QBU on the 
last day of a taxable year is determined in the functional currency of 
the section 987 QBU and is equal to the aggregate amount of functional 
currency and the adjusted basis of each other asset that is 
attributable to the section 987 QBU on that day, less the aggregate 
amount of each liability that is attributable to the section 987 QBU on 
that day. The QBU net value of a section 987 QBU on the last day of a 
taxable year may be determined either by preparing an adjusted balance 
sheet or by following the steps described in paragraph (e)(2)(iii) of 
this section (provided that the calculation is made consistently for 
all years in which a current rate election is in effect). However, in 
the first taxable year in which a current rate election ceases to be in 
effect, the owner functional currency net value of the section 987 QBU 
for the preceding taxable year must be determined by preparing an 
adjusted balance sheet.
    (iii) Alternative calculation of QBU net value. The QBU net value 
of a section 987 QBU on the last day of a taxable year can be computed 
using the following steps (each applied in the functional currency of 
the section 987 QBU). See paragraph (g)(2)(iii) of this section 
(Example 2) for an example illustrating this rule.
    (A) Step 1: Determine the QBU net value on the last day of the 
preceding taxable year. Determine the QBU net value on the last day of 
the preceding taxable year under this paragraph (e)(2). If the owner's 
taxable year is the first taxable year of a section 987 QBU, the QBU 
net value on the last day of the preceding taxable year is zero. In the 
first taxable year in which a current rate election is in effect (other 
than the taxable year beginning on the transition date or the first 
taxable year of a section 987 QBU), the QBU net value on the last day 
of the preceding taxable year is determined by preparing an adjusted 
balance sheet. In the taxable year beginning on the transition date 
(other than the first taxable year of a section 987 QBU), the QBU net 
value on the last day of the preceding taxable year may be determined 
either by preparing an adjusted balance sheet or by applying the steps 
described in this paragraph (e)(2)(iii) for each taxable year beginning 
with the first taxable year of the section 987 QBU.
    (B) Step 2: Adjust for transfers between the section 987 QBU and 
its owner. The amount determined in paragraph (e)(2)(iii)(A) of this 
section is increased by the amount of each transfer described in 
paragraph (d)(3) or (4) of this section and decreased by the amount of 
each transfer described in paragraph (d)(2) or (5) of this section (in 
each case, after adjustment for gain or loss recognized under Sec.  
1.988-1(a)(10)). For this purpose, the amount of assets and liabilities 
transferred from an owner to a section 987 QBU is determined by 
translating the basis of the assets and the amount of the liabilities 
under Sec.  1.987-2(d)(1).
    (C) Step 3: Adjust for income or loss of the section 987 QBU. The 
amount determined in paragraph (e)(2)(iii)(B) of this section is 
increased by items of income and gain attributable to the section 987 
QBU (including tax-exempt income described in paragraph (d)(8) of this 
section) for the taxable year and reduced by items of deduction and 
loss attributable to the section 987 QBU (including non-deductible 
expenses described in paragraph (d)(7) of this section) for the taxable 
year. However, no adjustment is made under the preceding sentence for 
any item of income, gain, deduction, or loss described in paragraph 
(d)(9) of this section.
    (f) Combinations and separations--(1) Combinations. The net 
accumulated unrecognized section 987 gain or loss of a combined QBU for 
a taxable year is equal to the sum of the combining QBUs' net 
accumulated unrecognized section 987 gain or loss. See paragraph 
(f)(3)(i) of this section (Example 1) for an illustration of this rule.
    (2) Separations. The net accumulated unrecognized section 987 gain 
or loss of a separated QBU for a taxable year is equal to the 
separating QBU's net accumulated unrecognized section 987 gain or loss 
multiplied by the separation fraction. For purposes of determining the 
owner functional currency net value and QBU net value of the separated 
QBUs on the last day of the taxable year preceding the taxable year of 
separation under paragraphs (d)(1)(i)(B) and (e) of this section, the 
assets and liabilities attributable to the separating QBU on

[[Page 100188]]

that day are deemed to be attributable to the separated QBUs on that 
day, and are apportioned between the separated QBUs in a reasonable 
manner that takes into account the assets and liabilities attributable 
to the separated QBUs immediately after the separation. See paragraph 
(f)(3)(ii) of this section (Example 2) for an illustration of this 
rule.
    (3) Examples. The following examples illustrate the rules of 
paragraphs (f)(1) and (2) of this section. For purposes of these 
examples, assume that no section 987 elections are in effect.
    (i) Example 1: Combination of two section 987 QBUs that have the 
same owner--(A) Facts. DC1, a domestic corporation, owns Entity A, a 
DE. Entity A conducts a manufacturing business that constitutes a 
section 987 QBU (Manufacturing QBU) that has the euro as its functional 
currency. Manufacturing QBU has a net accumulated unrecognized section 
987 loss of $100. DC1 also owns Entity B, a DE. Entity B conducts a 
sales business that constitutes a section 987 QBU (Sales QBU) that has 
the euro as its functional currency. Sales QBU has a net accumulated 
unrecognized section 987 gain of $110. During the taxable year, Entity 
A merges into Entity B under local law pursuant to which Entity A 
ceases to exist, Entity B survives, and Entity B acquires all the 
assets and liabilities of Entity A. As a result, the books and records 
of Manufacturing QBU and Sales QBU are combined into a new single set 
of books and records. The combined entity has the euro as its 
functional currency.
    (B) Analysis. Pursuant to Sec.  1.987-2(c)(9)(i), Manufacturing QBU 
and Sales QBU are combining QBUs, and their combination does not give 
rise to a transfer that is taken into account in determining the amount 
of a remittance (as defined in Sec.  1.987-5(c)). For purposes of 
computing net unrecognized section 987 gain or loss under this section 
for the year of the combination, the combination is deemed to have 
occurred on the last day of the owner's prior taxable year, such that 
the owner functional currency net value of the combined section 987 QBU 
at the end of that taxable year described under paragraph (d)(1)(i)(B) 
of this section takes into account items attributable to both 
Manufacturing QBU and Sales QBU at that time. Additionally, any 
transactions between Manufacturing QBU and Sales QBU occurring during 
the year of the merger will not result in transfers to or from a 
section 987 QBU. Pursuant to paragraph (f)(1) of this section, the 
combined QBU will have a net accumulated unrecognized section 987 gain 
of $10 (the $100 loss from Manufacturing QBU plus the $110 gain from 
Sales QBU).
    (ii) Example 2: Separation of two section 987 QBUs that have the 
same owner--(A) Facts. DC1, a domestic corporation, owns Entity A, a 
DE. Entity A conducts a business in the Netherlands that constitutes a 
section 987 QBU (Dutch QBU) that has the euro as its functional 
currency. The business of Dutch QBU consists of manufacturing and 
selling bicycles and scooters and is recorded on a single set of books 
and records. On the last day of year 1, the adjusted basis of the gross 
assets of Dutch QBU is [euro]1,000. In year 2, the net accumulated 
unrecognized section 987 loss of Dutch QBU from all prior taxable years 
is $200. During year 2, Entity A separates the bicycle and scooter 
business such that each business begins to have its own books and 
records and to meet the definition of a section 987 QBU under Sec.  
1.987-1(b)(3) (hereafter, ``bicycle QBU'' and ``scooter QBU''). There 
are no transfers between DC1 and Dutch QBU before the separation. After 
the separation, the aggregate adjusted basis of bicycle QBU's assets is 
[euro]600 and the aggregate adjusted basis of scooter QBU's assets is 
[euro]400. Each section 987 QBU continues to have the euro as its 
functional currency.
    (B) Analysis. Pursuant to Sec.  1.987-2(c)(9)(iii), bicycle QBU and 
scooter QBU are separated QBUs, and the separation of Dutch QBU, a 
separating QBU, does not give rise to a transfer taken into account in 
determining the amount of a remittance. For purposes of computing net 
unrecognized section 987 gain or loss under this section for year 2, 
the separation will be deemed to have occurred on the last day of the 
owner's prior taxable year, year 1. Pursuant to paragraph (f)(2) of 
this section and Sec.  1.987-1(h), bicycle QBU will have a separation 
fraction of [euro]600/[euro]1,000 and net accumulated unrecognized 
section 987 loss of $120 ([euro]600/[euro]1,000 x $200), and scooter 
QBU will have a separation fraction of [euro]400/[euro]1,000 and net 
accumulated unrecognized section 987 loss of $80 ([euro]400/[euro]1,000 
x $200).
    (g) Examples. The following examples illustrate the provisions of 
this section. For purposes of the examples, U.S. Corp is a domestic 
corporation that uses the calendar year as its taxable year and has the 
dollar as its functional currency. Except as otherwise indicated, no 
section 987 elections are in effect. The examples are not intended to 
demonstrate when activities constitute a trade or business within the 
meaning of Sec.  1.989(a)-1(b)(2)(ii)(A) and (c) and therefore whether 
a section 987 QBU is considered to exist.
    (1) Example 1: Determination of net unrecognized section 987 gain 
or loss--(i) Facts. On July 1, year 1, U.S. Corp establishes Japan 
Branch, a section 987 QBU that has the yen as its functional currency, 
and U.S. Corp transfers to Japan Branch [yen]100,000 with a basis of 
$1,000 and raw land with a basis of $500. On the same day, Japan Branch 
borrows [yen]10,000 from a bank. In year 1, Japan Branch earns 
[yen]12,000 for providing services and incurs [yen]2,000 of related 
expenses. Japan Branch thus earns [yen]10,000 of net income in year 1. 
The spot rate on July 1, year 1, is $1 = [yen]100; the spot rate on 
December 31, year 1, is $1 = [yen]120; and the average rate for the 
period of July 1, year 1, to December 31, year 1, is $1 = [yen]110. 
Thus, the [yen]12,000 of services revenue when translated under Sec.  
1.987-3(c)(1) at the yearly average exchange rate equals $109.09 
([yen]12,000 x ($1/[yen]110)) = $109.09). The [yen]2,000 of expenses 
translated at the same yearly average exchange rate equals $18.18 
([yen]2,000 x ($1/[yen]110) = $18.18). Thus, Japan Branch's net income 
translated into dollars equals $90.91 ($109.09-$18.18 = $90.91).
    (ii) Analysis. Under paragraph (a) of this section, U.S. Corp must 
compute the net unrecognized section 987 gain or loss of Japan Branch 
for year 1. Because this is Japan Branch's first taxable year, the net 
unrecognized section 987 gain or loss (as defined under paragraph (b) 
of this section) is equal to the branch's unrecognized section 987 gain 
or loss for year 1 as determined in paragraph (d) of this section. The 
calculations under paragraph (d) of this section are made as follows:
    (A) Step 1. Under paragraph (d)(1) of this section (step 1), U.S. 
Corp must determine the change in the owner functional currency net 
value (OFCNV) of Japan Branch for year 1 in dollars. The change in the 
OFCNV of Japan Branch for year 1 is equal to the OFCNV of Japan Branch 
determined in dollars on the last day of year 1, less the OFCNV of 
Japan Branch determined in dollars on the last day of the preceding 
taxable year.
    (1) The OFCNV of Japan Branch on December 31, year 1 is determined 
under paragraph (e) of this section as the sum of the basis of each 
asset on Japan Branch's adjusted balance sheet on December 31, year 1, 
less the sum of each liability on Japan Branch's adjusted balance sheet 
on that date, translated into dollars as provided in paragraphs 
(e)(1)(i) and (ii) of this section.
    (2) For this purpose, Japan Branch will show the following assets 
and liabilities on its adjusted balance sheet

[[Page 100189]]

for December 31, year 1: cash of [yen]120,000; raw land with a basis of 
[yen]55,000 ($500 translated under Sec.  1.987-2(d)(2) at the historic 
rate of $1 = [yen]110); and liabilities of [yen]10,000.
    (3) Under paragraphs (e)(1)(i) and (ii) of this section, U.S. Corp 
will translate these items as follows. The [yen]120,000 is a marked 
asset and the [yen]10,000 liability is a marked liability. These items 
are translated into dollars on December 31, year 1, using the spot rate 
on December 31, year 1, of $1 = [yen]120. The raw land is a historic 
asset and is translated into dollars under paragraph (e)(1)(ii) of this 
section at the historic rate, which under Sec.  1.987-1(c)(3)(i)(A) is 
the yearly average exchange rate of $1 = [yen]110 applicable to the 
year the land was transferred to the QBU.
    (4) The OFCNV of Japan Branch on December 31, year 1, in dollars is 
$1,416.67. The determination of the OFCNV of Japan Branch on December 
31, year 1, is shown below in dollars together with the corresponding 
amounts in yen.

                           Table 1 to Paragraph (g)(1)(ii)(A)(4)--OFCNV--End of Year 1
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                     [yen]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Assets
    Yen.......................................         120,000  $1 = [yen]120 (spot rate-12/31/        $1,000.00
                                                                 year 1).
    Land......................................          55,000  $1 = [yen]110 (historic rate-             500.00
                                                                 yearly average rate-year 1).
                                               -----------------------------------------------------------------
    Total assets..............................         175,000  ................................        1,500.00
Liabilities
    Bank loan.................................          10,000  $1 = [yen]120 (spot rate-12/31/            83.33
                                                                 year 1).
                                               -----------------------------------------------------------------
    Total liabilities.........................          10,000  ................................           83.33
Year 1 ending net value.......................         165,000  ................................        1,416.67
----------------------------------------------------------------------------------------------------------------

    (5) Under paragraph (d)(1) of this section, the change in OFCNV of 
Japan Branch for year 1 is equal to the OFCNV of the branch determined 
in dollars on December 31, year 1, (which is $1,416.67) less the OFCNV 
of the branch determined in dollars on the last day of the preceding 
taxable year. Because this is the first taxable year of Japan Branch, 
the OFCNV of Japan Branch determined in dollars on the last day of the 
preceding taxable year is zero under paragraph (d)(1)(iii) of this 
section. Accordingly, the change in OFCNV of Japan Branch for year 1 is 
$1,416.67.
    (B) Step 2 (no adjustment). No adjustment is made under paragraph 
(d)(2) of this section (step 2) because no assets were transferred by 
Japan Branch to U.S. Corp during the taxable year.
    (C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan 
Branch [yen]100,000 with a basis of $1,000.00 and raw land with a basis 
of $500.00 (equal to [yen]55,000, translated under Sec.  1.987-2(d)(2) 
at the historic rate of $1 = [yen]110). The total amount of assets 
transferred from U.S. Corp to Japan Branch in dollars is $1,500, and 
the total amount of the transfer in yen is [yen]155,000. Therefore, 
under paragraph (d)(3) of this section (step 3), the amount determined 
in previous steps is reduced by $1,500.00, from $1,416.67 to negative 
$83.33.
    (D) Steps 4 and 5 (no adjustment). No adjustment is made under 
paragraphs (d)(4) and (5) of this section (steps 4 and 5) because no 
liabilities were transferred by U.S. Corp to Japan Branch or by Japan 
Branch to U.S. Corp during the taxable year.
    (E) Step 6. Under paragraph (d)(6) of this section (step 6), the 
amount determined in previous steps is decreased by the section 987 
taxable income of Japan Branch of $90.91, from negative $83.33 to 
negative $174.24.
    (F) Steps 7 through 9 (no adjustment). No adjustment is made under 
paragraphs (d)(7) through (9) of this section (steps 7 through 9) 
because all of Japan Branch's items of income or deduction for the 
taxable year impact the basis of Japan Branch's assets or the amount of 
its liabilities and are taken into account in computing taxable income.
    (G) Step 10 (no adjustment)--(1) Calculation of residual increase 
or decrease to net assets. Under paragraph (d)(10)(ii) of this section, 
the residual increase (or decrease) to net assets is the positive (or 
negative) amount, if any, that would be determined under paragraphs 
(d)(1) through (9) of this section (steps 1 through 9) in the 
functional currency of the section 987 QBU if such amounts were 
determined in the functional currency of the section 987 QBU. In year 
1, the relevant steps that must be applied in the functional currency 
of Japan Branch (the yen) are paragraphs (d)(1), (3), and (6) of this 
section (steps 1, 3, and 6). For purposes of applying paragraph (d)(1) 
of this section (step 1) in yen, the change in the net value of Japan 
Branch is [yen]165,000. See paragraph (g)(1)(ii)(A)(4) of this section. 
For purposes of applying paragraph (d)(3) of this section (step 3) in 
yen, the amount of assets transferred from U.S. Corp to Japan Branch is 
[yen]155,000. See paragraph (g)(1)(ii)(C) of this section. For purposes 
of applying paragraph (d)(6) of this section (step 6) in yen, Japan 
Branch earned [yen]10,000 of net income in year 1. The application of 
these steps results in no residual increase or decrease to the adjusted 
balance sheet, as shown below:

 Table 2 to Paragraph (g)(1)(ii)(G)(1)--Application of Relevant Steps in
                                   Yen
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Change in net value in yen (step 1)..................       [yen]165,000
Subtract amount determined in yen under step 3            ([yen]155,000)
 (transfers from owner to section 987 QBU)...........
Subtract amount determined in yen under step 6             ([yen]10,000)
 (section 987 taxable income or loss)................
    Residual increase or decrease to the adjusted                 [yen]0
     balance sheet...................................
------------------------------------------------------------------------

    (2) No residual increase or decrease to the adjusted balance sheet. 
As explained in paragraph (g)(1)(ii)(G)(1) of this section, there is no 
residual increase or decrease to the adjusted balance sheet of Japan 
Branch in year 1. Therefore, no adjustment is made under paragraph 
(d)(10) of this section (step 10). Accordingly, the unrecognized 
section 987 loss of Japan Branch for year 1 is $174.24.

[[Page 100190]]

    (2) Example 2: Determination of net unrecognized section 987 gain 
or loss if a current rate election is in effect--(i) Facts. The facts 
are the same as in paragraph (g)(1) of this section (Example 1), except 
that U.S. Corp makes a current rate election under Sec.  1.987-1(d)(2) 
for year 1.
    (ii) Analysis. Because a current rate election is in effect for 
year 1, the unrecognized section 987 gain or loss for year 1 is 
determined by applying only paragraphs (d)(1) through (5) and (10) of 
this section (steps 1 through 5 and step 10). The calculations under 
paragraph (d) of this section are made as follows:
    (A) Step 1. The change in the OFCNV of Japan Branch for year 1 is 
equal to the OFCNV of Japan Branch determined in dollars on the last 
day of year 1, less the OFCNV of Japan Branch determined in dollars on 
the last day of the preceding taxable year.
    (1) For this purpose, Japan Branch will show the same assets and 
liabilities on its adjusted balance sheet for December 31, year 1 as 
are described in paragraph (g)(1)(ii)(A)(2) of this section (Example 
1), but the land is treated as a marked asset as a result of the 
current rate election. The adjusted balance sheet reflects cash of 
[yen]120,000, raw land with a basis of [yen]50,000 ($500 translated 
under Sec.  1.987-2(d)(1) at the July 1, year 1 spot rate of $1 = 
[yen]100), and liabilities of [yen]10,000.
    (2) Under paragraph (e)(2)(ii) of this section, because a current 
rate election is in effect, the OFCNV of Japan Branch at the end of 
year 1 is equal to the QBU net value, translated into U.S. dollars at 
the applicable spot rate on the last day of the taxable year. The QBU 
net value of Japan Branch at the end of year 1 is [yen]160,000, as 
shown below. The OFCNV of Japan Branch is $1,333.33, which is equal to 
the QBU net value of [yen]160,000, translated at the applicable spot 
rate on December 31, year 1 of $1 = [yen]120.

      Table 3 to Paragraph (g)(2)(ii)(A)(2)--QBU Net Value--Year 1
------------------------------------------------------------------------
                                                             Amount in
                                                               [yen]
------------------------------------------------------------------------
Assets:
    Yen.................................................         120,000
    Land................................................          50,000
                                                         ---------------
        Total assets....................................         170,000
Liabilities:
    Bank loan...........................................          10,000
                                                         ---------------
        Total liabilities...............................          10,000
Year 1 QBU net value....................................         160,000
------------------------------------------------------------------------

    (3) Under paragraph (d)(1) of this section, the change in OFCNV of 
Japan Branch for year 1 is equal to the OFCNV of the branch determined 
in dollars on December 31, year 1, (which is $1,333.33) less the OFCNV 
of the branch determined in dollars on the last day of the preceding 
taxable year. Because this is the first taxable year of Japan Branch, 
the OFCNV of Japan Branch determined in dollars on the last day of the 
preceding taxable year is zero under paragraph (d)(1)(iii) of this 
section. Accordingly, the change in OFCNV of Japan Branch for year 1 is 
$1,333.33.
    (B) Step 2 (no adjustment). No adjustment is made under paragraph 
(d)(2) of this section (step 2) because no assets were transferred by 
Japan Branch to U.S. Corp during the taxable year.
    (C) Step 3. On July 1, year 1, U.S. Corp transferred to Japan 
Branch [yen]100,000 with a basis of $1,000.00 and raw land with a basis 
of $500.00 (equal to [yen]50,000, translated under Sec.  1.987-2(d)(1) 
at the spot rate on July 31, year 1 of $1 = [yen]100). The total amount 
of assets transferred in dollars is $1,500.00, and the amount of assets 
transferred in yen is [yen]150,000. Therefore, under paragraph (d)(3) 
of this section (step 3), the amount determined in previous steps is 
reduced by $1,500, from $1,333.33 to negative $166.67.
    (D) Steps 4 and 5 (no adjustment). No adjustment is made under 
paragraphs (d)(4) and (5) of this section (steps 4 and 5) because no 
liabilities were transferred by U.S. Corp to Japan Branch or by Japan 
Branch to U.S. Corp during the taxable year.
    (E) Steps 6 through 9 do not apply. Under paragraph (d) of this 
section, paragraphs (d)(6) through (9) of this section (steps 6 through 
9) do not apply because a current rate election is in effect.
    (F) Step 10--(1) Application of relevant steps in Japan Branch's 
functional currency. Under paragraph (d)(10)(iii) of this section, 
because a current rate election is in effect, the residual increase or 
decrease to net assets is determined by applying paragraphs (d)(1) 
through (5) of this section (steps 1 through 5) in the functional 
currency of the section 987 QBU. The relevant steps that must be 
applied under paragraph (d)(10) of this section in the functional 
currency of Japan Branch are paragraphs (d)(1) and (3) of this section 
(steps 1 and 3). Under paragraph (d)(10)(ii)(B) of this section, step 1 
is applied by reference to Japan Branch's QBU net value. See paragraphs 
(g)(2)(ii)(A) and (C) of this section for amounts determined in yen. 
The residual increase to net assets is determined as follows:

 Table 4 to Paragraph (g)(2)(ii)(F)(1)--Application of Relevant Steps in
                                   Yen
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Step 1: Change in net value..........................       [yen]160,000
Step 3: Subtract amount of transfers from owner to        ([yen]150,000)
 section 987 QBU.....................................
                                                      ------------------
    Residual increase or decrease to the adjusted            [yen]10,000
     balance sheet...................................
------------------------------------------------------------------------

    (2) Residual increase or decrease to net assets. As explained in 
paragraph (g)(2)(ii)(F)(1) of this section, the residual increase to 
Japan Branch's net assets in year 1 is [yen]10,000. This amount, 
translated at the yearly average exchange rate of $1 = [yen]110, equals 
$90.91. Therefore, the amount determined in previous steps is reduced 
by $90.91, from negative $166.67 to negative $257.58. Accordingly, the 
unrecognized section 987 loss of Japan Branch for year 1 is $257.58.
    (iii) Alternative computation of QBU net value. Alternatively, for 
purposes of applying steps 1 and 10 (paragraphs (d)(1) and (10) of this 
section), U.S. Corp can determine QBU net value using the following 
steps under paragraph (e)(2)(iii) of this section.
    (A) Step 1: Determine QBU net value at the end of the preceding 
taxable year. Because year 1 is the first taxable year in which Japan 
Branch exists, the QBU net value at the end of the preceding taxable 
year is zero.
    (B) Step 2: Adjust for transfers between the section 987 QBU and 
its owner. During year 1, U.S. Corp transferred assets to Japan Branch 
with an aggregate basis of [yen]150,000, as described in paragraph 
(g)(2)(ii)(C) of this section. Therefore, the amount determined in step 
1 is increased from zero to [yen]150,000.
    (C) Step 3: Adjust for income or loss of the section 987 QBU. 
During year 1, Japan Branch earned [yen]10,000 of net income. 
Therefore, the amount

[[Page 100191]]

determined in step 2 is increased from [yen]150,000 to [yen]160,000.
    (D) QBU net value. Japan Branch's QBU net value at the end of the 
preceding taxable year is zero. This amount is increased by the 
transfer from U.S. Corp of [yen]150,000 and by Japan Branch's taxable 
income of [yen]10,000. Japan Branch did not have any tax-exempt income 
or non-deductible expenses in year 1. Accordingly, Japan Branch's QBU 
net value at the end of year 1 is [yen]160,000.
    (3) Example 3: Determination of net unrecognized section 987 gain 
or loss when a current rate election is revoked--(i) Facts--(A) 
Background. The facts in year 1 are the same as in paragraph (g)(2) of 
this section (Example 2). In year 9, a current rate election remains in 
effect, U.S. Corp has net unrecognized section 987 loss of $1,000 with 
respect to Japan Branch, and Japan Branch does not make a remittance. 
On December 31, year 9, the adjusted balance sheet of Japan Branch 
shows the following assets and liabilities: cash of [yen]120,000; raw 
land with a basis of [yen]50,000; and liabilities of [yen]10,000. 
Effective for year 10, U.S. Corp revokes the current rate election.
    (B) Operations in year 10. In year 10, Japan Branch earns 
[yen]12,000 for providing services and incurs [yen]2,000 of related 
expenses. Japan Branch thus earns [yen]10,000 of net income in year 10. 
On December 31, year 10, the adjusted balance sheet of Japan Branch 
shows the following assets and liabilities: cash of [yen]130,000; raw 
land with a basis of [yen]50,000; and liabilities of [yen]10,000. 
Assume that the spot rate on December 31, year 9, is $1 = [yen]120; the 
spot rate on December 31, year 10, is $1 = [yen]130; and the yearly 
average exchange rate for year 10 is $1 = [yen]125. Thus, the 
[yen]12,000 of services revenue when properly translated under Sec.  
1.987-3(c)(1) at the yearly average exchange rate equals $96.00 
([yen]12,000 x ($1/[yen]125)) = $96.00). The [yen]2,000 of expenses 
translated at the same yearly average exchange rate equals $16.00 
([yen]2,000 x ($1/[yen]125) = $16.00). Thus, Japan Branch's net income 
translated into dollars equals $80. There are no transfers of assets or 
liabilities between U.S. Corp and Japan Branch in year 10.
    (ii) Analysis--(A) Determination of OFCNV for year 9. Under 
paragraph (d)(1)(iv) of this section, the OFCNV of a section 987 QBU on 
the last day of the preceding taxable year is determined based on the 
elections that were (or were not) in effect on the last day of that 
taxable year. In year 9, a current rate election was in effect. 
Therefore, in determining the OFCNV of Japan Branch for year 9, all 
assets and liabilities of Japan Branch (including the land) are treated 
as marked items. Under paragraph (e)(2)(ii) of this section, because a 
current rate election was in effect for year 9, the OFCNV of Japan 
Branch at the end of year 9 is equal to the QBU net value, translated 
into U.S. dollars at the applicable spot rate on the last day of the 
taxable year. The QBU net value of Japan Branch at the end of year 9 is 
[yen]160,000, as shown below. The OFCNV of Japan Branch is $1,333.33, 
which is equal to the QBU net value of [yen]160,000, translated at the 
applicable spot rate on December 31, year 9 of $1 = [yen]120.

    Table 5 to Paragraph (g)(3)(ii)(A)--QBU Net Value--End of Year 9
------------------------------------------------------------------------
                                                             Amount in
                                                               [yen]
------------------------------------------------------------------------
Assets:
    Yen.................................................         120,000
    Land................................................          50,000
                                                         ---------------
        Total assets....................................         170,000
Liabilities:
    Bank loan...........................................          10,000
                                                         ---------------
        Total liabilities...............................          10,000
Year 9 ending net value.................................         160,000
------------------------------------------------------------------------

    (B) Determination of OFCNV for year 10. In year 10, a current rate 
election is not in effect. Therefore, in determining the OFCNV of Japan 
Branch for year 10, the land owned by Japan Branch is treated as a 
historic item. Under Sec.  1.987-1(c)(3)(i)(E), the historic rate 
applicable to historic items that were attributable to Japan Branch on 
the last day of the last taxable year in which a current rate election 
was in effect (December 31, year 9) generally is equal to the spot rate 
applicable to that day. Therefore, the historic rate applicable to the 
land is the spot rate on December 31, year 9. The OFCNV of Japan Branch 
for year 10 is $1,339.74, determined under paragraph (e) of this 
section as follows (together with the corresponding amounts in yen):

                            Table 6 to Paragraph (g)(3)(ii)(B)--OFCNV--End of Year 10
----------------------------------------------------------------------------------------------------------------
                                                   Amount in
                                                     [yen]              Translation rate            Amount in $
----------------------------------------------------------------------------------------------------------------
Assets:
    Yen.......................................    [yen]130,000  $1 = [yen]130 (spot rate-12/31/        $1,000.00
                                                                 year 10).
    Land......................................          50,000  $1 = [yen]120 (historic rate-             416.67
                                                                 spot rate-12/31/year 9).
                                               -----------------------------------------------------------------
        Total assets..........................         180,000  ................................        1,416.67
Liabilities:
    Bank loan.................................          10,000  $1 = [yen]130 (spot rate-12/31/            76.92
                                                                 year 10).
                                               -----------------------------------------------------------------
        Total liabilities.....................          10,000  ................................           76.92
Year 10 ending net value......................         170,000  ................................        1,339.74
----------------------------------------------------------------------------------------------------------------

    (C) Determination of unrecognized section 987 gain or loss for year 
10. The unrecognized section 987 gain or loss of Japan Branch for year 
10 is determined under paragraph (d) of this section as follows:
    (1) Step 1. The change in the OFCNV of Japan Branch for year 10 is 
equal to the OFCNV of Japan Branch determined in dollars on the last 
day of year 10, less the OFCNV of Japan Branch determined in dollars on 
the last day of year 9. Therefore, the change in OFCNV is equal to 
$6.41 ($1,339.74--$1,333.33).
    (2) Steps 2 through 5 (no adjustment). No adjustment is made under 
paragraphs (d)(2) through (5) of this section (steps 2 through 5) 
because no assets or liabilities were transferred by U.S. Corp to Japan 
Branch or by Japan Branch to U.S. Corp during the taxable year.
    (3) Step 6. Under paragraph (d)(6) of this section (step 6), the 
amount determined in previous steps is decreased by the section 987 
taxable income of Japan Branch of $80.00, from $6.41 to negative 
$73.59.
    (4) Steps 7 through 10 (no adjustment). No adjustment is made under 
paragraphs (d)(7) through (10) of this section (steps 7 through 10) 
because all of Japan Branch's items of income or deduction for the 
taxable year impact the basis of Japan Branch's assets or the amount of 
its liabilities and are taken

[[Page 100192]]

into account in computing taxable income. In addition, Japan Branch 
does not have a residual increase or decrease to net assets (because 
the change in net value of [yen]10,000 is equal to the amount of Japan 
Branch's net income in year 10). Accordingly, the unrecognized section 
987 loss of Japan Branch for year 10 is negative $73.59.
    (D) Determination of net unrecognized section 987 gain or loss. In 
year 10, Japan Branch has net accumulated section 987 loss of $1,000. 
Because U.S. Corp revoked the current rate election for year 10, the 
net accumulated section 987 loss of $1,000 becomes suspended section 
987 loss under Sec.  1.987-11(d)(2) and Japan Branch's net accumulated 
section 987 loss is reduced to zero. Therefore, in year 10, Japan 
Branch's net unrecognized section 987 loss is equal to $73.59, its 
unrecognized section 987 loss for year 10.


Sec.  1.987-5  Recognition of section 987 gain or loss.

    (a) Recognition of section 987 gain or loss by the owner of a 
section 987 QBU. The taxable income of an owner of a section 987 QBU 
includes the owner's section 987 gain or loss recognized with respect 
to the section 987 QBU for the taxable year. Except as otherwise 
provided in the section 987 regulations (including Sec.  1.987-11(c), 
Sec.  1.987-12(b) or (e), or Sec.  1.987-13(h) or (k)), for any taxable 
year the owner's section 987 gain or loss recognized with respect to a 
section 987 QBU is equal to:
    (1) The owner's net unrecognized section 987 gain or loss with 
respect to the section 987 QBU determined under Sec.  1.987-4 on the 
last day of such taxable year (or, if earlier, on the day the section 
987 QBU is terminated under Sec.  1.987-8); multiplied by
    (2) The owner's remittance proportion for the taxable year, as 
determined under paragraph (b) of this section.
    (b) Remittance proportion--(1) In general. Except as provided in 
paragraph (b)(2) of this section, the owner's remittance proportion 
with respect to a section 987 QBU for a taxable year is equal to:
    (i) The amount of the remittance, as determined under paragraph (c) 
of this section, to the owner from the section 987 QBU for such taxable 
year; divided by
    (ii) The sum of:
    (A) The aggregate adjusted basis of the gross assets that are 
attributable to the section 987 QBU as of the end of the taxable year, 
determined in the functional currency of the section 987 QBU; and
    (B) The amount of the remittance, as determined under paragraph (c) 
of this section.
    (2) Annual recognition election. A taxpayer may elect to recognize 
its net unrecognized section 987 gain or loss with respect to the 
section 987 QBU on an annual basis (annual recognition election). For 
any taxable year in which the annual recognition election is in effect, 
the owner's remittance proportion with respect to a section 987 QBU is 
one. See paragraph (g) of this section for an example illustrating this 
rule. Additionally, for any taxable year of an original deferral QBU 
owner in which an annual recognition election is in effect, the 
remittance proportion with respect to any successor deferral QBU is 
one.
    (c) Remittance--(1) Definition. A remittance is determined in the 
section 987 QBU's functional currency and equals the excess, if any, 
of:
    (i) The aggregate of all amounts transferred from the section 987 
QBU to the owner during the taxable year, as determined in paragraph 
(d) of this section; over
    (ii) The aggregate of all amounts transferred from the owner to the 
section 987 QBU during the taxable year, as determined in paragraph (e) 
of this section.
    (2) Alternative calculation. The amount of a remittance described 
in paragraph (c)(1) of this section may alternatively be determined 
under the following steps (each applied in the functional currency of 
the section 987 QBU). If the amount determined under this paragraph 
(c)(2) is negative, the amount of the remittance is zero.
    (i) Step 1: Determine the change in QBU net value. The change in 
QBU net value is equal to the QBU net value on the date provided in 
paragraph (c)(3) of this section, less the QBU net value on the last 
day of the preceding taxable year. In the first taxable year in which 
the section 987 QBU exists, the QBU net value on the last day of the 
preceding taxable year is zero.
    (ii) Step 2: Adjust the amount determined in step 1 for income or 
loss of the section 987 QBU. The amount determined in paragraph 
(c)(2)(i) of this section is reduced (including below zero) by items of 
income and gain attributable to the section 987 QBU (including tax-
exempt income described in Sec.  1.987-4(d)(8)) for the taxable year 
and increased by items of deduction and loss attributable to the 
section 987 QBU (including non-deductible expenses described in Sec.  
1.987-4(d)(7)) for the taxable year. However, no adjustment is made 
under the preceding sentence for any item of income, gain, deduction, 
or loss described in Sec.  1.987-4(d)(9) (items that do not impact the 
adjusted balance sheet).
    (iii) Step 3: Multiply the amount determined in step 2 by negative 
one. The amount of a remittance is equal to the amount determined in 
paragraph (c)(2)(ii) of this section multiplied by negative one.
    (3) Day when a remittance is determined. An owner's remittance from 
a section 987 QBU for a taxable year is determined on the last day of 
the taxable year (or, if earlier, on the day of the taxable year when 
the section 987 QBU is terminated under Sec.  1.987-8).
    (4) Termination. A termination of a section 987 QBU as determined 
under Sec.  1.987-8 is treated as a remittance of all the gross assets 
of the section 987 QBU to the owner on the date of such termination. 
See Sec.  1.987-8(e). Accordingly, for purposes of paragraph (b) of 
this section, the remittance proportion in the case of a termination is 
one.
    (d) Aggregate of all amounts transferred from the section 987 QBU 
to the owner for the taxable year. For purposes of paragraph (c)(1)(i) 
of this section, the aggregate of all amounts transferred from the 
section 987 QBU to the owner for the taxable year is the aggregate 
amount of functional currency and the aggregate adjusted basis of the 
other assets transferred (after taking into account Sec.  1.988-
1(a)(10)), determined in the section 987 QBU's functional currency. 
Solely for this purpose, the amount of liabilities transferred from the 
owner to the section 987 QBU (determined in the section 987 QBU's 
functional currency under Sec.  1.987-2(d) after taking into account 
Sec.  1.988-1(a)(10)) is treated as a transfer of assets from the 
section 987 QBU to the owner with an adjusted basis equal to the amount 
of such liabilities.
    (e) Aggregate of all amounts transferred from the owner to the 
section 987 QBU for the taxable year. For purposes of paragraph 
(c)(1)(ii) of this section, the aggregate of all amounts transferred 
from the owner to the section 987 QBU for the taxable year is the 
aggregate amount of functional currency and the aggregate adjusted 
basis of the assets transferred (determined in the section 987 QBU's 
functional currency under Sec.  1.987-2(d) after taking into account 
Sec.  1.988-1(a)(10)). Solely for this purpose, the amount of 
liabilities transferred from the section 987 QBU to the owner 
(determined in the section 987 QBU's functional currency after taking 
into account Sec.  1.988-1(a)(10)) is treated as a transfer of assets 
from the owner to the

[[Page 100193]]

section 987 QBU with an adjusted basis equal to the amount of such 
liabilities.
    (f) Determination of owner's adjusted basis in transferred assets 
and amount of transferred liabilities--(1) In general. The owner's 
adjusted basis in an asset or the amount of a liability received in a 
transfer from a section 987 QBU (whether or not such transfer is made 
in connection with a remittance) is determined in the owner's 
functional currency under the rules prescribed in paragraphs (f)(2) and 
(3) of this section.
    (2) Marked items. The basis of a marked asset or amount of a marked 
liability is the amount determined by translating the section 987 QBU's 
functional currency basis of the asset or amount of the liability, 
after taking into account Sec.  1.988-1(a)(10), into the owner's 
functional currency at the spot rate applicable to the date of 
transfer.
    (3) Historic items. The basis of a historic asset or amount of a 
historic liability is the amount determined by translating the section 
987 QBU's functional currency basis of the asset or amount of the 
liability into the owner's functional currency at the historic rate for 
the asset or liability.
    (g) Example--Calculation of section 987 gain or loss recognized. 
The following example illustrates the calculation of section 987 gain 
or loss under this section. For purposes of this example, except as 
otherwise indicated, assume that no section 987 elections are in 
effect. Depreciation is ignored for purposes of this example.
    (1) Facts--(i) In general. U.S. Corp, a domestic corporation with 
the dollar as its functional currency, operates in the United Kingdom 
through Business A, a section 987 QBU with the pound as its functional 
currency. The net unrecognized section 987 gain for Business A as 
determined under Sec.  1.987-4 as of the last day of year 2 is $80.
    (ii) Year 1 balance sheet. At the end of year 1, the following 
assets are attributable to Business A: cash of [pound]3,350; a computer 
with an adjusted basis of [pound]500; and a machine with an adjusted 
basis of [pound]500. Thus, the aggregate basis of Business A's assets 
is [pound]4,350. Business A has no liabilities.
    (iii) Transfers and income in year 2. During year 2, Business A 
earned income of [pound]1,500. In addition, the following transfers 
took place between U.S. Corp and Business A in year 2. On January 5, 
year 2, U.S. Corp transferred to Business A [pound]300 (acquired by 
U.S. Corp immediately before the transfer). On March 5, year 2, 
Business A transferred a machine (with an adjusted basis of [pound]500) 
to U.S. Corp. On November 1, year 2, Business A transferred 
[pound]2,300 to U.S. Corp. On December 7, year 2, U.S. Corp transferred 
a truck to Business A. The adjusted basis of the truck, when properly 
translated into pounds under Sec.  1.987-2(d), is [pound]2,000.
    (iv) Year 2 balance sheet. At the end of year 2, the following 
assets are attributable to Business A: cash of [pound]2,850, a computer 
with a pound adjusted basis of [pound]500, and a truck with a pound 
adjusted basis of [pound]2,000. Thus, the aggregate basis of Business 
A's assets is [pound]5,350. Business A has no liabilities.
    (2) Analysis. U.S. Corp's section 987 gain with respect to Business 
A is determined as follows:
    (i) Computation of amount of remittance. Under paragraphs (c)(1) 
and (2) of this section, U.S. Corp must determine the amount of the 
remittance for year 2 in the QBU's functional currency (pounds) on the 
last day of year 2. The amount of the remittance for year 2 is 
[pound]500, determined as follows:

                     Table 1 to Paragraph (g)(2)(i)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
            Transfers from Business A to U.S. Corp in pounds
------------------------------------------------------------------------
Machine.................................................      [pound]500
Pounds..................................................    [pound]2,300
                                                         ---------------
    Aggregate transfers from Business A to U.S. Corp....    [pound]2,800
------------------------------------------------------------------------
            Transfers from U.S. Corp to Business A in pounds
------------------------------------------------------------------------
Truck...................................................    [pound]2,000
Pounds..................................................      [pound]300
                                                         ---------------
    Aggregate transfers from U.S. Corp to Business A....    [pound]2,300
------------------------------------------------------------------------
                  Computation of amount of remittance:
------------------------------------------------------------------------
    Aggregate transfers from Business A to U.S. Corp....    [pound]2,800
    Less: aggregate transfers from U.S. Corp to Business  ([pound]2,300)
     A..................................................
                                                         ---------------
        Total remittance................................      [pound]500
------------------------------------------------------------------------

    (ii) Alternative computation of remittance amount. Under paragraph 
(c)(2) of this section, U.S. Corp can compute the amount of the 
remittance for year 2 using the following steps.
    (A) Step 1: Change in QBU net value. The change in Business A's QBU 
net value is equal to [pound]1,000 ([pound]5,350--[pound]4,350).
    (B) Step 2: Adjustment for income or loss. The amount determined in 
step 1 ([pound]1,000) is reduced by Business A's income for year 2 of 
[pound]1,500, to negative [pound]500.
    (C) Step 3: Multiply by negative one. The amount determined in step 
2 (negative [pound]500) is multiplied by negative one. The remittance 
for year 2 is equal to [pound]500.
    (iii) Computation of section 987 QBU gross assets plus remittance. 
Under paragraph (b)(1)(ii) of this section, Business A must determine 
the aggregate basis of its gross assets and must increase this amount 
by the amount of the remittance.

                    Table 2 to Paragraph (g)(2)(iii)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Computer................................................      [pound]500
Pounds..................................................    [pound]2,850
Truck...................................................    [pound]2,000
                                                         ---------------
  Aggregate gross assets................................    [pound]5,350
Remittance..............................................      [pound]500
Aggregate basis of Business A's gross assets at end of      [pound]5,850
 year 2, increased by amount of remittance..............
------------------------------------------------------------------------

    (iv) Computation of remittance proportion. Under paragraph (b) of 
this section, Business A must compute the remittance proportion by 
dividing the [pound]500 remittance amount by the [pound]5,850 sum of 
the aggregate basis of Business A's gross assets and the amount of the 
remittance. The resulting remittance proportion is 0.085.
    (v) Computation of section 987 gain or loss. The amount of U.S. 
Corp's section 987 gain or loss that is recognized with respect to 
Business A is determined under paragraph (a) of this section by 
multiplying the 0.085 remittance proportion by the $80 of net 
unrecognized section 987 gain. U.S. Corp's resulting recognized section 
987 gain for year 2 is $6.80.
    (3) Annual recognition election. If an annual recognition election 
under paragraph (b)(2) of this section were in effect for year 2, U.S. 
Corp's remittance proportion would be one. Accordingly, U.S. Corp would 
recognize all $80 of the net unrecognized section 987 gain with respect 
to Business A.


Sec.  1.987-6  Character and source of section 987 gain or loss.

    (a) Ordinary income or loss. Section 987 gain or loss is ordinary 
income or loss for Federal income tax purposes.
    (b) Character and source of section 987 gain or loss. With respect 
to each section 987 QBU, the character and source of section 987 gain 
or loss is determined under this paragraph (b) for all purposes of the 
Internal Revenue Code, including sections 904(d), 907, and 954.
    (1) Timing of character and source determination. The character and 
source of section 987 gain or loss is determined

[[Page 100194]]

based on the initial assignment pursuant to paragraph (b)(2)(i) of this 
section and may be reassigned in the year in which the section 987 gain 
or loss is recognized pursuant to paragraph (b)(2)(ii) of this section. 
The initial assignment is made in the earliest of the taxable years 
described in paragraphs (b)(1)(i) through (iv) of this section.
    (i) The taxable year in which net unrecognized section 987 gain or 
loss is recognized.
    (ii) The taxable year in which net unrecognized section 987 loss or 
pretransition loss becomes suspended section 987 loss.
    (iii) The taxable year in which net unrecognized section 987 gain 
or loss becomes deferred section 987 gain or loss.
    (iv) In the case of pretransition gain or loss that is recognized 
ratably over the transition period pursuant to the election under Sec.  
1.987-10(e)(5)(ii), the taxable year that includes the transition date.
    (2) Method for determining the character and source of section 987 
gain or loss--(i) Initial assignment--(A) In general. In the taxable 
year of the initial assignment, determined under paragraph (b)(1) of 
this section, the owner assigns gross section 987 gain or loss to the 
statutory and residual groupings in the same proportions as the 
proportions in which the tax book value of the assets of the section 
987 QBU are assigned to the groupings under the asset method in 
Sec. Sec.  1.861-9(g) and 1.861-9T(g), as modified by this paragraph 
(b)(2)(i). For purposes of applying the asset method, the owner takes 
into account only the assets that are attributable to the section 987 
QBU under Sec.  1.987-2(b). See Sec.  1.987-11(e) and (f) (grouping of 
section 987 gain and loss and applying the loss-to-the-extent-of-gain 
rule on basis of the initial assignment of section 987 gain and loss 
under this paragraph (b)(2)(i)).
    (B) Special rules for applying the asset method to assign section 
987 gain or loss. For purposes of assigning gross section 987 gain or 
loss to the statutory and residual groupings under paragraph 
(b)(2)(i)(A) of this section, the proportions in which the tax book 
value of the assets of the section 987 QBU are assigned to the 
groupings described in paragraph (b)(2)(i)(A) of this section are 
determined without regard to section 987 gain or loss. Further, the 
section 987 gain or loss is assigned after any reattribution of gross 
income required under Sec.  1.904-4(f)(2)(vi) or Sec.  1.951A-
2(c)(7)(ii)(B)(2) (or the principles thereof, as applicable), but 
before the allocation and apportionment of expenses or the application 
of provisions that are based on a net income computation, such as the 
high-tax exception to passive category income in Sec.  1.904-4(c), the 
high-tax exception to foreign base company income in Sec.  1.954-1(d), 
and the high-tax exclusion from tested income in Sec.  1.951A-2(c)(7).
    (C) Election to treat section 987 gain or loss that is assigned to 
subpart F income groups relating to foreign personal holding company 
income as attributable to section 988 transactions--(1) In general. If 
an election is made under this paragraph (b)(2)(i)(C)(1), section 987 
gain or loss assigned under paragraphs (b)(2)(i)(A) and (B) of this 
section to any grouping of passive foreign personal holding company 
income, as described in Sec.  1.960-1(d)(2)(ii)(B)(2)(i), is treated as 
foreign currency gain of the owner attributable to section 988 
transactions not directly related to the business needs of the 
controlled foreign corporation, or as loss allocated and apportioned to 
such foreign currency gain. See Sec.  1.987-1(g) for rules that apply 
to section 987 elections.
    (2) Coordination with Sec.  1.954-2(g). The rules of Sec.  1.954-
2(g)(2), (3) and (4) apply without regard to any section 987 gain 
treated as gain from section 988 transactions, or loss allocated and 
apportioned to such gain, by reason of an election under paragraph 
(b)(2)(i)(C)(1) of this section.
    (D) Section 987 gain or loss assigned to tentative tested income 
rather than tested income--(1) In general. In the case of a controlled 
foreign corporation, section 987 gain or loss is initially assigned to 
tentative tested income within a section 904 category (a tentative 
tested income group) under paragraphs (b)(2)(i)(A) and (B) of this 
section as though the election described in Sec.  1.951A-2(c)(7)(viii) 
is in effect for the taxable year. As a result, section 987 gain or 
loss that would have initially been characterized as tested income if 
no election under Sec.  1.951A-2(c)(7)(viii) was in effect is initially 
characterized as tentative tested income.
    (2) For purposes of the GILTI high-tax exclusion, section 987 gain 
or loss is not attributable to any tested unit. In the case of a 
controlled foreign corporation, the initial assignment of section 987 
gain or loss is made as though the section 987 gain or loss was not 
attributable to any tested unit for purposes of applying Sec.  1.951A-
2(c)(7) (GILTI high-tax exclusion). See paragraph (b)(2)(iii) of this 
section (applying the GILTI high-tax exclusion by treating all section 
987 gain or loss in the same tentative tested income group as composing 
a single tentative tested income item).
    (ii) Reassignment of section 987 gain or loss. In the taxable year 
in which section 987 gain or loss is recognized (determined by taking 
into account Sec. Sec.  1.987-5, 1.987-11(e), 1.987-12(c), and 1.987-
13(b) through (d), if applicable), the section 987 gain or loss is 
sourced and characterized based on the initial assignment in paragraph 
(b)(2)(i) of this section, but with appropriate changes to account for 
the application of provisions that apply to the section 987 gain or 
loss based on a net income computation such as the high-tax exception 
to passive category income in Sec.  1.904-4(c), the high-tax exception 
to foreign base company income in Sec.  1.954-1(d), and the high-tax 
exclusion to tested income in Sec.  1.951A-2(c)(7). Thus, for example, 
if an election under Sec.  1.951A-2(c)(7)(viii) is in effect for the 
taxable year, section 987 gain or loss initially assigned to a 
tentative tested income group will be reassigned to a tested income 
group (as defined in Sec.  1.960-1(d)(2)(ii)(C)) or to the residual 
income group (as defined in Sec.  1.960-1(d)(2)(ii)(D)), as applicable, 
depending on whether the item of income (as described in paragraph 
(b)(2)(iii) of this section) is subject to a high rate of tax (as 
determined under Sec.  1.951A-2(c)(7)(vi)). If no election is made 
under Sec.  1.951A-2(c)(7)(viii) for a taxable year, all of the section 
987 gain or loss that is recognized in the taxable year that was 
initially assigned to tentative tested income under paragraph (b)(2)(i) 
of this section, is reassigned to the appropriate tested income group 
(as defined in Sec.  1.960-1(d)(2)(ii)(C)).
    (iii) Special rule for the application of the GILTI high-tax 
exclusion to section 987 gain or loss. Section 987 gain in a tentative 
tested income group that is recognized by a controlled foreign 
corporation in a taxable year comprises a single tentative gross tested 
income item (as if it were allocable to its own tested unit) within the 
meaning of Sec.  1.951A-2(c)(7)(ii), and section 987 loss in a 
tentative tested income group that is recognized by a controlled 
foreign corporation in the taxable year is allocated and apportioned to 
the corresponding tentative gross tested income item for purposes of 
calculating the tentative tested income item within the meaning of 
Sec.  1.951A-2(c)(7)(iii). Thus, for purposes of applying the high-tax 
exclusion in Sec.  1.951A-2(c)(7), all of the section 987 gain and loss 
in a tentative tested income group that is recognized by the controlled 
foreign corporation in a taxable year is a single tentative tested 
income item.

[[Page 100195]]

    (3) Allocation and apportionment of foreign income tax to section 
987 items under section 861. For purposes of applying the definition of 
a corresponding U.S. item in Sec.  1.861-20(b), an item of foreign 
gross income and an item of section 987 gain or loss are treated as 
arising from the same transaction or other realization event only if 
the requirements in both paragraphs (b)(3)(i) and (ii) of this section 
are satisfied.
    (i) The foreign gross income is an item of foreign currency gain or 
loss. The owner of the section 987 QBU, original deferral QBU owner, or 
original suspended loss QBU owner includes the foreign gross income 
under the laws of the foreign country in which it is a tax resident 
because under that foreign law it is required to recognize foreign 
currency gain or loss with respect to its interest in the section 987 
QBU or with respect to a successor deferral QBU or successor suspended 
loss QBU.
    (ii) The same event or events give rise to both the foreign gross 
income and the section 987 gain or loss. The remittance under Sec.  
1.987-5(c) that gave rise to the item of section 987 gain or loss 
comprises one or more of the events that gave rise to the item of 
foreign gross income described in paragraph (b)(3)(i) of this section.
    (c) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, except as otherwise 
indicated, assume that no section 987 elections are in effect.
    (1) Example 1: Initial assignment and reassignment of section 987 
gain or loss--(i) Facts. CFC is a controlled foreign corporation with 
the Swiss franc (Sf) as its functional currency. CFC is the owner of 
Business A, a section 987 QBU that has the euro as its functional 
currency. For year 1, CFC does not have an election described in Sec.  
1.951A-2(c)(7)(viii) in effect but is subject to an election under 
paragraph (b)(2)(i)(C) of this section. CFC recognizes section 987 gain 
of Sf10,000 under Sec.  1.987-5. Business A has average total assets of 
Sf1,000,000 in year 1, which generate income (other than section 987 
gain) as follows: Sf750,000 of assets that produce gross income in the 
statutory grouping for foreign source general category tested income 
under sections 904(d)(1)(A) and 951A; and Sf250,000 of assets that 
produce foreign source passive gross income in one of the groupings 
described in Sec. Sec.  1.960-1(d)(2)(ii)(B)(2)(i) and 1.954-
1(c)(1)(iii)(B) (subpart F income groups relating to passive foreign 
personal holding company income).
    (ii) Analysis. Under paragraphs (b)(2)(i)(A), (B), and (D) of this 
section, Sf7,500 (Sf750,000/Sf1,000,000 x Sf10,000) of the section 987 
gain is initially assigned to the statutory grouping of foreign source 
general category tentative tested income. Because an election under 
Sec.  1.951A-2(c)(7)(viii) is not in effect for the taxable year in 
which the section 987 gain is recognized, the section 987 gain is 
reassigned under paragraph (b)(2)(ii) of this section to foreign source 
general category tested income. The remaining Sf2,500 (Sf250,000/
Sf1,000,000 x Sf10,000) is characterized under paragraphs (b)(2)(i)(A) 
and (B) of this section by reference to assets that give rise to 
foreign source passive gross income in one of the groupings described 
in Sec.  1.960-1(d)(2)(ii)(B)(2)(i) (subpart F income groups relating 
to passive foreign personal holding company income) and is therefore 
generally treated under the election in paragraph (b)(2)(i)(C) of this 
section as foreign source foreign currency gain of CFC attributable to 
section 988 transactions not directly related to the business needs of 
the controlled foreign corporation. All of the section 987 gain is 
treated as ordinary income under paragraph (a) of this section.
    (2) Example 2: Effect of GILTI high-tax exclusion--(i) Facts. The 
facts are the same as in paragraph (c)(1) of this section (Example 1) 
except that CFC does have an election described in Sec.  1.951A-
2(c)(7)(viii) in effect. Without regard to the section 987 gain or 
loss, CFC has two tentative gross tested income items: Sf100,000 of 
gross tentative tested income attributable to a CFC tested unit (the 
CFC item) and Sf5,000,000 of gross tentative tested income attributable 
to a Business A tested unit (the Business A item). CFC accrues 
Sf1,010,000 of current year taxes and has no other current year 
deductions. CFC is not required by its country of tax residence to 
include in foreign gross income foreign currency gain or loss with 
respect to its interest in a foreign QBU. For purposes of Sec.  1.951A-
2(c)(7)(iii)(A), Sf1,000,000 of current year tax is allocated and 
apportioned to the Business A item and Sf10,000 is allocated and 
apportioned to the CFC item. At all relevant times Sf1 = $1.
    (ii) Analysis. As in paragraph (c)(1)(ii) of this section (Example 
1), Sf7,500 of section 987 gain is initially assigned to the statutory 
grouping of foreign source general category tentative tested income. 
Under paragraph (b)(2)(iii) of this section, the section 987 gain 
comprises a single tentative gross tested income item of the CFC (the 
section 987 item). Therefore, the CFC has three tentative gross tested 
income items: the section 987 item, the CFC item, and the Business A 
item. No tax is allocated and apportioned to the section 987 item. See 
paragraph (b)(3) of this section. Applying Sec.  1.951A-2(c)(7)(vi), 
the effective tax rate of the section 987 item is 0% ($0/$7,500), the 
effective tax rate of the CFC item is 10% ($10,000/$100,000), and the 
effective tax rate of the Business A item is 20% ($1,000,000/
$5,000,000). An election under Sec.  1.951A-2(c)(7)(viii) is in effect; 
therefore, the section 987 gain is reassigned based on the application 
of Sec.  1.951A-2(c)(7). Because the section 987 item was not subject 
to an effective tax rate of greater than 90 percent of the maximum rate 
of tax specified in section 11, it is reassigned under paragraph (b)(2) 
of this section to foreign source general category tested income. The 
remaining Sf2,500 of section 987 gain is foreign source foreign 
currency gain of CFC attributable to section 988 transactions not 
directly related to the business needs of the controlled foreign 
corporation for the reasons stated in paragraph (c)(1)(ii) of this 
section (Example 1).
    (3) Example 3: Section 987 gain or loss treated as attributable to 
section 988 transactions--(i) Facts. The facts are the same as in 
paragraph (c)(1) of this section (Example 1) except that CFC recognizes 
section 987 loss of Sf40,000, Sf5,000 of which is characterized under 
paragraphs (b)(2)(i)(A) and (B) of this section by reference to assets 
that give rise to foreign source passive gross income in a separate 
subpart F income group for non-related party interest income of 
Business A and Sf5,000 of which is characterized by reference to assets 
that give rise to foreign source passive gross income in a separate 
subpart F income group for gains from certain property transactions of 
Business A not derived from the active conduct of a trade or business. 
CFC otherwise has Sf12,000 of net foreign currency gain determined 
under Sec.  1.954-2(g) that is taken into account in determining the 
excess of foreign currency gain over foreign currency losses 
characterized as foreign personal holding company income under section 
954(c)(1)(D).
    (ii) Analysis. Under paragraph (b)(2)(i)(C) of this section, the 
Sf10,000 total section 987 loss characterized by reference to assets 
that give rise to foreign source passive gross income in one of the 
groupings described in Sec. Sec.  1.960-1(d)(2)(ii)(B)(2)(i) and 1.954-
1(c)(1)(iii)(B) (subpart F income groups relating to passive foreign 
personal holding company income) is treated as foreign source foreign 
currency loss of

[[Page 100196]]

CFC attributable to section 988 transactions. Accordingly, CFC will 
aggregate the Sf10,000 section 987 loss with the Sf12,000 net foreign 
currency gain and will have Sf2,000 of net foreign currency gain 
characterized as passive foreign personal holding company income under 
section 954(c)(1)(D).
    (4) Example 4: Section 987 gain or loss assigned to passive foreign 
personal holding company income--(i) Facts. The facts are the same as 
in paragraph (c)(3) of this section (Example 3) except that CFC is not 
subject to an election under paragraph (b)(2)(i)(C) of this section.
    (ii) Analysis. As the CFC is not subject to an election under 
paragraph (b)(2)(i)(C) of this section, Sf5,000 of section 987 loss is 
initially assigned to the statutory grouping for foreign source passive 
gross income in a separate subpart F income group for non-related party 
interest income of Business A, and Sf5,000 is initially assigned to the 
statutory grouping for foreign source passive gross income in a 
separate subpart F income group for gains from certain property 
transactions of Business A not derived from the active conduct of a 
trade or business. The Sf12,000 net foreign currency gain is foreign 
source passive gross income in a separate subpart F income group for 
foreign currency gain of CFC attributable to section 988 transactions 
of CFC. As a result, if the net income in a subpart F income group to 
which either section 987 loss is assigned is less than zero, that loss 
will not reduce any other category of subpart F income, including CFC's 
foreign currency gain from section 988 transactions, except by reason 
of the earnings and profit limitation in section 952(c)(1). See Sec.  
1.954-1(c)(1)(ii).


Sec.  1.987-7  Application of the section 987 regulations to 
partnerships and S corporations.

    (a) Overview. This section provides rules relating to the 
application of the section 987 regulations to partnerships and S 
corporations. Paragraph (b) of this section provides the general rule 
that the section 987 regulations do not apply to partnerships. 
Paragraph (c) of this section identifies certain provisions of the 
section 987 regulations that are applicable to partnerships, subject to 
certain modifications. Paragraph (d) of this section provides special 
rules relating to suspended section 987 loss. Paragraph (e) of this 
section provides rules for adjusting a partner's basis in its 
partnership interest. Paragraph (f) of this section provides that S 
corporations are treated in the same manner as partnerships for 
purposes of the section 987 regulations. Paragraph (g) of this section 
provides examples that illustrate the rules of this section.
    (b) Section 987 regulations generally do not apply to partnerships. 
Except as otherwise provided in this section, the section 987 
regulations do not apply to a partnership, and the section 987 
regulations do not apply to an eligible QBU if a partnership is the 
owner for Federal income tax purposes of the eligible QBU's assets and 
liabilities. However, a taxpayer must apply sections 987 and 989(a) to 
partnerships and eligible QBUs of partnerships in a reasonable manner 
using a method that is applied consistently from year to year with 
respect to a particular partnership or eligible QBU. In addition, all 
members of the same controlled group must apply the same method 
consistently with respect to a particular partnership or eligible QBU.
    (c) Provisions of the section 987 regulations that apply to 
partnerships--(1) In general--(i) Eligible QBU. The rules described in 
paragraph (c)(2) of this section apply to an eligible QBU if a 
partnership is the owner for Federal income tax purposes of the 
eligible QBU's assets and liabilities and either--
    (A) The partnership (or a partner) treats the eligible QBU as a 
qualified business unit of the partnership that is subject to section 
987 (for example, under an entity approach); or
    (B) A partner in the partnership treats all or a portion of the 
eligible QBU as a qualified business unit of the partner that is 
subject to section 987 (for example, under an aggregate approach).
    (ii) Partnership. The rules described in paragraph (c)(2) of this 
section apply to a partnership if a partner in the partnership treats 
the partnership itself (or an interest in the partnership) as a 
qualified business unit that is subject to section 987 (for example, 
under an entity approach).
    (2) Applicable provisions--(i) In general. Sections 1.987-6 
(character and source of section 987 gain or loss), 1.987-9(d) 
(information on a dedicated section 987 form), Sec. Sec.  1.987-11 
through 1.987-13 (suspended section 987 loss, deferral of section 987 
gain or loss, and suspended section 987 loss upon terminations, 
respectively), and Sec.  1.987-15 (applicability dates) apply to a QBU 
described in paragraph (c)(1) of this section, subject to the 
modifications described in this paragraph (c) and in paragraph (d) of 
this section.
    (ii) Annual recognition election. An annual recognition election 
under Sec.  1.987-5(b)(2) applies to a QBU described in paragraph 
(c)(1) of this section, subject to the modifications described in this 
paragraph (c). In each taxable year of the owner of a QBU described in 
paragraph (c)(1) of this section in which an annual recognition 
election is in effect, the owner recognizes any unrecognized gain or 
loss with respect to the QBU under section 987(3) (other than suspended 
section 987 loss) as though the QBU terminated on the last day of the 
taxable year. Appropriate adjustments must be made to prevent the gain 
or loss from being taken into account again after it is recognized 
under this paragraph (c)(2)(ii) (for example, in the case of a taxpayer 
applying the 1991 proposed regulations, by adjusting the equity and 
basis pools to reflect the gain or loss recognized). The rules of Sec.  
1.987-1(g) apply with respect to an annual recognition election that is 
made by or for an owner of a QBU described in paragraph (c)(1) of this 
section.
    (iii) Section 988 mark-to-market election. A section 988 mark-to-
market election under Sec.  1.987-3(b)(4)(ii) applies to a QBU 
described in paragraph (c)(1) of this section. The rules of Sec.  
1.987-1(g) apply with respect to a section 988 mark-to-market election 
that is made by or for an owner of a QBU described in paragraph (c)(1) 
of this section.
    (3) Modifications to applicable provisions--(i) In general. An 
owner of a QBU described in paragraph (c)(1) of this section must adapt 
the rules described in paragraph (c)(2) of this section as necessary to 
recognize section 987 gain or loss in a manner that is consistent with 
the principles of those rules. For purposes of applying this section 
and the rules described in paragraph (c)(2) of this section to a QBU 
described in paragraph (c)(1) of this section, the definitions provided 
in the section 987 regulations apply with appropriate modifications. 
For example, in the case of a QBU described in paragraph (c)(1) of this 
section, the term section 987 gain or loss means gain or loss 
recognized under section 987(3), the term owner means the person that 
recognizes gain or loss under section 987(3), and the term section 987 
QBU means any qualified business unit subject to section 987 (including 
a QBU described in paragraph (c)(1) of this section). In addition, 
references to other rules of the section 987 regulations must be 
adapted as necessary to apply section 987 in a manner that is 
consistent with the principles of this section and the rules described 
in paragraphs (c)(2) of this section. For example, references to the 
recognition of section 987 gain or loss under Sec.  1.987-5 encompass 
any recognition of gain or loss under section 987(3).
    (ii) Controlled group. For purposes of applying Sec. Sec.  1.987-12 
and 1.987-13, if a

[[Page 100197]]

partner in a partnership is treated as the owner of an eligible QBU 
described in paragraph (c)(1)(i) of this section (for example, under an 
aggregate approach) before the QBU terminates, each member of the 
partnership's controlled group is treated as a member of the partner's 
controlled group at any time that the partner (or any member of the 
partner's controlled group, determined without regard to this paragraph 
(c)(3)(ii)) continues to be a direct or indirect partner in the 
partnership. This paragraph (c)(3)(ii) does not apply for purposes of 
the de minimis rule in Sec.  1.987-11(c)(2).
    (4) Terminating QBUs. In the case of a terminating QBU described in 
paragraph (c)(1) of this section, the rules of this section and the 
rules described in paragraph (c)(2) of this section apply immediately 
before the termination, but Sec.  1.987-10 does not apply because Sec.  
1.987-10 is not applicable to a QBU described in paragraph (c)(1) of 
this section.
    (d) Suspended section 987 loss--(1) In general--(i) Rules of Sec.  
1.987-11(c) and (d)(2) do not apply. The rules of Sec.  1.987-11(c) and 
(d)(2) do not apply to a QBU described in paragraph (c)(1) of this 
section.
    (ii) Suspension of section 987 loss. Except as provided in 
paragraph (d)(2) of this section, any loss that would otherwise be 
recognized under section 987(3) (after applying Sec.  1.987-12) with 
respect to a QBU described in paragraph (d)(1)(ii)(A) or (B) of this 
section is not recognized and becomes suspended section 987 loss.
    (A) Eligible QBU. This paragraph (d)(1)(ii) applies to an eligible 
QBU described in paragraph (c)(1)(i) of this section.
    (B) Partnership. This paragraph (d)(1)(ii) applies to a partnership 
(or a partnership interest) described in paragraph (c)(1)(ii) of this 
section if at least 95 percent of the interests in partnership capital 
and profits are owned, directly or indirectly, by persons related to 
each other within the meaning of section 267(b) or section 707(b). For 
this purpose, ownership of an interest in partnership capital or 
profits is determined in accordance with the rules for constructive 
ownership provided in section 267(c), other than section 267(c)(3).
    (2) Exceptions--(i) Method under which historic items do not give 
rise to section 987 gain or loss. Paragraph (d)(1)(ii) of this section 
does not apply to an eligible QBU described in paragraph (d)(1)(ii)(A) 
of this section if section 987 is consistently applied to the QBU using 
a method under which historic items of the QBU do not give rise to 
section 987 gain or loss (for example, a method that follows the 
principles of Sec. Sec.  1.987-3 through 1.987-5).
    (ii) Annual recognition election. Paragraph (d)(1)(ii) of this 
section does not apply in a taxable year in which an annual recognition 
election is in effect.
    (iii) De minimis rule. Paragraph (d)(1)(ii) of this section does 
not apply in a taxable year described in Sec.  1.987-11(c)(2).
    (3) Recognition of suspended section 987 loss--(i) In general. 
Except as provided in paragraph (d)(3)(ii) of this section, suspended 
section 987 loss with respect to a QBU described in paragraph 
(d)(1)(ii)(A) or (B) of this section is recognized under the rules of 
Sec. Sec.  1.987-11(e) and 1.987-13.
    (ii) Partnership that is not engaged in a trade or business. In the 
case of a partnership described in paragraph (d)(1)(ii)(B) of this 
section that is not engaged in a trade or business, suspended section 
987 loss cannot be recognized under Sec.  1.987-13(b) through (d) (and 
thus can only be recognized under Sec.  1.987-11(e)).
    (iii) Application of the loss-to-the-extent-of-gain rule. If a 
partner in a partnership is the owner of a section 987 QBU described in 
paragraph (c)(1) of this section and also owns one or more section 987 
QBUs that are not described in paragraph (c)(1) of this section, the 
loss-to-the-extent-of-gain rule of Sec.  1.987-11(e) is applied by 
taking into account all of the owner's section 987 gain and suspended 
section 987 loss in each recognition grouping with respect to all of 
its section 987 QBUs (whether or not they are described in paragraph 
(c)(1) of this section).
    (e) Adjustments to the basis of a partner's interest in the 
partnership. When, and to the extent that, a partner recognizes section 
987 gain or loss, defers section 987 gain or loss, or suspends section 
987 loss at the partner level with respect to a partnership described 
in paragraph (c)(1)(ii) of this section or an eligible QBU of the 
partnership described in paragraph (c)(1)(i) of this section, the 
principles of sections 704(d) and 705 apply as though the item of 
income or loss was part of the partner's distributive share of 
partnership items. Thus, proper adjustments must be made to the 
partner's adjusted basis in the partnership under the principles of 
section 705, taking into account the principles of section 704(d).
    (f) S corporations treated as partnerships. For purposes of the 
section 987 regulations, S corporations are treated in the same manner 
as partnerships and shareholders of S corporations are treated in the 
same manner as partners of partnerships.
    (g) Examples. The following examples illustrate the principles of 
this section. For purposes of these examples, DC1 and DC2 are domestic 
corporations, and P is a foreign partnership. P is also the owner for 
Federal income tax purposes of the assets and liabilities of Business 
A, an eligible QBU that has the pound as its functional currency. DC1 
and DC2 each own 50% of the capital and profits interests in P. If P is 
treated as a qualified business unit under section 989(a), P would have 
the euro as its functional currency due to activities unrelated to 
Business A.
    (1) Example 1: Aggregate approach to section 987--(i) Facts. DC1 
and DC2 each apply section 987 using an aggregate approach, under which 
each partner's indirect interest in Business A is treated as a section 
987 QBU of the partner. DC1 and DC2 each use the earnings and capital 
method described in the 1991 proposed regulations to apply section 987 
with respect to Business A. Neither DC1 nor DC2 has made an annual 
recognition election. Under the earnings and capital method, but for 
the application of paragraph (d)(1)(ii) of this section, DC1 and DC2 
each would recognize section 987 loss of $10 million in year 1 with 
respect to Business A.
    (ii) Analysis--(A) Application of loss suspension rule to Business 
A. Business A is an eligible QBU described in paragraph (c)(1)(i) of 
this section because a partnership (P) is the owner of Business A's 
assets and liabilities for federal income tax purposes and P's partners 
treat Business A as a section 987 QBU. Therefore, under paragraph 
(d)(1)(ii) of this section, the section 987 loss of DC1 and DC2 that 
would otherwise be recognized in year 1 becomes suspended section 987 
loss, which DC1 and DC2 may recognize in year 1 or in future taxable 
years under Sec. Sec.  1.987-11(e) and 1.987-13(b) through (d).
    (B) Annual recognition election. If DC1 and DC2 were subject to an 
annual recognition election in year 1, they would recognize section 987 
gain or loss with respect to Business A as though Business A terminated 
at the end of year 1, and the loss suspension rule of paragraph 
(d)(1)(ii) of this section would not apply.
    (C) FEEP method. If DC1 and DC2 applied section 987 to Business A 
under the principles of Sec. Sec.  1.987-3 through 1.987-5, such that 
historic items of Business A did not give rise to section 987 gain or 
loss, the loss suspension rule of paragraph (d)(1)(ii) of this section 
would not apply.

[[Page 100198]]

    (2) Example 2: Entity approach to section 987--(i) Facts. P applies 
section 987 to Business A using an entity approach, under which 
Business A is treated as a section 987 QBU of P. P is treated as a 
qualified business unit under section 989(a) and uses the euro as its 
functional currency. P uses the earnings and capital method described 
in the 1991 proposed regulations to apply section 987 with respect to 
Business A. Under the earnings and capital method, but for the 
application of paragraph (d)(1)(ii) of this section, P would recognize 
section 987 loss of $10 million in year 1 with respect to Business A. 
In addition, DC1 and DC2 apply section 987 to P using an entity 
approach, treating each partner's interest in P as a section 987 QBU. 
DC1 and DC2 each use the earnings and capital method described in the 
1991 proposed regulations to apply section 987 with respect to P. Under 
the earnings and capital method, but for the application of paragraph 
(d)(1)(ii) of this section, DC1 and DC2 each would recognize section 
987 loss of $10 million in year 1 with respect to P. Neither DC1 nor 
DC2 has made an annual recognition election.
    (ii) Analysis--(A) Business A treated as a QBU subject to section 
987. Business A is an eligible QBU described in paragraph (c)(1)(i) of 
this section because a partnership (P) is the owner of Business A's 
assets and liabilities for Federal income tax purposes, and P treats 
Business A as a QBU subject to section 987. Therefore, the loss 
suspension rule in paragraph (d)(1)(ii) of this section applies to 
suspend P's recognition of section 987 loss with respect to Business A.
    (B) Treatment of P as a section 987 QBU. P is a partnership 
described in paragraph (c)(1)(ii) of this section because DC1 and DC2 
each treat their interest in P as a section 987 QBU. Under paragraph 
(d)(1)(ii)(B) of this section, if DC1 and DC2 are related within the 
meaning of section 267(b) or section 707(b), the loss suspension rule 
in paragraph (d)(1)(ii) of this section applies to suspend DC1's and 
DC2's recognition of section 987 loss with respect to their interest in 
P. However, if DC1 and DC2 are unrelated, the loss suspension rule in 
paragraph (d)(1)(ii) of this section does not apply.


Sec.  1.987-8  Termination of a section 987 QBU.

    (a) Scope. This section provides rules regarding the termination of 
a section 987 QBU. Paragraph (b) of this section provides general rules 
for determining when a termination occurs. Paragraph (c) of this 
section provides exceptions to the general termination rules for 
certain transactions described in section 381(a). Paragraph (d) of this 
section is reserved. Paragraph (e) of this section describes certain 
effects of terminations. Paragraph (f) of this section contains 
examples that illustrate the principles of this section.
    (b) In general. Except as provided in paragraph (c) of this 
section, a section 987 QBU terminates if the conditions described in 
any one of paragraphs (b)(1) through (6) of this section are satisfied.
    (1) Trade or business ceases. A section 987 QBU ceases its trade or 
business. When a section 987 QBU ceases its trade or business is 
determined based on all the facts and circumstances, provided that an 
owner may continue to treat a section 987 QBU as a section 987 QBU for 
a reasonable period during the winding up of such trade or business, 
which period may in no event exceed two years from the date on which 
such QBU ceases its activities carried on for profit. See paragraph 
(f)(1) of this section (Example 1).
    (2) Substantially all assets transferred. The section 987 QBU 
transfers substantially all (within the meaning of section 
368(a)(1)(C)) of its assets to its owner. For purposes of this 
paragraph (b)(2), the amount of assets transferred from the section 987 
QBU to its owner as a result of a transaction is reduced by the amount 
of assets transferred from the owner to the section 987 QBU pursuant to 
the same transaction. See paragraphs (f)(2), (6), and (7) of this 
section (Examples 2, 6, and 7).
    (3) Owner no longer a CFC. A foreign corporation that is a 
controlled foreign corporation that is the owner of a section 987 QBU 
ceases to be a controlled foreign corporation as a result of a 
transaction or series of transactions after which persons that were 
related to the corporation within the meaning of section 267(b) 
immediately before the transaction or series of transactions 
collectively own sufficient interests in the corporation such that the 
corporation would continue to be considered a controlled foreign 
corporation if such persons were United States shareholders within the 
meaning of section 951(b). See paragraph (f)(3) of this section 
(Example 3).
    (4) Owner ceases to exist. The owner of the section 987 QBU ceases 
to exist (including in connection with a transaction described in 
section 381(a)). See paragraph (f)(4) of this section (Example 4).
    (5) Section 987 QBU ceases to be an eligible QBU with a functional 
currency different from its owner. The section 987 QBU ceases to be an 
eligible QBU that has a functional currency different from its owner. 
See Sec.  1.985-5(d)(2) and (e)(4)(iii) (providing that a termination 
resulting from a change in functional currency occurs on the last day 
of the last taxable year ending before the year of change).
    (6) Change in form of ownership. An individual or corporation that 
was the direct owner of a section 987 QBU ceases to be the direct owner 
of the section 987 QBU (for example, because the assets of the section 
987 QBU are transferred to a partnership).
    (c) Transactions described in section 381(a)--(1) Liquidations. 
Notwithstanding paragraph (b) of this section, a termination does not 
occur when the owner (distributor) of a section 987 QBU ceases to exist 
in a liquidation described in section 332 pursuant to which it 
transfers the section 987 QBU to another corporation (distributee), 
except in the following cases:
    (i) The distributor is a domestic corporation and the distributee 
is a foreign corporation.
    (ii) The distributor is a foreign corporation and the distributee 
is a domestic corporation.
    (iii) The distributor and the distributee are both foreign 
corporations and the functional currency of the distributee is the same 
as the functional currency of the distributor's section 987 QBU.
    (2) Reorganizations. Notwithstanding paragraph (b) of this section, 
a termination does not occur when the owner (transferor) of the section 
987 QBU ceases to exist in a reorganization described in section 
381(a)(2) pursuant to which it transfers the section 987 QBU to another 
corporation (acquiring corporation), except in the following cases:
    (i) The transferor is a domestic corporation and the acquiring 
corporation is a foreign corporation.
    (ii) The transferor is a foreign corporation and the acquiring 
corporation is a domestic corporation.
    (iii) The transferor is a controlled foreign corporation 
immediately before the transfer, the acquiring corporation is a foreign 
corporation that is not a controlled foreign corporation immediately 
after the transfer, and the acquiring corporation was related to the 
transferor within the meaning of section 267(b) immediately before the 
transfer.
    (iv) The transferor and the acquiring corporation are foreign 
corporations and the functional currency of the acquiring corporation 
is the same as the functional currency of the transferor's section 987 
QBU.

[[Page 100199]]

    (d) [Reserved]
    (e) Effect of terminations. A termination of a section 987 QBU as 
determined in this section is treated as a remittance of all the gross 
assets of the section 987 QBU to its owner immediately before the 
section 987 QBU terminates. Thus, except as otherwise provided in the 
section 987 regulations, a termination generally results in the 
recognition of any net unrecognized section 987 gain or loss of the 
section 987 QBU (unless it is treated as deferred section 987 gain or 
loss or suspended section 987 loss). See Sec.  1.987-5(c)(3) (generally 
recognizing section 987 gain or loss on a termination) and Sec. Sec.  
1.987-11 through 1.987-13 (suspending section 987 gain or loss and 
deferring section 987 loss in certain instances).
    (f) Examples. The following examples illustrate the principles of 
this section. Except as otherwise provided, U.S. Corp is a domestic 
corporation that has the U.S. dollar as its functional currency, and 
Business A is a section 987 QBU.
    (1) Example 1: Cessation of operations--(i) Facts. U.S. Corp is the 
owner of Business A, a sales office of U.S. Corp in Country X. Business 
A ceases sales activities on December 31, year 1. During year 2, 
Business A sells all of the assets used in its sales activities and 
winds up its business, settling outstanding accounts.
    (ii) Analysis. Business A's trade or business ceases on December 
31, year 1. The cessation of Business A's trade or business causes a 
termination of the Business A section 987 QBU under paragraph (b)(1) of 
this section on December 31, year 1, unless U.S. Corp chooses to 
continue to treat Business A as a section 987 QBU until completion of 
the wind-up activities in year 2. If U.S. Corp chooses to continue to 
treat Business A as a section 987 QBU during the wind-up of Business A, 
the Business A section 987 QBU would terminate under paragraph (b)(1) 
of this section upon completion of the wind-up in year 2.
    (2) Example 2: Transfer of a section 987 QBU to a member of a 
consolidated group--(i) Facts. U.S. Corp, the owner of Business A, 
transfers all the assets and liabilities of Business A to DS, a 
domestic corporation all of the stock of which is owned by U.S. Corp, 
in a transaction qualifying under section 351. U.S. Corp and DS are 
members of the same consolidated group.
    (ii) Analysis. Pursuant to Sec.  1.987-2(c)(2)(i) and (ii), as a 
result of the deemed exchange of the assets and liabilities of Business 
A for DS stock in a section 351 transaction, Business A is treated as 
transferring its assets and liabilities to U.S. Corp immediately before 
the transfer by U.S. Corp of the assets and liabilities to DS. Because 
a section 351 transaction is not a transaction described in section 
381(a)(2), the transfer of all of the assets of Business A to U.S. Corp 
causes a termination of the Business A section 987 QBU under paragraph 
(b)(2) of this section.
    (3) Example 3: Cessation of controlled foreign corporation status--
(i) Facts. Foreign parent (FP) is a foreign corporation that owns all 
the stock of U.S. Corp, a domestic corporation. U.S. Corp owns all of 
the stock of FC, a controlled foreign corporation as defined in section 
957. FC is the owner of Business A. U.S. Corp liquidates into FP. FC no 
longer constitutes a controlled foreign corporation after the 
liquidation.
    (ii) Analysis. Because FC ceases to qualify as a controlled foreign 
corporation as a result of a transaction after which persons that were 
related to FC within the meaning of section 267(b) immediately before 
the transaction collectively own sufficient interests in FC such that 
FC would continue to be considered a controlled foreign corporation if 
such persons were United States shareholders within the meaning of 
section 951(b), the Business A section 987 QBU terminates pursuant to 
paragraph (b)(3) of this section.
    (4) Example 4: Section 332 liquidation--(i) Facts. U.S. Corp owns 
all of the stock of FC, a foreign corporation. FC is the owner of 
Business A. Pursuant to a liquidation described in section 332, FC 
distributes all of its assets and liabilities to U.S. Corp.
    (ii) Analysis. FC's liquidation causes a termination of the 
Business A section 987 QBU as provided in paragraph (b)(4) of this 
section because FC ceases to exist as a result of the liquidation. The 
exception for certain section 332 liquidations provided under paragraph 
(c)(1) of this section does not apply because U.S. Corp is a domestic 
corporation and FC is a foreign corporation. See paragraph (c)(1)(ii) 
of this section.
    (5) [Reserved]
    (6) Example 6: Deemed transfers to a CFC upon a check-the-box 
election--(i) Facts. In year 1, U.S. Corp forms an entity in a foreign 
country, Entity A. Entity A owns Business A, which has the pound as its 
functional currency. Entity A forms Entity B in another foreign 
country. Entity B owns Business B, a section 987 QBU that has the euro 
as its functional currency. At the time of formation, Entity A and 
Entity B elect to be DEs. In year 6, Entity A files an election on Form 
8832 to be classified as a corporation under Sec.  301.7701-3(g)(1)(iv) 
of this chapter and becomes a CFC (FC) owned directly by U.S. Corp. FC 
has the pound as its functional currency.
    (ii) Analysis--(A) Under Sec.  1.987-1(b)(5), U.S. Corp is the 
owner of Business A and Business B. In year 6, when Entity A elects to 
be classified as a corporation, U.S. Corp is deemed to contribute the 
assets and liabilities of Business A and Business B to FC under section 
351 in exchange for FC stock. Pursuant to Sec.  1.987-2(c)(2)(i) and 
(ii), as a result of the deemed exchange of the assets and liabilities 
of Business A and Business B for FC stock in a section 351 transaction, 
Business A and Business B are each treated as transferring their assets 
and liabilities to U.S. Corp immediately before U.S. Corp's transfer of 
such assets and liabilities to FC. The transfer of assets from Business 
A and Business B to U.S. Corp causes terminations of those section 987 
QBUs under paragraph (b)(2) of this section. The assets and liabilities 
of Business A and Business B are now owned by FC, but because FC and 
Business A have the same functional currency, only Business B qualifies 
as a section 987 QBU to which section 987 applies.
    (B) Terminations also would have occurred in year 6 if U.S. Corp 
had contributed Entity A and Entity B to an existing foreign 
corporation owned by U.S. Corp or to a newly created foreign 
corporation owned by U.S. Corp pursuant to a section 351 exchange 
because the transfer of all of the assets of Business A and Business B 
would cause terminations of those section 987 QBUs under paragraph 
(b)(2) of this section.
    (7) Example 7: Sale of a section 987 QBU to a member of a 
consolidated group--(i) Facts. U.S. Corp, the owner of Business A, 
sells all of the assets and liabilities of Business A to DS, a domestic 
corporation, in exchange for cash. U.S. Corp and DS are members of the 
same consolidated group. The cash received on the sale is recorded on 
the books of U.S. Corp.
    (ii) Analysis. Pursuant to Sec.  1.987-2(c)(2)(i) and (ii), 
Business A is treated as transferring all of its assets and liabilities 
to U.S. Corp immediately before the sale by U.S. Corp to DS. As a 
result of this deemed transfer from Business A to U.S. Corp, the 
Business A section 987 QBU terminates under paragraph (b)(2) of this 
section.


Sec.  1.987-9  Recordkeeping requirements.

    (a) In general. An owner (or the authorized person on behalf of an 
owner) must keep a copy of the statement described in Sec.  1.987-
1(g)(3)(i) for each section 987 election made by or

[[Page 100200]]

on behalf of the owner (if not required to be made on a form published 
by the Commissioner) and reasonable records sufficient to establish 
section 987 taxable income or loss and section 987 gain or loss with 
respect to each section 987 QBU, successor deferral QBU, and successor 
suspended loss QBU, as applicable, for each taxable year.
    (b) Supplemental information. A person's obligation to maintain 
records under section 6001 and paragraph (a) of this section is not 
satisfied unless the following information is maintained in those 
records with respect to each section 987 QBU, successor deferral QBU, 
and successor suspended loss QBU for each taxable year:
    (1) The amount of the items of income, gain, deduction, or loss 
attributed to the section 987 QBU in the functional currency of the 
section 987 QBU and its owner.
    (2) The adjusted balance sheet of the section 987 QBU in the 
functional currency of the section 987 QBU and its owner. If a current 
rate election is in effect and the owner computes QBU net value under 
Sec.  1.987-4(e)(2)(iii) without preparing an adjusted balance sheet, 
the information needed to apply Sec.  1.987-4(e)(2)(iii) must be 
maintained in lieu of an adjusted balance sheet.
    (3) The exchange rates used to translate items of income, gain, 
deduction, or loss of the section 987 QBU into the owner's functional 
currency and, if a spot rate convention is used, the manner in which 
the convention is determined.
    (4) The exchange rates used to translate the assets and liabilities 
of the section 987 QBU into the owner's functional currency and, if a 
spot rate convention is used, the manner in which the convention is 
determined.
    (5) The amount of assets and liabilities transferred by the owner 
to the section 987 QBU determined in the functional currency of the 
owner and the section 987 QBU.
    (6) The amount of assets and liabilities transferred by the section 
987 QBU to the owner determined in the functional currency of the owner 
and the section 987 QBU.
    (7) The amount of the unrecognized section 987 gain or loss for the 
taxable year determined under Sec.  1.987-4(d).
    (8) The amount of the net accumulated unrecognized section 987 gain 
or loss for the taxable year determined under Sec.  1.987-4(c).
    (9) The amount of the remittance and the remittance proportion for 
the taxable year.
    (10) The computations required under Sec. Sec.  1.861-9(g) and 
1.861-9T(g) for purposes of sourcing and characterizing section 987 
gain or loss, deferred section 987 gain or loss, suspended section 987 
loss, or pretransition gain or loss under Sec.  1.987-6.
    (11) The cumulative suspended section 987 loss in each recognition 
grouping.
    (12) The outstanding deferred section 987 gain or loss in each 
recognition grouping.
    (13) The transition information required to be determined under 
Sec.  1.987-10(k).
    (14) The identification required under Sec.  1.987-14(c) with 
respect to a section 987 hedging transaction.
    (c) Retention of records. The records required by this section, or 
records that support the information required on a form published by 
the Commissioner regarding section 987, must be maintained and kept 
available for inspection by the Internal Revenue Service for so long as 
the contents thereof may become relevant in the administration of the 
Internal Revenue Code.
    (d) Information on a dedicated section 987 form. Information 
necessary to determine section 987 gain or loss and section 987 taxable 
income or loss must be reported on a form prescribed for that purpose 
(or, until that form is published, on Form 8858 or its successor) in 
accordance with the applicable forms and instructions. A taxpayer 
satisfies its obligation described in paragraphs (a) and (b) of this 
section to the extent that the taxpayer provides the specific 
information required on Form 8858 (or its successor) or other form 
prescribed for this purpose (including the information required by the 
instructions accompanying those forms).


Sec.  1.987-10  Transition rules.

    (a) Overview--(1) In general. This section provides transition 
rules for the first taxable year in which the section 987 regulations 
apply. Paragraph (b) of this section describes the scope of this 
section's application. Paragraph (c) of this section provides rules for 
determining the transition date. Paragraph (d) of this section provides 
rules relating to the application of the section 987 regulations after 
the transition date. Paragraph (e) of this section provides rules 
relating to the determination and recognition of pretransition gain or 
loss. Paragraph (f) of this section provides special rules for section 
987 QBUs to which the fresh start transition method was applied. 
Paragraph (g) of this section is reserved. Paragraph (h) of this 
section provides rules relating to the source and character of 
pretransition gain or loss. Paragraph (i) of this section is reserved. 
Paragraph (j) of this section provides adjustments to avoid double 
counting or omissions. Paragraph (k) of this section provides reporting 
requirements that apply in the taxable year beginning on the transition 
date. Paragraph (l) of this section provides examples illustrating the 
rules of this section.
    (2) Terms defined under prior Sec.  1.987-12. For purposes of this 
section, the terms deferral QBU, deferral QBU owner, successor QBU, 
outbound loss QBU, outbound section 987 loss, and qualified successor 
have the meaning provided in prior Sec.  1.987-12.
    (b) Scope--(1) Owner of a section 987 QBU. Except as provided in 
paragraph (f) of this section, any person that is an owner of a section 
987 QBU on the applicable transition date and any person that is the 
owner of a terminating QBU on the termination date must apply the rules 
of this section with respect to the section 987 QBU.
    (2) Deferral QBU owner and owner of outbound loss QBU. Except as 
provided in paragraph (f) of this section, a deferral QBU owner or the 
owner of an outbound loss QBU must apply the rules of this section with 
respect to the deferral QBU or outbound loss QBU if the deferral event 
or outbound loss event occurred before the applicable transition date. 
This paragraph (b)(2) does not apply to the owner of a terminating QBU.
    (c) Transition date--(1) In general. Except as provided in 
paragraph (c)(2) of this section, the transition date for a section 987 
QBU, deferral QBU, or outbound loss QBU is the first day of the first 
taxable year described in Sec.  1.987-15(a)(1), (b), or (c) to which 
this section applies.
    (2) Terminating QBU--(i) In general. With respect to a terminating 
QBU, the transition date is the day after the termination date. Until 
the transition date described in paragraph (c)(1) of this section, the 
owner of the terminating QBU must apply the section 987 regulations 
with respect to the terminating QBU, and any section 987 gain or loss 
attributable thereto, without regard to any section 987 elections 
(other than the election described in Sec.  1.987-6(b)(2)(i)(C)).
    (ii) Ordering rule. In the case of a terminating QBU, the 
transition rules of this section are applied immediately before the 
termination, and the consequences of the termination are determined 
under the section 987 regulations after applying this section.
    (d) Application of the section 987 regulations after the transition 
date--(1) Owner functional currency net value on the last day of the 
preceding taxable

[[Page 100201]]

year. Except as provided in paragraph (f) of this section, for purposes 
of applying Sec.  1.987-4 in the taxable year beginning on the 
transition date, the owner functional currency net value of a section 
987 QBU on the last day of the preceding taxable year under Sec.  
1.987-4(d)(1)(i)(B) is determined by translating the assets and 
liabilities that are attributable to the section 987 QBU on the day 
before the transition date into the owner's functional currency at the 
transition exchange rate described in paragraph (d)(3) of this section.
    (2) Determination of historic rate. If a current rate election is 
not in effect for the taxable year beginning on the transition date, 
the historic rate for historic items that are attributable to a section 
987 QBU on the day before the transition date (other than non-LIFO 
inventory subject to the simplified inventory method under Sec.  1.987-
3(c)(2)(iv)(A)) is the transition exchange rate described in paragraph 
(d)(3) of this section.
    (3) Transition exchange rate--(i) In general. Except as provided in 
paragraph (d)(3)(ii) of this section, the transition exchange rate is 
the spot rate applicable to the day before the transition date.
    (ii) Earnings only method. If an earnings only method described in 
paragraph (e)(4)(ii) of this section was applied with respect to a 
section 987 QBU before the transition date, and a current rate election 
is not in effect in the taxable year beginning on the transition date, 
the transition exchange rate for each historic item (other than 
inventory subject to the simplified inventory method under Sec.  1.987-
3(c)(2)(iv)(A)) is the pretransition translation rate described in 
paragraph (e)(2)(i)(C) of this section. This paragraph (d)(3)(ii) does 
not apply with respect to a terminating QBU.
    (e) Pretransition gain or loss--(1) In general. Except as provided 
in paragraph (f) of this section, pretransition gain or loss is 
determined and recognized under this paragraph (e).
    (2) Amount of pretransition gain or loss for an owner that applied 
an eligible pretransition method--(i) Owner of a section 987 QBU. If an 
owner of a section 987 QBU described in paragraph (b)(1) of this 
section applied an eligible pretransition method with respect to the 
section 987 QBU, the amount of pretransition gain or loss with respect 
to the section 987 QBU is equal to the sum of the deemed termination 
amount described in paragraph (e)(2)(i)(A) of this section and the 
owner functional currency net value adjustment described in paragraph 
(e)(2)(i)(B) of this section. See paragraphs (l)(1) through (3) of this 
section (Examples 1 through 3) for an illustration of this rule.
    (A) Deemed termination amount. The deemed termination amount is the 
amount of section 987 gain or loss that would have been recognized by 
the owner under the eligible pretransition method if the section 987 
QBU terminated and transferred all of its assets and liabilities to the 
owner on the day before the transition date and Sec. Sec.  1.987-12 and 
1.987-13 and prior Sec.  1.987-12 did not apply.
    (B) Owner functional currency net value adjustment. The owner 
functional currency net value adjustment may be either positive or 
negative and is equal to the amount described in paragraph 
(e)(2)(i)(B)(1) of this section reduced by the amount described in 
paragraph (e)(2)(i)(B)(2) of this section.
    (1) The basis of the assets, reduced by the amount of liabilities, 
that are attributable to the section 987 QBU on the day before the 
transition date, translated into the owner's functional currency at the 
transition exchange rate.
    (2) The basis of the assets, reduced by the amount of liabilities, 
that are attributable to the section 987 QBU on the day before the 
transition date, translated into the owner's functional currency at the 
pretransition translation rate.
    (C) Pretransition translation rate. The pretransition translation 
rate is the rate that would be used under the eligible pretransition 
method to determine the basis of an asset or the amount of a liability 
in the hands of the owner of a section 987 QBU if the section 987 QBU 
transferred all of its assets and liabilities to the owner on the day 
before the transition date.
    (ii) Deferral QBU owner. If a deferral QBU owner described in 
paragraph (b)(2) of this section applied an eligible pretransition 
method with respect to the deferral QBU, the amount of pretransition 
gain or loss with respect to the deferral QBU is equal to the deferred 
section 987 gain or loss (determined under prior Sec.  1.987-12) that 
was not recognized before the transition date with respect to the 
deferral QBU.
    (iii) Owner of an outbound loss QBU. If the owner of an outbound 
loss QBU described in paragraph (b)(2) of this section applied an 
eligible pretransition method with respect to the outbound loss QBU, 
the pretransition loss with respect to the outbound loss QBU is equal 
to the outbound section 987 loss that was not added to the basis of 
stock or recognized under prior Sec.  1.987-12 before the transition 
date with respect to the outbound loss QBU.
    (3) Amount of pretransition gain or loss for an owner that did not 
apply an eligible pretransition method--(i) In general. If the owner of 
a section 987 QBU described in paragraph (b)(1) of this section did not 
apply an eligible pretransition method with respect to the section 987 
QBU, the amount of pretransition gain or loss with respect to the 
section 987 QBU is determined under paragraph (e)(3)(ii) of this 
section. See paragraph (l)(4) of this section (Example 4) for an 
illustration of this rule.
    (ii) Computation of pretransition gain or loss. With respect to a 
section 987 QBU described in paragraph (e)(3)(i) of this section, 
pretransition gain or loss is equal to the amount described in 
paragraph (e)(3)(ii)(A) of this section reduced by the amount described 
in paragraph (e)(3)(ii)(B) of this section.
    (A) The sum of the owner's annual unrecognized section 987 gain or 
loss determined under paragraph (e)(3)(iii) of this section with 
respect to the section 987 QBU for all taxable years ending before the 
transition date and beginning after September 7, 2006, in which it was 
the owner of the section 987 QBU.
    (B) The total net amount of section 987 gain or loss recognized by 
the owner with respect to the section 987 QBU in all taxable years 
ending before the transition date and beginning after September 7, 
2006.
    (iii) Annual unrecognized section 987 gain or loss. An owner of a 
section 987 QBU described in paragraph (e)(3)(i) of this section 
determines annual unrecognized section 987 gain or loss with respect to 
a section 987 QBU under the rules of Sec.  1.987-4(d), applied as 
though a current rate election was in effect for all relevant taxable 
years, and subject to the following modifications--
    (A) Only Sec.  1.987-4(d)(1) and (10) (steps 1 and 10) are applied; 
and
    (B) Section 1.987-4(d)(10) is applied by replacing ``paragraphs 
(d)(1) through (9) of this section'' with ``paragraph (d)(1) of this 
section.''
    (iv) Deferral QBU owner. If a deferral QBU owner described in 
paragraph (b)(2) of this section did not apply an eligible 
pretransition method with respect to the deferral QBU, the 
pretransition gain or loss with respect to the deferral QBU is equal to 
the amount that would be determined under paragraph (e)(3)(ii) of this 
section with respect to the deferral QBU if the transition date was the 
day of the deferral event, reduced by the amount of deferred section 
987 gain or loss (determined under prior Sec.  1.987-12) recognized 
before the actual transition date.
    (v) Owner of an outbound loss QBU. If the owner of an outbound loss 
QBU

[[Page 100202]]

described in paragraph (b)(2) of this section did not apply an eligible 
pretransition method with respect to the outbound loss QBU, the 
pretransition loss with respect to the outbound loss QBU is equal to 
the amount that would be determined under paragraph (e)(3)(ii) of this 
section with respect to the outbound loss QBU if the transition date 
was the day of the outbound loss event, reduced by any outbound section 
987 loss recognized or added to the basis of stock under prior Sec.  
1.987-12 before the actual transition date.
    (4) Eligible pretransition method. An eligible pretransition method 
means a method of applying section 987 before the transition date that 
is described in paragraphs (e)(4)(i) through (iii) of this section. An 
owner is treated as applying an eligible pretransition method with 
respect to a section 987 QBU only if it applied an eligible 
pretransition method with respect to the QBU on a return filed before 
November 9, 2023.
    (i) Earnings and capital method. An earnings and capital method is 
an eligible pretransition method if it is applied in a reasonable 
manner. For purposes of this paragraph (e)(4)(i), an earnings and 
capital method means a method of applying section 987 that requires 
section 987 gain or loss to be determined and recognized with respect 
to both the earnings of the section 987 QBU and capital contributed to 
the section 987 QBU (for example, the method prescribed in the 1991 
proposed regulations under section 987). See paragraph (l)(1) of this 
section (Example 1) for an illustration of this rule.
    (ii) Other reasonable methods. Any reasonable method of applying 
section 987 is an eligible pretransition method if it produces the same 
total amount of income over the life of the owner of a section 987 QBU 
as the method described in paragraph (e)(4)(i) of this section (taking 
into account the aggregate of section 987 gain or loss, section 987 
taxable income or loss, and income or loss recognized by the owner of 
the section 987 QBU with respect to property transferred between the 
section 987 QBU and the owner or any QBU of the owner). See paragraph 
(l)(2) of this section (Example 2) for an illustration of this rule.
    (iii) Other earnings only methods. An earnings only method that 
does not meet the requirements of paragraph (e)(4)(ii) of this section 
is an eligible pretransition method, provided that--
    (A) The earnings only method was first applied by the owner on a 
return filed before November 9, 2023;
    (B) The earnings only method was applied consistently to all 
section 987 QBUs of the owner since the first taxable year in which the 
owner applied an eligible pretransition method; and
    (C) The owner of the section 987 QBU otherwise applied section 987 
in a reasonable manner. See paragraph (l)(3) of this section (Example 
3) for an illustration of this rule.
    (iv) Error in the application of a section 987 method. If an owner 
generally applied section 987 with respect to a section 987 QBU before 
the transition date under a method described in paragraph (e)(4)(i), 
(ii), or (iii) of this section but made errors in the application of 
the method or failed to apply the method to every taxable year since 
the QBU's inception, the owner is considered to have applied an 
eligible pretransition method with respect to the QBU. However, 
pretransition gain or loss must be determined under paragraph (e)(2) of 
this section as though the eligible pretransition method was applied 
without error since the section 987 QBU's inception. See paragraph 
(l)(5) of this section (Example 5) for an illustration of this rule.
    (v) Certain consistent practices not treated as errors--(A) In 
general. If an owner generally applied section 987 with respect to a 
section 987 QBU before the transition date under a method described in 
paragraph (e)(4)(i), (ii), or (iii) of this section and used a 
consistent practice described in paragraph (e)(4)(v)(B) of this section 
for purposes of applying that method, the owner is considered to have 
applied an eligible pretransition method with respect to the QBU. In 
addition, the consistent practice is not treated as an error under 
paragraph (e)(4)(iv) of this section. Therefore, the owner must take 
the consistent practice into account in determining pretransition gain 
or loss under paragraph (e)(2) of this section. See paragraph (l)(6) of 
this section (Example 6) for an illustration of this rule.
    (B) Practices not treated as errors--(1) Reasonable conventions. 
The use of a reasonable convention (for example, the use of a yearly 
average exchange rate rather than the applicable spot rate to translate 
frequently recurring transfers) is a practice described in this 
paragraph (e)(4)(v)(B).
    (2) Disregarded transactions. If, in determining the amount of a 
remittance that requires the recognition of gain or loss under section 
987(3), an owner of a QBU consistently disregarded certain transfers to 
or from the QBU (other than transfers from the QBU to the owner that 
would be treated as distributions if the QBU were treated as a separate 
corporation), the owner is considered to have applied a practice 
described in this paragraph (e)(4)(v)(B) with respect to the QBU, 
provided that the owner otherwise accounts for the disregarded 
transfers in a reasonable manner (for example, under the method 
described in the 1991 proposed regulations, by taking the disregarded 
transfers into account in computing equity and basis pools so as to 
properly reflect the owner's net equity in the QBU and its functional 
currency basis in the QBU).
    (vi) Deferral of section 987 gain or loss until termination is not 
reasonable. For purposes of this paragraph (e)(4), a method under which 
the owner of a section 987 QBU defers the recognition of section 987 
gain or loss until the section 987 QBU is terminated, sold, or 
liquidated is not a reasonable method.
    (vii) Anti-abuse rule. If an owner changes its pretransition method 
of applying section 987 with a principal purpose of reducing its 
pretransition gain or increasing its pretransition loss, the 
Commissioner may redetermine pretransition gain or loss based on the 
owner's original method of applying section 987 or by treating the 
owner as not applying an eligible pretransition method.
    (5) Recognition of pretransition gain or loss--(i) In general. 
Except as provided in paragraph (e)(5)(ii) of this section, 
pretransition gain is recognized under paragraph (e)(5)(i)(A) of this 
section and pretransition loss is recognized under paragraph 
(e)(5)(i)(B) of this section.
    (A) Pretransition gain. Pretransition gain with respect to a 
section 987 QBU is treated as net accumulated unrecognized section 987 
gain (within the meaning of Sec.  1.987-4(c)). Pretransition gain with 
respect to a deferral QBU is treated as deferred section 987 gain and 
is attributed to one or more successor deferral QBUs under the 
principles of Sec.  1.987-12(b)(2) and (c)(2).
    (B) Pretransition loss--(1) In general. Except as provided in 
paragraph (e)(5)(i)(B)(2) of this section, pretransition loss with 
respect to a section 987 QBU, a deferral QBU, or an outbound loss QBU 
is treated as suspended section 987 loss with respect to the section 
987 QBU, the deferral QBU, or the outbound loss QBU. In the case of a 
deferral QBU or outbound loss QBU, suspended section 987 loss is 
attributed to one or more successor suspended loss QBUs under the 
principles of Sec.  1.987-13(b)(1) and (c)(1).
    (2) Current rate election. If a current rate election is in effect 
(and an annual recognition election is not in effect) in the taxable 
year beginning on the transition date, pretransition loss with respect 
to a section 987 QBU (other than

[[Page 100203]]

a terminating QBU) is treated as net accumulated unrecognized section 
987 loss (within the meaning of Sec.  1.987-4(c)), and pretransition 
loss with respect to a deferral QBU is treated as deferred section 987 
loss and is attributed to one or more successor deferral QBUs under the 
principles of Sec.  1.987-12(b)(2) and (c)(2).
    (ii) Election to recognize pretransition section 987 gain or loss 
ratably over the transition period--(A) In general. A taxpayer may 
elect to recognize pretransition gain or loss ratably over the 
transition period. If an election is made to recognize pretransition 
gain or loss ratably over the transition period, then paragraph 
(e)(5)(i) of this section does not apply, and each owner to which the 
election applies recognizes one tenth of its pretransition gain or loss 
with respect to each section 987 QBU, original deferral QBU, and 
outbound loss QBU in each taxable year for ten taxable years beginning 
with the taxable year that begins on the transition date described in 
paragraph (c)(1) of this section. See Sec.  1.987-1(g) for rules 
relating to section 987 elections (including consistency rules).
    (B) Special rules for certain transactions--(1) Scope. This 
paragraph (e)(5)(ii)(B) applies if a corporation (acquiring 
corporation) acquires the assets of an owner that is subject to an 
election under paragraph (e)(5)(ii)(A) of this section in a transaction 
described in section 381(a), and either the owner is a foreign 
corporation and the acquiring corporation is a domestic corporation or 
the owner is a domestic corporation and the acquiring corporation is a 
foreign corporation. This paragraph (e)(5)(ii)(B) also applies to any 
transaction entered into with a principal purpose of avoiding the 
recognition of pretransition gain under paragraph (e)(5)(ii)(A) of this 
section.
    (2) Recognition of pretransition gain or loss. In the case of a 
transaction described in paragraph (e)(5)(ii)(B)(1) of this section, 
pretransition gain or loss that has not been recognized under paragraph 
(e)(5)(ii)(A) of this section ceases to be subject to the election to 
be recognized ratably over the transition period. Any unrecognized 
pretransition gain is recognized immediately before the transaction, 
and any unrecognized pretransition loss becomes suspended section 987 
loss immediately before the transaction. As a result, the suspended 
section 987 loss may be recognized to the extent of section 987 gain 
recognized in the same recognition grouping pursuant to Sec.  1.987-
11(e). See also Sec.  1.987-13(g) (providing that any remaining 
suspended section 987 loss does not carry over to the acquiring 
corporation upon an inbound transaction to which section 381(a) 
applies).
    (C) Terminating QBU. This paragraph (e)(5)(ii)(C) applies with 
respect to a terminating QBU if, in the taxable year beginning on the 
transition date described in paragraph (c)(1) of this section, the 
owner of the terminating QBU elects to recognize pretransition gain or 
loss ratably over the transition period. Any deferred section 987 gain 
or loss or suspended section 987 loss with respect to the terminating 
QBU that was not recognized before the transition date described in 
paragraph (c)(1) of this section is treated as pretransition gain or 
loss for purposes of this paragraph (e)(5)(ii) (and ceases to be 
treated as deferred section 987 gain or loss or suspended section 987 
loss). The pretransition gain or loss is recognized ratably over ten 
taxable years beginning with the taxable year that begins on the 
transition date described in paragraph (c)(1) of this section.
    (6) Predecessor of an owner--(i) In general. For purposes of this 
paragraph (e), references to an owner of a section 987 QBU, a deferral 
QBU owner, and the owner of an outbound loss QBU include a predecessor 
described in paragraph (e)(6)(ii) of this section.
    (ii) Predecessor. If a corporation (acquiring corporation) becomes 
the owner of a section 987 QBU in a transaction described in section 
381(a) in which the section 987 QBU does not terminate, the corporation 
that was the owner of the section 987 QBU immediately before the 
transaction is a predecessor of the acquiring corporation. If a 
corporation (acquiring corporation) becomes a qualified successor of a 
deferral QBU owner or the owner of an outbound loss QBU (each, a 
transferor corporation), the transferor corporation is a predecessor of 
the acquiring corporation. A predecessor of a corporation includes the 
predecessor of a predecessor of the corporation.
    (7) Small business election--(i) Scope. This paragraph (e)(7) 
applies if the owner of a QBU meets the threshold described in 
paragraph (e)(7)(ii) of this section and the QBU meets the threshold 
described in paragraph (e)(7)(iii) of this section. This paragraph 
(e)(7) does not apply with respect to a terminating QBU.
    (ii) Owner threshold. An owner of a QBU meets the requirements of 
this paragraph (e)(7)(ii) if the owner would qualify for the small 
business exemption provided in section 163(j)(3) for the taxable year 
beginning on the transition date described in paragraph (c)(1) of this 
section.
    (iii) QBU threshold. A QBU meets the requirements of this paragraph 
(e)(7)(iii) if the assets attributable to the QBU have an adjusted 
basis (translated at the spot rate applicable to the last day of each 
taxable year) of $10 million or less at the end of each of the three 
taxable years of the owner ending before the transition date described 
in paragraph (c)(1) of this section (or, if the QBU was not in 
existence for three taxable years, each taxable year ending before the 
transition date in which the QBU existed). For this purpose, all QBUs 
owned by members of the same controlled group that have the same 
country of residence (as defined in section 988(a)(3)(B)) are treated 
as a single QBU. Solely for purposes of applying this paragraph 
(e)(7)(iii) in the case of a deferral QBU or outbound loss QBU 
described in paragraph (b)(2) of this section, the termination date is 
treated as the transition date.
    (iv) Small business election. If the owner of a QBU meets the 
requirements of paragraph (e)(7)(ii) of this section, the owner may 
elect to treat all QBUs that meet the requirements of paragraph 
(e)(7)(iii) of this section as having no pretransition gain or loss.
    (f) QBUs to which the fresh start transition method was applied--
(1) In general. Paragraphs (d) and (e) of this section do not apply 
with respect to any section 987 QBU, deferral QBU, or outbound loss QBU 
with respect to which the taxpayer applied the rules of prior Sec.  
1.987-10 (or applied Sec.  1.987-10 of the 2006 proposed regulations in 
a reasonable manner) on a return filed before November 9, 2023 or 
pursuant to paragraph (f)(3) of this section.
    (2) Application of the section 987 regulations after the transition 
date--(i) Owner functional currency net value on the last day of the 
preceding taxable year. For purposes of applying Sec.  1.987-4 with 
respect to a section 987 QBU described in paragraph (f)(1) of this 
section for the taxable year beginning on the transition date, the 
owner functional currency net value of the section 987 QBU on the last 
day of the preceding taxable year under Sec.  1.987-4(d)(1)(i)(B) is 
the amount that was determined for the preceding taxable year under 
prior Sec.  1.987-4(d)(1)(A) or Sec.  1.987-4(d)(1)(A) of the 2006 
proposed section 987 regulations, as applicable.
    (ii) Determination of historic rate. For purposes of applying the 
section 987 regulations with respect to historic items (other than 
inventory subject to the simplified inventory method under Sec.  1.987-
3(c)(2)(iv)(A)) that are attributable to the section 987 QBU on the day 
before the transition date, a taxpayer must use the same historic

[[Page 100204]]

rates as were used under the taxpayer's application of the 2016 and 
2019 section 987 regulations or the 2006 proposed section 987 
regulations, as applicable, in place of the historic rates that 
otherwise would be determined under Sec.  1.987-1(c)(3).
    (iii) Unrecognized section 987 gain or loss--(A) Net accumulated 
unrecognized section 987 gain or loss of a section 987 QBU. In taxable 
years beginning on or after the transition date, for purposes of 
calculating the net accumulated unrecognized section 987 gain or loss 
of a section 987 QBU described in paragraph (f)(1) of this section 
under Sec.  1.987-4(c)--
    (1) Amounts determined under prior Sec.  1.987-4(d) or under Sec.  
1.987-4(d) or Sec.  1.987-10 of the 2006 proposed section 987 
regulations, as applicable, are included in amounts determined under 
Sec.  1.987-4(d) for all prior taxable years; and
    (2) Amounts taken into account under prior Sec.  1.987-5(a) or 
under Sec.  1.987-5(a) of the 2006 proposed section 987 regulations, as 
applicable, are included in amounts recognized under Sec.  1.987-5(a) 
for all prior taxable years. For this purpose, amounts taken into 
account under prior Sec.  1.987-5(a) or under Sec.  1.987-5(a) of the 
2006 proposed section 987 regulations, as applicable, are determined 
without regard to prior Sec.  1.987-12 or prior Sec.  1.987-12T.
    (B) Deferred section 987 gain or loss attributable to a successor 
deferral QBU. In the taxable year beginning on the transition date, the 
outstanding deferred section 987 gain or loss (as determined under 
prior Sec.  1.987-12) of a deferral QBU described in paragraph (f)(1) 
of this section becomes deferred section 987 gain or loss (within the 
meaning of Sec.  1.987-12). The deferred section 987 gain or loss is 
attributed to one or more successor deferral QBUs under the principles 
of Sec.  1.987-12(b)(2) and (c)(2).
    (C) Outbound section 987 loss attributable to a successor suspended 
loss QBU. In the taxable year beginning on the transition date, 
outbound section 987 loss of an outbound loss QBU described in 
paragraph (f)(1) of this section that has not been recognized or added 
to the basis of stock under prior Sec.  1.987-12 becomes suspended 
section 987 loss. The suspended section 987 loss is attributed to one 
or more successor suspended loss QBUs under the principles of Sec.  
1.987-13(b)(1) and (c)(1).
    (3) Taxpayers that are required to transition using the fresh start 
transition method. If a taxpayer is subject to a consent agreement 
under which it is required to apply the fresh start transition method 
with respect to a section 987 QBU, then the taxpayer must apply the 
transition rules of prior Sec.  1.987-10 to that section 987 QBU for 
the taxable year beginning on the transition date and immediately 
before the taxpayer applies this section. In applying this section, the 
taxpayer is treated as having applied prior Sec.  1.987-10 to the 
section 987 QBU.
    (g) [Reserved]
    (h) Determination of source and character--(1) In general. Except 
as provided in paragraph (h)(2) of this section, the source and 
character of pretransition gain or loss is determined under the rules 
of Sec.  1.987-6. See Sec.  1.987-6(b)(1) (timing of source and 
character determination).
    (2) Deferral QBU or outbound loss QBU. Notwithstanding paragraph 
(h)(1) of this section and Sec.  1.987-6, the source and character of 
pretransition gain or loss with respect to a deferral QBU or an 
outbound loss QBU described in paragraph (b)(2) of this section is the 
same as the source and character of the outstanding deferred section 
987 gain or loss (determined under prior Sec.  1.987-12) of the 
deferral QBU or the outbound section 987 loss of the outbound loss QBU 
(determined under prior Sec.  1.987-12(e)).
    (i) [Reserved]
    (j) Adjustments to avoid double counting or omissions. If a 
difference between the treatment of any item under the section 987 
regulations and the treatment of the item under the taxpayer's prior 
section 987 method would result in income, gain, deduction, or loss 
(including section 988 gain or loss) being taken into account more than 
once or not being taken into account, then pretransition gain or loss, 
as determined under paragraphs (e)(2) and (3) of this section, is 
adjusted to account for the difference. In case of a QBU described in 
paragraph (f)(1) of this section, appropriate adjustments must be made 
under the principles of paragraph (e)(5) of this section. In the case 
of a terminating QBU, the determination as to whether an adjustment is 
required under this paragraph (j) is made after taking into account 
section 988 gain or loss recognized in connection with the termination.
    (k) Reporting--(1) In general. Except as otherwise provided in this 
paragraph (k), a statement titled ``Section 987 Transition 
Information'' must be attached to an owner's timely filed (including 
extensions) return for the taxable year beginning on the transition 
date providing the following information for each QBU described in 
paragraph (k)(2) of this section:
    (i) A description of each QBU, the QBU's principal place of 
business, and a description of the prior method used by the taxpayer to 
determine its section 987 gain or loss, deferred section 987 gain or 
loss, or outbound section 987 loss with respect to the QBU, including 
an explanation as to whether such method was an eligible pretransition 
method.
    (ii) The pretransition gain or loss with respect to each QBU and 
the computations used to determine pretransition gain or loss.
    (iii) Whether the authorized person has elected to recognize 
pretransition gain or loss ratably over the transition period pursuant 
to paragraph (e)(5)(ii) of this section.
    (iv) Whether the authorized person has made a small business 
election under paragraph (e)(7) of this section and the computations 
used to determine eligibility for the election.
    (v) With respect to each QBU for which any adjustment is made under 
paragraph (j) of this section, a description of each adjustment and the 
basis for computing the adjustment.
    (vi) A list of the QBUs described in paragraph (f)(1) of this 
section, or a statement that no QBUs are described in paragraph (f)(1) 
of this section.
    (2) QBUs for which reporting is required--(i) In general. Except as 
provided in paragraph (k)(2)(ii) of this section, the information 
described in paragraph (k)(1) of this section must be provided with 
respect to--
    (A) Each section 987 QBU described in paragraph (b)(1) of this 
section;
    (B) Each deferral QBU described in paragraph (b)(2) of this section 
and each of its successor deferral QBUs; and
    (C) Each outbound loss QBU described in paragraph (b)(2) of this 
section and each of its successor suspended loss QBUs.
    (ii) QBUs to which the fresh start transition method was applied. A 
taxpayer is not required to provide the information described in 
paragraphs (k)(1)(i) through (iv) of this section with respect to a QBU 
described in paragraph (f)(1) of this section.
    (3) Attachments not required where information is reported on a 
form. This paragraph (k) does not apply to the extent provided on a 
form or instructions published by the Commissioner.
    (4) No change in method of accounting. The application of this 
section is not treated as a change in method of accounting for purposes 
of sections 446 and 481.
    (l) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, DC is a

[[Page 100205]]

domestic corporation with the U.S. dollar as its functional currency 
and Branch is a section 987 QBU with the euro as its functional 
currency. DC has a taxable year ending December 31, and the transition 
date is January 1, year 4. For purposes of the examples, except as 
otherwise indicated, assume that no section 987 elections are in 
effect.
    (1) Example 1: Earnings and capital method--(i) Facts--(A) 
Formation of Branch and Branch's operations. DC formed Branch on 
November 30, year 1, with a contribution of [euro]150. In year 1, 
Branch purchased a parcel of unimproved land for [euro]100. In year 2, 
Branch earned [euro]25. In year 3, Branch again earned [euro]25. On 
June 30, year 3, Branch distributed [euro]100 cash to DC, and DC 
immediately exchanged the [euro]100 for $135.
    (B) Exchange rates. The relevant exchange rates are shown below.

            Table 1 to Paragraph (l)(1)(i)(B)--Exchange Rates
------------------------------------------------------------------------
                                                        Yearly average
                                       Spot rate         exchange rate
------------------------------------------------------------------------
November 30, Year 1.............  [euro]1 = $1......
December 31, Year 1.............  [euro]1 = $1.10...
December 31, Year 2.............  [euro]1 = $1.20...
June 30, Year 3.................  [euro]1 = $1.35...
December 31, Year 3.............  [euro]1 = $1.40...
Year 1..........................  ..................  [euro]1 = $1.05.
Year 2..........................  ..................  [euro]1 = $1.15.
Year 3..........................  ..................  [euro]1 = $1.25.
------------------------------------------------------------------------

    (C) Pretransition method. DC used the method prescribed in the 1991 
proposed regulations under section 987 with respect to Branch before 
the transition date. Under this method, DC maintains an equity pool in 
euros (Branch's functional currency) and a basis pool in U.S. dollars 
(DC's functional currency). When Branch makes a remittance (whether out 
of earnings or capital), DC recognizes section 987 gain or loss equal 
to the difference between the amount of the remittance (translated into 
U.S. dollars at the spot rate on the date of the remittance) and the 
portion of the basis pool attributable to the remittance. DC's basis in 
assets distributed from Branch is equal to Branch's basis in the 
assets, translated into U.S. dollars at the spot rate on the date of 
the remittance. Branch's earnings are translated into U.S. dollars at 
the average exchange rate for the taxable year. DC otherwise applies 
section 987 in a reasonable manner.
    (D) Application of the pretransition method before the transition 
date. For purposes of determining section 987 gain or loss recognized 
as a result of the June 30, year 3, remittance, DC was required to 
determine the amount in Branch's equity and basis pools. Branch's 
equity pool was equal to [euro]200, and its basis pool was equal to 
$210, as shown in the table below. Because the remittance was equal to 
50% of the equity pool ([euro]100), 50% of the basis pool, or $105, was 
attributable to the remittance. The amount of the remittance was $135 
([euro]100 translated at the spot rate on June 30, year 3, of [euro]1 = 
$1.35). Therefore, in year 3, DC recognized section 987 gain of $30, 
equal to the difference between the amount of the remittance ($135) and 
the portion of the basis pool attributable to the remittance ($105). As 
a result of the remittance, the equity pool was reduced by the amount 
distributed ([euro]100), and the basis pool was reduced by the portion 
of the basis pool attributable to the remittance ($105). Therefore, 
after the remittance, the equity pool was equal to [euro]100, and the 
basis pool was equal to $105. In the hands of DC, the euros distributed 
had a basis of $135 (equal to the [euro]100 distribution translated at 
the spot rate on June 30, year 3, of [euro]1 = $1.35). DC did not 
recognize section 988 gain or loss when it exchanged the euros for 
$135.

                        Table 2 to Paragraph (l)(1)(i)(D)--Year 3 Equity and Basis Pools
----------------------------------------------------------------------------------------------------------------
                                                  Equity pool           Translation rate            Basis pool
----------------------------------------------------------------------------------------------------------------
Contribution (11/30/Year 1)...................       [euro]150  [euro]1 = $1....................            $150
Year 2 Earnings...............................        [euro]25  [euro]1 = $1.15.................           28.75
Year 3 Earnings...............................        [euro]25  [euro]1 = $1.25.................           31.25
                                               -----------------------------------------------------------------
    Total.....................................       [euro]200  ................................             210
----------------------------------------------------------------------------------------------------------------

    (ii) Analysis--(A) DC's method is an eligible pretransition method. 
Before the transition date, DC followed the method prescribed in the 
1991 proposed regulations under section 987 with respect to Branch. 
This method is an eligible pretransition method under paragraph 
(e)(4)(i) of this section. Therefore, DC determines its pretransition 
gain or loss with respect to Branch under paragraph (e)(2) of this 
section.
    (B) Pretransition gain or loss. Under paragraph (e)(2) of this 
section, DC's pretransition gain or loss with respect to Branch is 
equal to the sum of the deemed termination amount described in 
paragraph (e)(2)(i)(A) of this section and the owner functional 
currency net value adjustment described in paragraph (e)(2)(i)(B) of 
this section. As explained in paragraphs (l)(1)(ii)(B)(1) and (2) of 
this section (Example 1), DC's deemed termination amount is $35 and its 
owner functional currency net value adjustment is zero. Therefore, DC 
has $35 of pretransition gain with respect to Branch. Under paragraph 
(e)(5)(i)(A) of this section, the pretransition gain is treated as 
Branch's net accumulated unrecognized section 987 gain. However, if DC 
elects to recognize its pretransition gain ratably over the transition 
period under paragraph (e)(5)(ii) of this section, the pretransition 
gain is not treated as net accumulated unrecognized section 987 gain. 
Instead, DC recognizes $3.50 (one tenth of its pretransition gain) for 
each of the ten taxable years from year 4 through year 13.
    (1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this 
section, the deemed termination amount is the amount of section 987 
gain or loss that would have been recognized by DC under the eligible 
pretransition method if Branch terminated and transferred all its 
assets and liabilities to DC (the land with a basis of [euro]100) on 
December 31, year 3. Under DC's eligible pretransition method, DC would 
have recognized section 987 gain of $35, determined by subtracting the 
remaining basis pool of $105 from the amount of the remittance of $140 
([euro]100 translated at the spot rate on December 31, year 3, of 
[euro]1 = $1.40). Therefore, the deemed termination amount is $35.
    (2) Owner functional currency net value adjustment. On December 31, 
year 3, Branch had no liabilities and only one asset: land with a basis 
of [euro]100. Under paragraph (e)(2)(i)(B) of this section, the owner 
functional currency net value adjustment is equal to the basis of the 
land, translated into U.S. dollars at the transition exchange rate, 
reduced by the basis of the land,

[[Page 100206]]

translated into U.S. dollars at the pretransition translation rate. 
Under paragraph (d)(3)(i) of this section, the transition exchange rate 
is the spot rate applicable to December 31, year 3. Under paragraph 
(e)(2)(i)(C) of this section, the pretransition translation rate is the 
rate that would be used under DC's eligible pretransition method to 
determine the basis of the land in the hands of DC if Branch 
transferred the land to DC on December 31, year 3. Under DC's eligible 
pretransition method, if Branch transferred the land to DC, DC's basis 
in the land would be equal to Branch's basis ([euro]100) translated at 
the spot rate on the date of the remittance. Therefore, the 
pretransition translation rate on December 31, year 3, is equal to the 
spot rate on December 31, year 3. Consequently, the owner functional 
currency net value adjustment is zero.
    (C) Determination of unrecognized section 987 gain or loss in year 
4. For purposes of determining unrecognized section 987 gain or loss in 
year 4 under Sec.  1.987-4(d), the owner functional currency net value 
of Branch on the last day of year 3 is determined by translating the 
[euro]100 basis of the land at the transition exchange rate, which is 
the spot rate on December 31, year 3 ([euro]1 = $1.40). Therefore, the 
owner functional currency net value of Branch on the last day of year 3 
is $140.
    (2) Example 2: Earnings only method described in paragraph 
(e)(4)(ii) of this section--(i) Facts--(A) In general. The facts and 
exchange rates are the same as in paragraph (l)(1) of this section 
(Example 1), except that DC uses an earnings only method with respect 
to Branch before the transition date, as described in paragraph 
(l)(2)(i)(B) of this section. In addition, a current rate election is 
in effect for Year 4.
    (B) Pretransition method. Under the earnings only method, DC 
maintains an equity pool in euros (Branch's functional currency) and a 
basis pool in U.S. dollars (DC's functional currency) with respect to 
Branch's earnings. DC also maintains separate equity and basis pools 
with respect to Branch's capital. Distributions are treated as being 
made first out of earnings and then out of capital. When Branch makes a 
remittance out of earnings, DC recognizes section 987 gain or loss 
equal to the difference between the amount of the remittance 
(translated into U.S. dollars at the spot rate on the date of the 
remittance) and the portion of the earnings basis pool attributable to 
the remittance. No section 987 gain or loss is recognized on a 
distribution out of capital. DC's basis in assets distributed out of 
Branch's earnings is equal to Branch's basis in the assets translated 
at the spot rate on the date of the remittance. DC's basis in assets 
distributed out of Branch's capital is equal to the portion of the 
capital basis pool attributable to the distribution. Branch's earnings 
are translated into U.S. dollars at the average exchange rate for the 
taxable year. DC otherwise applies section 987 in a reasonable manner.
    (C) Application of the pretransition method before the transition 
date. On June 30, year 3, Branch distributed [euro]100 cash to DC. Of 
this amount, [euro]50 represented a remittance out of earnings, and 
[euro]50 represented a distribution out of capital.
    (1) Remittance out of earnings. For purposes of determining section 
987 gain or loss recognized on the remittance, Branch's earnings equity 
pool was equal to [euro]50, and its earnings basis pool was equal to 
$60, as shown in the table below. Because Branch remitted 100% of the 
earnings equity pool ([euro]50), the entire earnings basis pool, or 
$60, was attributable to the remittance. The value of the remittance 
was $67.50 ([euro]50 translated at the spot rate on June 30, year 3, of 
[euro]1 = $1.35). Therefore, in year 3, DC recognized section 987 gain 
of $7.50, equal to the difference between the value of the remittance 
($67.50) and the portion of the basis pool attributable to the 
remittance ($60). As a result of the remittance, the earnings equity 
pool and the earnings basis pool were each reduced to zero. In the 
hands of DC, the [euro]50 distributed out of earnings had a basis of 
$67.50 ([euro]50 translated at the spot rate on June 30, year 3, of 
[euro]1 = $1.35).

                      Table 3 to Paragraph (l)(2)(i)(C)(1)--Earnings Equity and Basis Pools
----------------------------------------------------------------------------------------------------------------
                                                  Equity pool              Translation rate         Basis pool
----------------------------------------------------------------------------------------------------------------
Year 2 Earnings.........................  [euro]25..................  [euro]1 = $1.15...........          $28.75
Year 3 Earnings.........................  [euro]25..................  [euro]1 = $1.25...........           31.25
                                         -----------------------------------------------------------------------
    Total...............................  [euro]50..................  ..........................              60
----------------------------------------------------------------------------------------------------------------

    (2) Distribution out of capital. The basis of the [euro]50 
distributed out of capital was equal to the portion of the capital 
basis pool attributable to the distribution. For this purpose, the 
capital equity pool was equal to [euro]150, and the capital basis pool 
was equal to $150, as shown in the table below. Because Branch 
distributed 33% of the capital equity pool, or [euro]50, 33% of the 
capital basis pool, or $50, was attributable to the distribution. In 
the hands of DC, the [euro]50 distributed out of capital had a basis of 
$50. As a result of the capital distribution, the capital equity pool 
was reduced to [euro]100 and the capital basis pool was reduced to 
$100.

                      Table 4 to Paragraph (l)(2)(i)(C)(2)--Capital Equity and Basis Pools
----------------------------------------------------------------------------------------------------------------
                                                  Equity pool              Translation rate         Basis pool
----------------------------------------------------------------------------------------------------------------
Contribution (11/30/Year 1).............  [euro]150.................  [euro]1 = $1..............            $150
                                         -----------------------------------------------------------------------
    Total...............................  [euro]150.................  ..........................             150
----------------------------------------------------------------------------------------------------------------

    (3) Section 988 gain recognized. On June 30, year 3, DC exchanged 
[euro]100 with an aggregate basis of $117.50 (equal to the sum of the 
$67.50 basis of the remittance out of earnings and the $50 basis of the 
distribution out of capital) for $135. Therefore, DC recognized $17.50 
of gain under section 988.
    (ii) Analysis--(A) DC's method is an eligible pretransition method. 
Before the

[[Page 100207]]

transition date, DC followed a reasonable method of applying section 
987 that would result in the same total amount of income over the life 
of DC ($125) as an earnings and capital method, as explained in 
paragraphs (l)(2)(ii)(A)(1) and (2) of this section (Example 2). 
Therefore, this method is an eligible pretransition method under 
paragraph (e)(4)(ii) of this section. Consequently, DC determines its 
pretransition gain or loss with respect to Branch under paragraph 
(e)(2) of this section.
    (1) DC's total amount of income under its pretransition method. 
Under DC's pretransition method, DC recognized $7.50 of section 987 
gain and $17.50 of section 988 gain in year 3. In addition, on December 
31, year 3, DC had $40 of embedded gain in its capital equity and basis 
pools (equal to the difference between its capital equity pool of 
[euro]100, translated at the spot rate on December 31, year 3, of 
[euro]1 = $1.40, and its capital basis pool of $100) which will be 
taken into account in the future (when Branch distributes property out 
of capital and the property is sold). DC also recognized $60 of 
earnings with respect to Branch ($28.75 in year 2 and $31.25 in year 
3). Thus, DC's total income (recognized and unrecognized) with respect 
to Branch is $125.
    (2) DC's total amount of income under an earnings and capital 
method. If DC had instead applied an earnings and capital method, as 
described in paragraph (l)(1)(i)(C) of this section (Example 1), DC 
would have recognized section 987 gain of $30 in year 3 and would not 
have recognized section 988 gain in year 3, as explained in paragraph 
(l)(1)(i)(D) of this section. On December 31, year 3, DC would have 
unrecognized section 987 gain in its equity and basis pools of $35 (see 
paragraph (l)(1)(ii)(B)(1) of this section (Example 1)). DC would also 
have recognized $60 of earnings with respect to Branch ($28.75 in year 
2 and $31.25 in year 3). Thus, DC's total income (recognized and 
unrecognized) with respect to Branch is $125.
    (B) Pretransition gain or loss. Under paragraph (e)(2) of this 
section, DC's pretransition gain or loss with respect to Branch is 
equal to sum of the deemed termination amount described in paragraph 
(e)(2)(i)(A) of this section and the owner functional currency net 
value adjustment described in paragraph (e)(2)(i)(B) of this section. 
As explained in paragraphs (l)(2)(ii)(B)(1) and (2) of this section 
(Example 2), the deemed termination amount is zero and the owner 
functional currency net value adjustment is $40. Therefore, DC has $40 
of pretransition gain with respect to Branch. Under paragraph 
(e)(5)(i)(A) of this section, the pretransition gain is treated as 
Branch's net accumulated unrecognized section 987 gain. However, if DC 
elects to recognize its pretransition gain ratably over the transition 
period under paragraph (e)(5)(ii) of this section, the pretransition 
gain is not treated as net accumulated unrecognized section 987 gain. 
Instead, DC recognizes $4 (one tenth of its pretransition gain) for 
each of the ten taxable years from year 4 through year 13.
    (1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this 
section, the deemed termination amount is the amount of section 987 
gain or loss that would have been recognized by DC under the eligible 
pretransition method if Branch terminated and transferred all of its 
assets and liabilities to DC on December 31, year 3. Under DC's 
eligible pretransition method, if Branch had transferred all of its 
assets and liabilities to DC, this would have been treated as a 
distribution out of capital. Under its eligible pretransition method, 
DC would not have recognized section 987 gain or loss on a distribution 
out of capital. Therefore, the deemed termination amount is zero.
    (2) Owner functional currency net value adjustment. On December 31, 
year 3, Branch had no liabilities and only one asset: land with a basis 
of [euro]100. Under paragraph (e)(2)(i)(B) of this section, the owner 
functional currency net value adjustment is equal to the basis of 
Branch's land, translated into U.S. dollars at the transition exchange 
rate, reduced by the basis of Branch's land, translated into U.S. 
dollars at the pretransition translation rate on December 31, year 3. 
Under paragraph (e)(2)(i)(C) of this section, the pretransition 
translation rate is the rate that would be used under the eligible 
pretransition method to determine the basis of the land in the hands of 
DC if Branch transferred the land to DC. Under DC's eligible 
pretransition method, DC's basis in assets distributed from Branch is 
equal to the portion of the capital basis pool attributable to the 
distribution. If Branch transferred the land with a basis of [euro]100 
to DC on December 31, year 3, its remaining capital basis pool of $100 
would be attributable to the distribution, and the land would have a 
basis of $100 in the hands of DC. Because the land had a basis of 
[euro]100 in the hands of Branch, and would have a basis of $100 in the 
hands of DC if it were distributed on December 31, year 3, the 
pretransition translation rate is [euro]1 = $1. Under paragraph 
(d)(3)(i) of this section, because a current rate election is in effect 
for year 4, the transition exchange rate is the spot rate applicable to 
December 31, year 3. The [euro]100 basis of Branch's land, translated 
at the spot rate on December 31, year 3 of [euro]1 = $1.40 is equal to 
$140. The [euro]100 basis of Branch's land, translated at the 
pretransition translation rate on December 31, year 3 of [euro]1 = $1 
is equal to $100. Therefore, the owner functional currency net value 
adjustment is equal to $40 ($140-$100).
    (C) Determination of unrecognized section 987 gain or loss in year 
4. For purposes of determining unrecognized section 987 gain or loss in 
year 4 under Sec.  1.987-4(d), the owner functional currency net value 
of Branch on the last day of year 3 is determined by translating the 
[euro]100 basis of the land at the transition exchange rate, which is 
the spot rate on December 31, year 3 ([euro]1 = $1.40). Therefore, the 
owner functional currency net value of Branch on the last day of year 3 
is $140.
    (iii) Alternative facts--(A) No current rate election. Assume the 
facts are the same as described in paragraph (l)(2)(i) of this section 
(Example 2), except that a current rate election is not in effect for 
year 4.
    (B) Analysis. As explained in paragraph (l)(2)(ii)(A) of this 
section (Example 2), DC determines its pretransition gain or loss with 
respect to Branch under paragraph (e)(2) of this section. Because a 
current rate election is not in effect, the transition exchange rate is 
determined under paragraph (d)(3)(ii) of this section.
    (1) Transition exchange rate. DC applied an earnings only method 
described in paragraph (e)(4)(ii) of this section before the transition 
date. Under paragraph (d)(3)(ii) of this section, because a current 
rate election is not in effect for year 4, the transition exchange rate 
for Branch's land is equal to the pretransition translation rate. As 
explained in paragraph (l)(2)(ii)(B)(2) of this section (Example 2), 
the pretransition translation rate is [euro]1 = $1.
    (2) Pretransition gain or loss. Because the transition exchange 
rate for the land (Branch's sole asset) is equal to the pretransition 
translation rate, the owner functional currency net value adjustment is 
zero. As explained in paragraph (l)(2)(ii)(B)(1) of this section 
(Example 2), the deemed termination amount is also zero. Therefore, DC 
has no pretransition gain or loss with respect to Branch.
    (3) Determination of unrecognized section 987 gain or loss in year 
4. For purposes of determining unrecognized section 987 gain or loss in 
year 4 under Sec.  1.987-4(d), the owner functional currency net value 
of Branch on the last

[[Page 100208]]

day of year 3 is determined by translating the [euro]100 basis of the 
land at the transition exchange rate, which is the pretransition 
translation rate of [euro]1 = $1. Therefore, the owner functional 
currency net value of Branch on the last day of year 3 is $100.
    (3) Example 3: Earnings only method described in paragraph 
(e)(4)(iii) of this section--(i) Facts--(A) In general. The facts and 
exchange rates are the same as in paragraph (l)(1) of this section 
(Example 1), except that DC used an earnings only method with respect 
to Branch before the transition date, as described in paragraph 
(l)(3)(i)(B) of this section.
    (B) Pretransition method. Under the earnings only method, DC 
maintains an equity pool in euros (Branch's functional currency) and a 
basis pool in U.S. dollars (DC's functional currency) with respect to 
Branch's earnings. However, DC does not maintain separate equity and 
basis pools with respect to Branch's capital. Distributions are treated 
as being made first out of earnings and then out of capital. When 
Branch makes a remittance out of earnings, DC recognizes section 987 
gain or loss equal to the difference between the amount of the 
remittance (translated into U.S. dollars at the spot rate on the date 
of the remittance) and the portion of the earnings basis pool 
attributable to the remittance. No section 987 gain or loss is 
recognized on a distribution out of capital. Under DC's pretransition 
method, DC's basis in assets distributed by Branch (whether out of 
earnings or capital) is equal to Branch's basis in the assets 
translated at the spot rate on the date of the distribution. Branch's 
earnings are translated into U.S. dollars at the average exchange rate 
for the taxable year. DC first applied its earnings only method on a 
return filed before November 9, 2023. In addition, DC applied its 
earnings only method consistently to all of its section 987 QBUs and 
otherwise applied section 987 in a reasonable manner.
    (C) Application of the pretransition method before the transition 
date. On June 30, year 3, Branch distributed [euro]100 cash to DC. Of 
this amount, [euro]50 represented a remittance out of earnings, and 
[euro]50 represented a distribution out of capital.
    (1) Remittance out of earnings. For purposes of determining section 
987 gain or loss recognized on the remittance, Branch's earnings equity 
pool was equal to [euro]50, and its earnings basis pool was equal to 
$60, as shown in the table below. Because Branch remitted 100% of the 
earnings equity pool ([euro]50), the entire earnings basis pool, or 
$60, was attributable to the remittance. The value of the remittance 
was $67.50 ([euro]50 translated at the spot rate on June 30, year 3, of 
[euro]1 = $1.35). Therefore, in year 3, DC recognized section 987 gain 
of $7.50, equal to the difference between the value of the remittance 
($67.50) and the portion of the basis pool attributable to the 
remittance ($60). As a result of the remittance, the earnings equity 
pool and the earnings basis pool were each reduced to zero.

                      Table 5 to Paragraph (l)(3)(i)(C)(1)--Earnings Equity and Basis Pools
----------------------------------------------------------------------------------------------------------------
                                                  Equity pool           Translation rate            Basis pool
----------------------------------------------------------------------------------------------------------------
Year 2 Earnings...............................        [euro]25  [euro]1 = $1.15.................          $28.75
Year 3 Earnings...............................        [euro]25  [euro]1 = $1.25.................           31.25
                                               -----------------------------------------------------------------
    Total.....................................        [euro]50  ................................              60
----------------------------------------------------------------------------------------------------------------

    (2) Basis of euros distributed. In the hands of DC, the [euro]100 
distributed had a basis of $135 ([euro]100 translated at the spot rate 
on June 30, year 3, of [euro]1 = $1.35). DC did not recognize gain or 
loss under section 988 when it exchanged the [euro]100 for $135.
    (ii) Analysis--(A) DC's method is an eligible pretransition method. 
Unlike in paragraph (l)(2) of this section (Example 2), DC's earnings 
only method would not result in the same total amount of income over 
the life of DC as an earnings and capital method described in paragraph 
(e)(4)(i) of this section because DC does not maintain capital basis 
and equity pools and DC translates the basis of all property 
distributed from Branch at the spot rate on the distribution date. 
However, this method is an eligible pretransition method under 
paragraph (e)(4)(iii) of this section because DC first applied its 
earnings only method on a return filed before November 9, 2023, DC 
applied its earnings only method consistently to all of its section 987 
QBUs, and DC otherwise applied section 987 in a reasonable manner. 
Consequently, DC determines its pretransition gain or loss with respect 
to Branch under paragraph (e)(2) of this section.
    (B) Pretransition gain or loss. Under paragraph (e)(2) of this 
section, DC's pretransition gain or loss with respect to Branch is 
equal to the sum of the deemed termination amount described in 
paragraph (e)(2)(i)(A) of this section and the owner functional 
currency net value adjustment described in paragraph (e)(2)(i)(B) of 
this section. As explained in paragraphs (l)(3)(ii)(B)(1) and (2) of 
this section (Example 3), the deemed termination amount is zero and the 
owner functional currency net value adjustment is zero. Therefore, DC 
has no pretransition gain or loss with respect to Branch.
    (1) Deemed termination amount. Under paragraph (e)(2)(i)(A) of this 
section, the deemed termination amount is the amount of section 987 
gain or loss that would have been recognized by DC under the eligible 
pretransition method if Branch terminated and transferred all of its 
assets and liabilities to DC on December 31, year 3. Under DC's 
eligible pretransition method, if Branch had transferred all of its 
assets and liabilities to DC, it would have been treated as a 
distribution out of capital. Under its eligible pretransition method, 
DC would not have recognized section 987 gain or loss on a distribution 
out of capital. Therefore, the deemed termination amount is zero.
    (2) Owner functional currency net value adjustment. On December 31, 
year 3, Branch has no liabilities and only one asset: land with a basis 
of [euro]100. Under paragraph (e)(2)(i)(B) of this section, the owner 
functional currency net value adjustment is equal to the basis of the 
land, translated into U.S. dollars at the transition exchange rate, 
reduced by the basis of the land, translated into U.S. dollars at the 
pretransition translation rate. Under paragraph (d)(3)(i) of this 
section, the transition exchange rate is the spot rate applicable to 
December 31, year 3. Under paragraph (e)(2)(i)(C) of this section, the 
pretransition translation rate is the rate that would be used under 
DC's eligible pretransition method to determine the basis of the land 
in the hands of DC if Branch transferred the land to DC on December 31, 
year 3. Under DC's eligible pretransition method, if Branch transferred 
the land to DC, DC's basis in the land would be equal to Branch's basis 
([euro]100) translated at the spot rate on the date of the 
distribution. Therefore, the pretransition translation rate on December 
31, year 3, is equal to the spot rate on December 31, year 3.

[[Page 100209]]

Consequently, the owner functional currency net value adjustment is 
zero.
    (C) Determination of unrecognized section 987 gain or loss in year 
4. For purposes of determining unrecognized section 987 gain or loss in 
year 4 under Sec.  1.987-4(d), the owner functional currency net value 
of Branch on the last day of year 3 is determined by translating the 
[euro]100 basis of the land at the spot rate on December 31, year 3 
([euro]1 = $1.40). Therefore, the owner functional currency net value 
of Branch on the last day of year 3 is $140.
    (4) Example 4: Owner did not apply section 987(3)--(i) Facts. The 
facts and exchange rates are the same as in paragraph (l)(1) of this 
section (Example 1), except that DC did not apply section 987(3) with 
respect to Branch and did not recognize section 987 gain or loss with 
respect to Branch before the transition date.
    (ii) Analysis--(A) DC's method is not an eligible pretransition 
method. Because DC did not apply section 987(3) with respect to Branch 
before the transition date, DC did not apply an eligible pretransition 
method under paragraph (e)(4) of this section. Therefore, DC determines 
pretransition gain or loss under paragraph (e)(3) of this section.
    (B) Pretransition gain or loss. Under paragraph (e)(3) of this 
section, DC's pretransition gain or loss with respect to Branch is 
equal to the annual unrecognized section 987 gain or loss with respect 
to Branch for all taxable years ending before the transition date in 
which DC was the owner of Branch (that is, years 1 through 3), reduced 
by section 987 gain or loss recognized by DC before the transition 
date. As explained in paragraphs (l)(4)(ii)(C) through (E) of this 
section (Example 4), DC's annual unrecognized section 987 gain for year 
1 is $7.50, DC's annual unrecognized section 987 gain for year 2 is 
$16.25, and DC's annual unrecognized section 987 gain for year 3 is 
$23.75. DC did not recognize any section 987 gain or loss with respect 
to Branch before the transition date. Therefore, DC has $47.50 of 
pretransition gain with respect to Branch. Under paragraph (e)(5)(i)(A) 
of this section, the pretransition gain is treated as Branch's net 
accumulated unrecognized section 987 gain. However, if DC elects to 
recognize its pretransition gain ratably over the transition period 
under paragraph (e)(5)(ii) of this section, the pretransition gain is 
not treated as net accumulated unrecognized section 987 gain. Instead, 
DC recognizes $4.75 (one tenth of its pretransition gain) for each of 
the ten taxable years from year 4 through year 13.
    (C) Annual unrecognized section 987 gain or loss for year 1. Under 
paragraph (e)(3)(iii) of this section, annual unrecognized section 987 
gain or loss with respect to a section 987 QBU is determined under the 
rules of Sec.  1.987-4(d), applied as though a current rate election 
was in effect for all relevant taxable years (such that all items are 
treated as marked items), but modified so that only Sec. Sec.  1.987-
4(d)(1) (change in owner functional currency net value) and 1.987-
4(d)(10) (adjustment for residual increase or decrease to net assets) 
are applied. As explained in paragraphs (l)(4)(ii)(C)(1) and (2) of 
this section (Example 4), in year 1, the change in owner functional 
currency net value under Sec.  1.987-4(d)(1) is an increase of $165, 
and there is a negative adjustment of $157.50 under Sec.  1.987-
4(d)(10). Therefore, DC's annual unrecognized section 987 gain for year 
1 is $7.50.
    (1) Change in owner functional currency net value for year 1. On 
December 31, year 1, Branch held land with a basis of [euro]100 and 
[euro]50 cash. Therefore, on the last day of year 1, Branch's owner 
functional currency net value is $165 (150 euros translated at the spot 
rate on December 31, year 1, of [euro]1 = $1.10). Because Branch was 
formed in year 1, its owner functional currency net value on the last 
day of the preceding taxable year is zero. See Sec.  1.987-
4(d)(1)(iii). Therefore, the change in owner functional currency net 
value is an increase of $165.
    (2) Residual increase to net assets for year 1. Under Sec.  1.987-
4(d)(10), unrecognized section 987 gain or loss for a taxable year is 
decreased by any residual increase to net assets (and increased by any 
residual decrease to net assets), translated into the owner's 
functional currency at the yearly average exchange rate for the taxable 
year. For this purpose, the residual increase (or decrease) to net 
assets is equal to the change in net value of the section 987 QBU, 
determined in the section 987 QBU's functional currency (that is, the 
QBU net value). See Sec.  1.987-4(d)(10)(ii)(B) and (e)(2)(ii). On 
December 31, year 1, Branch held land with a basis of [euro]100 euros 
and [euro]50 cash. Therefore, on the last day of year 1, Branch has a 
QBU net value of [euro]150. Because Branch was formed in year 1, its 
QBU net value on the last day of the preceding taxable year is zero. 
See Sec.  1.987-4(d)(1)(iii). Therefore, the residual increase to net 
assets is [euro]150. This results in a negative adjustment to annual 
unrecognized section 987 gain or loss of $157.50 for year 1 (equal to 
[euro]150 translated at the yearly average exchange rate for year 1 of 
[euro]1 = $1.05).
    (D) Annual unrecognized section 987 gain or loss for year 2. As 
explained in paragraphs (l)(4)(ii)(D)(1) and (2) of this section 
(Example 4), in year 2, the change in owner functional currency net 
value under Sec.  1.987-4(d)(1) is an increase of $45, and there is a 
negative adjustment of $28.75 under Sec.  1.987-4(d)(10). Therefore, 
DC's annual unrecognized section 987 gain for year 2 is $16.25.
    (1) Change in owner functional currency net value for year 2. On 
December 31, year 2, Branch held land with a basis of [euro]100 and 
[euro]75 cash. Therefore, on the last day of year 2, Branch's owner 
functional currency net value is $210 (175 euros translated at the spot 
rate on December 31, year 2, of [euro]1 = $1.20). As explained in 
paragraph (l)(4)(ii)(C)(1) of this section (Example 4), Branch's owner 
functional currency net value on the last day of year 1 was $165. 
Therefore, the change in owner functional currency net value is an 
increase of $45.
    (2) Residual increase to net assets for year 2. On December 31, 
year 2, Branch held land with a basis of [euro]100 and [euro]75 cash. 
Therefore, on the last day of year 2, Branch has a QBU net value of 
[euro]175. As explained in paragraph (l)(4)(ii)(C)(2) of this section 
(Example 4), Branch had a QBU net value of [euro]150 on December 31, 
year 1. Therefore, the residual increase to net assets is [euro]25. 
This results in a negative adjustment to annual unrecognized section 
987 gain or loss of $28.75 for year 2 (equal to a reduction of 
[euro]25, translated at the yearly average exchange rate for year 2 of 
[euro]1 = $1.15).
    (E) Annual unrecognized section 987 gain or loss for year 3. As 
explained in paragraphs (l)(4)(ii)(E)(1) and (2) of this section 
(Example 4), in year 3, the change in owner functional currency net 
value under Sec.  1.987-4(d)(1) is a decrease of $70, and there is a 
positive adjustment of $93.75 under Sec.  1.987-4(d)(10). Therefore, 
DC's annual unrecognized section 987 gain for year 3 is $23.75.
    (1) Change in owner functional currency net value for year 3. On 
December 31, year 3, Branch held land with a basis of [euro]100. 
Therefore, on the last day of year 3, Branch's owner functional 
currency net value is $140 (100 euros translated at the spot rate on 
December 31, year 3, of [euro]1 = $1.40). As explained in paragraph 
(l)(4)(ii)(D)(1) of this section (Example 4), Branch's owner functional 
currency net value on the last day of year 2 was $210. Therefore, the 
change in owner functional currency net value is a decrease of $70.

[[Page 100210]]

    (2) Residual decrease to net assets for year 3. On December 31, 
year 3, Branch held land with a basis of [euro]100. Therefore, on the 
last day of year 3, Branch has a QBU net value of [euro]100. As 
explained in paragraph (l)(4)(ii)(D)(2) of this section (Example 4), 
Branch had a QBU net value of [euro]175 on December 31, year 2. 
Therefore, the residual decrease to net assets is [euro]75. This 
results in a positive adjustment to annual unrecognized section 987 
gain or loss of $93.75 for year 3 (equal to [euro]75, translated at the 
yearly average exchange rate for year 3 of [euro]1 = $1.25).
    (F) Determination of unrecognized section 987 gain or loss in year 
4. For purposes of determining unrecognized section 987 gain or loss in 
year 4 under Sec.  1.987-4(d), the owner functional currency net value 
of Branch on the last day of year 3 is determined by translating the 
[euro]100 basis of the land at the spot rate on December 31, year 3 
([euro]1 = $1.40). Therefore, the owner functional currency net value 
of Branch on the last day of year 3 is $140.
    (5) Example 5: Error in application of method--(i) Facts. The facts 
are the same as described in paragraph (l)(1)(i) of this section 
(Example 1), except that DC inadvertently miscalculated the amount of 
the June 30, year 3, remittance as being [euro]90 rather than 
[euro]100. This reduced the amount of section 987 gain recognized by DC 
in year 3.
    (ii) Analysis. DC committed an error in its application of the 
earnings and capital method to Branch. Under paragraph (e)(4)(iv)(A) of 
this section, DC is nonetheless treated as having applied an eligible 
pretransition method. However, under paragraph (e)(4)(iv)(B) of this 
section, DC must determine its pretransition gain or loss as though the 
error had not been made. Therefore, DC computes its pretransition gain 
or loss as described in paragraph (l)(1)(ii)(B) of this section 
(Example 1). DC has $35 of pretransition gain with respect to Branch.
    (6) Example 6: Consistent practice not treated as an error--(i) 
Facts. Before the transition date, DC used the earnings and capital 
method described in the 1991 proposed regulations under section 987 
with respect to Branch, as described in paragraph (l)(1)(i) of this 
section (Example 1). In years 1, 2, and 3, Branch made recurring 
purchases of inventory from Owner, which Branch sold to unrelated 
customers. In connection with the purchase transactions, Branch 
transferred cash to Owner, and Owner transferred inventory to Branch. 
Owner did not take these transfers into account in determining the 
amount of any remittance and, accordingly, did not recognize section 
987 gain or loss with respect to these transfers. However, Owner 
consistently adjusted Branch's equity and basis pools in a reasonable 
manner to reflect all transfers between Owner and Branch; for this 
purpose, the amount of each transfer made in connection with the 
purchase transactions was translated using the average rate for the 
relevant taxable year. Owner also adjusted Branch's equity and basis 
pools to account for Branch's income from the sale of inventory.
    (ii) Analysis--(A) DC's method is an eligible pretransition method. 
Before the transition date, DC followed the earnings and capital method 
described in the 1991 proposed regulations under section 987 with 
respect to Branch. This method is an eligible pretransition method 
under paragraph (e)(4)(i) of this section. Therefore, DC determines its 
pretransition gain or loss with respect to Branch under paragraph 
(e)(2) of this section.
    (B) Effect of consistent practice. Before the transition date, 
Owner engaged in a consistent practice under which Owner did not 
account for inventory purchase transactions in determining the amount 
of a remittance requiring the recognition of gain or loss under section 
987(3). However, Owner consistently accounted for the disregarded 
transfers in a reasonable manner for purposes of computing its equity 
and basis pools. Under paragraph (e)(4)(v) of this section, this 
consistent practice is not treated as an error in the application of a 
pretransition method and does not preclude Owner's method from being 
treated as an eligible pretransition method. Therefore, Owner must take 
this consistent practice into account in determining pretransition gain 
or loss under paragraph (e)(2) of this section. In particular, Owner 
must use the equity and basis pools computed under its consistent 
practice (rather than the equity and basis pools it would have computed 
if it had historically taken the disregarded transfers into account in 
determining the amount of remittances) to determine the deemed 
termination amount under paragraph (e)(2)(i)(A) of this section.


Sec.  1.987-11  Suspended section 987 loss relating to certain 
elections; loss-to-the-extent-of-gain rule.

    (a) In general. This section provides rules relating to suspended 
section 987 loss. Paragraph (b) of this section provides rules for 
computing the cumulative suspended section 987 loss with respect to a 
section 987 QBU or successor suspended loss QBU. Paragraph (c) of this 
section provides rules that suspend section 987 loss that would 
otherwise be recognized when a current rate election is in effect. 
Paragraph (d) of this section provides rules that treat net 
unrecognized section 987 loss and deferred section 987 loss as 
suspended section 987 loss when an annual recognition election is made 
or a current rate election is revoked. Paragraph (e) of this section 
describes the extent to which suspended section 987 loss is recognized 
under a loss-to-the-extent-of-gain rule. Paragraph (f) of this section 
provides rules for determining recognition groupings based on the 
source and character of section 987 gain or loss. Paragraph (g) of this 
section provides examples illustrating the rules of this section.
    (b) Cumulative suspended section 987 loss in a recognition 
grouping--(1) In general. The cumulative suspended section 987 loss in 
a recognition grouping with respect to a section 987 QBU or a successor 
suspended loss QBU for the current taxable year is equal to the 
cumulative suspended section 987 loss in the recognition grouping for 
the prior taxable year, decreased by the amount of suspended section 
987 loss in the recognition grouping that was recognized with respect 
to the QBU under paragraph (e) of this section or under Sec.  1.987-
13(b) through (d) in the prior taxable year, and increased by the 
amount that becomes suspended section 987 loss in the recognition 
grouping with respect to the QBU in the current taxable year (including 
under Sec.  1.987-10(e)(5)(i)(B)(1)). If the taxable year is the first 
taxable year of the section 987 QBU (or the first taxable year in which 
the section 987 regulations apply), the cumulative suspended section 
987 loss for the prior taxable year is zero. An owner's (or original 
suspended loss QBU owner's) total cumulative suspended section 987 loss 
in a recognition grouping is equal to the sum of its cumulative 
suspended section 987 gain or loss with respect to each section 987 QBU 
and successor suspended loss QBU.
    (2) Combined QBU. For purposes of paragraph (b)(1) of this section, 
in the taxable year of a combination, the cumulative suspended section 
987 loss in a recognition grouping with respect to a combined QBU for 
the prior taxable year is equal to the sum of the cumulative suspended 
section 987 loss in the recognition grouping with respect to each 
combining QBU for the prior taxable year; the suspended section 987 
loss in a recognition grouping with respect to a combined QBU that was 
recognized in the prior taxable year is equal to sum of the suspended 
section

[[Page 100211]]

987 loss in the recognition grouping with respect to each combining QBU 
that was recognized in the prior taxable year.
    (3) Separated QBU. For purposes of paragraph (b)(1) of this 
section, in the taxable year of a separation, the cumulative suspended 
section 987 loss in a recognition grouping with respect to a separated 
QBU for the prior taxable year is equal to the cumulative suspended 
section 987 loss in the recognition grouping with respect to the 
separating QBU for the prior taxable year multiplied by the separation 
fraction; the suspended section 987 loss in a recognition grouping with 
respect to a separated QBU that was recognized in the prior taxable 
year is equal to the suspended section 987 loss in the recognition 
grouping with respect to the separating QBU that was recognized in the 
prior taxable year multiplied by the separation fraction.
    (c) Suspension of section 987 loss for taxable years in which a 
current rate election is in effect and an annual recognition election 
is not in effect--(1) In general. Except as provided in paragraph 
(c)(2) of this section, in a taxable year in which a current rate 
election is in effect and an annual recognition election is not in 
effect, to the extent that an owner's net unrecognized section 987 loss 
with respect to a section 987 QBU would otherwise be recognized under 
Sec.  1.987-5 (including pursuant to Sec.  1.987-12(b)), or its 
deferred section 987 loss would otherwise be recognized under Sec.  
1.987-12(c), the net unrecognized section 987 loss or deferred section 
987 loss is not recognized by the owner and instead becomes suspended 
section 987 loss. See paragraph (g)(1) of this section (Example 1) for 
an illustration of this rule.
    (2) De minimis rule. Paragraph (c)(1) of this section does not 
apply in a taxable year of an owner in which the total amount of net 
unrecognized section 987 loss or deferred section 987 loss of the owner 
and all members of the owner's controlled group that would (but for the 
application of this paragraph (c)(2) and Sec.  1.987-7(d)(2)(iii)) 
become suspended section 987 loss under paragraph (c)(1) of this 
section or Sec.  1.987-7(d) does not exceed the lesser of--
    (i) $3 million; or
    (ii) Two percent of the total amount of gross income of the owner 
and all members of the owner's controlled group for the taxable year.
    (3) Taxable year of controlled group members--(i) In general. 
Except as provided in paragraph (c)(3)(ii) of this section, for 
purposes of applying paragraph (c)(2) of this section with respect to 
an owner, suspended section 987 loss and gross income of a member of 
the owner's controlled group is determined by reference to the member's 
suspended section 987 loss and gross income for its taxable year ending 
with or within the owner's taxable year.
    (ii) Owner is a CFC. For purposes of applying paragraph (c)(2) of 
this section with respect to an owner that is a CFC, suspended section 
987 loss and gross income of a member of the owner's controlled group 
is determined by reference to the member's suspended section 987 loss 
and gross income for its taxable year ending with or within the owner's 
required year described in section 898(c)(1), without regard to section 
898(c)(2).
    (d) Suspension of net unrecognized section 987 loss upon making or 
revoking certain elections--(1) Making an annual recognition election. 
At the beginning of the first taxable year for which an annual 
recognition election is in effect, an owner's net accumulated 
unrecognized section 987 loss and deferred section 987 loss are 
converted into suspended section 987 loss if either--
    (i) A current rate election was in effect for the immediately 
preceding taxable year; or
    (ii) A current rate election was not in effect for the immediately 
preceding taxable year and, as of the beginning of the taxable year, 
the sum of the owner's net accumulated unrecognized section 987 loss 
and deferred section 987 loss exceeds the sum of the owner's net 
accumulated unrecognized section 987 gain and deferred section 987 gain 
by more than $5 million.
    (2) Revoking a current rate election. At the beginning of the first 
taxable year in which a current rate election ceases to be in effect, 
an owner's net accumulated unrecognized section 987 loss and deferred 
section 987 loss are converted into suspended section 987 loss. See 
paragraph (g)(3) of this section (Example 3) for an illustration of 
this rule.
    (e) Loss-to-the-extent-of-gain rule--(1) In general. An owner of a 
section 987 QBU (or an original suspended loss QBU owner) only 
recognizes suspended section 987 loss to the extent described in this 
paragraph (e) (the loss-to-the-extent-of-gain rule). See Sec.  1.987-
13(b) through (d) for rules requiring the recognition of additional 
suspended section 987 loss (after the application of the loss-to-the-
extent-of-gain rule) in connection with certain transactions.
    (2) Separate determination for each recognition grouping. The 
amount of suspended section 987 loss recognized is determined 
separately for the suspended section 987 loss in each recognition 
grouping. Because the recognition groupings generally are determined on 
the basis of the initial assignment of section 987 gain or loss under 
Sec.  1.987-6(b)(2)(i), the loss-to-the-extent-of-gain rule generally 
is applied on the basis of the initial assignment of section 987 gain 
or loss.
    (3) Amount of suspended section 987 loss recognized. Except as 
provided in paragraph (e)(5) or (6) of this section, the amount of 
suspended section 987 loss in each recognition grouping that an owner 
recognizes in a taxable year is equal to the sum (if positive) of the 
current year gain amount described in paragraph (e)(3)(i) of this 
section and the lookback gain amount described in paragraph (e)(3)(ii) 
of this section, but may not exceed the owner's total cumulative 
suspended section 987 loss in the recognition grouping. If the sum of 
the current year gain amount and the lookback gain amount is negative, 
then the amount of suspended section 987 loss recognized under this 
paragraph (e) is zero. See paragraphs (g)(1) and (2) of this section 
(Examples 1 and 2) for an illustration of this rule.
    (i) Current year gain amount. The current year gain amount 
described in this paragraph (e)(3)(i) is equal to the section 987 gain 
in the recognition grouping that is recognized by the owner in the 
taxable year, reduced (including below zero) by section 987 loss (other 
than suspended section 987 loss) in the recognition grouping that is 
recognized by the owner in the taxable year.
    (ii) Lookback gain amount. The lookback gain amount described in 
this paragraph (e)(3)(ii) is equal to the section 987 gain in the 
recognition grouping that was recognized by the owner in the lookback 
period, reduced (including below zero) by section 987 loss (other than 
suspended section 987 loss described in paragraph (e)(3)(iii) of this 
section) in the recognition grouping that was recognized by the owner 
in the lookback period. The total amount of suspended section 987 loss 
recognized by reason of the recognition of an amount of section 987 
gain cannot, in any event, exceed the amount of section 987 gain 
recognized.
    (iii) Suspended section 987 loss not taken into account--(A) In 
general. For purposes of applying paragraph (e)(3)(ii) of this section 
in a taxable year (the current taxable year), suspended section 987 
loss recognized during the lookback period is not taken into account if 
it was recognized under this paragraph (e) by reason of the recognition 
of section 987

[[Page 100212]]

gain that was recognized before the lookback period for the current 
taxable year.
    (B) Ordering rule. For purposes of this paragraph (e)(3)(iii), 
suspended section 987 loss is treated as recognized by reason of the 
most recently recognized section 987 gain in the same recognition 
grouping. See paragraph (g)(2) of this section (Example 2) for an 
illustration of this rule.
    (iv) Lookback period--(A) In general. Except as provided in 
paragraph (e)(3)(iv)(B) of this section, the lookback period with 
respect to a taxable year of an owner means the three preceding taxable 
years of the owner (or, if the owner was not in existence for three 
preceding taxable years, each taxable year in which the owner existed), 
but it does not include any taxable year beginning before the 
transition date described in Sec.  1.987-10(c)(1).
    (B) Taxable years in which both a current rate election and an 
annual recognition election are in effect. In a taxable year of an 
owner in which both a current rate election and an annual recognition 
election are in effect, the lookback period includes all prior taxable 
years of the owner in which both a current rate election and an annual 
recognition election were continuously in effect.
    (v) Anti-abuse rule. If an owner recognizes section 987 gain with a 
principal purpose of reducing the Federal income tax liability of the 
owner (or its U.S. shareholders or partners, as applicable), including 
over multiple taxable years, the section 987 gain is disregarded for 
purposes of this paragraph (e)(3). For example, this paragraph 
(e)(3)(v) may apply if an owner that is a CFC recognizes section 987 
gain that is offset by a tax attribute of one of the CFC's U.S. 
shareholders that would not otherwise be used (such as excess foreign 
tax credits with respect to section 951A category income, or a tested 
loss). In determining whether a principal purpose described in this 
paragraph (e)(3)(v) exists, all relevant facts and circumstances are 
considered, including the extent to which the transaction giving rise 
to the recognition of section 987 gain resulted in a sustained economic 
contraction of the section 987 QBU over a period of at least twelve 
months.
    (4) Suspended section 987 loss recognized with respect to each 
section 987 QBU and suspended section 987 loss QBU. The amount of 
suspended section 987 loss in a recognition grouping that is recognized 
by an owner in a taxable year is treated as attributable to each 
section 987 QBU or successor suspended loss QBU in proportion to the 
QBU's suspended section 987 loss in that recognition grouping.
    (5) Section 381(a) transactions--(i) In general. Except as provided 
in paragraph (e)(5)(ii) of this section (or to the extent that other 
limitations apply), if one corporation (acquiring corporation) acquires 
the assets of another corporation (transferor corporation) in a 
transaction described in section 381(a), section 987 gain or loss 
recognized by the transferor corporation during the lookback period is 
taken into account in determining the lookback gain amount of the 
acquiring corporation in taxable years ending after the transaction 
under paragraph (e)(3)(ii) of this section. If the lookback period for 
a taxable year of the acquiring corporation is determined under 
paragraph (e)(3)(iv)(A) of this section, the lookback period includes 
each taxable year of the transferor corporation ending with or within 
the current taxable year of the acquiring corporation or during the 
acquiring corporation's lookback period. If the lookback period for a 
taxable year of the acquiring corporation is determined under paragraph 
(e)(3)(iv)(B) of this section, the lookback period includes only 
taxable years of the transferor corporation in which both an annual 
recognition election and a current rate election were continuously in 
effect before the transaction (and only if both elections were 
continuously in effect from the date of the transaction through the 
current taxable year).
    (ii) Limitation for inbound nonrecognition transactions. If a 
foreign corporation ceases to exist in a transaction described in Sec.  
1.987-8(c)(1)(ii) (inbound section 332 liquidation) or Sec.  1.987-
8(c)(2)(ii) (inbound reorganization), section 987 gain recognized by 
the foreign corporation before the transaction is disregarded for 
purposes of applying paragraph (e)(3) of this section in taxable years 
ending after the transaction.
    (6) Consolidated group members--(i) In general. All members of a 
consolidated group are treated as a single owner for purposes of 
applying this paragraph (e).
    (ii) Suspended section 987 losses arising in separate return 
limitation years. This paragraph (e)(6)(ii) applies to suspended 
section 987 losses arising in a separate return limitation year (SRLY, 
as defined in Sec.  1.1502-1(f)) or treated as arising in a SRLY under 
the principles of Sec.  1.1502-21(c) (SRLY section 987 losses). The 
aggregate of a member's SRLY section 987 losses that are included in 
the determination of consolidated taxable income for all consolidated 
return years of the group may not exceed the aggregate consolidated net 
income for all consolidated return years of the group determined by 
reference to only the member's items of section 987 gain or loss, 
including the member's section 987 losses actually absorbed by the 
group in the taxable year (whether or not absorbed by the member). For 
purposes of applying this paragraph (e)(6)(ii), the principles of Sec.  
1.1502-21(c) (including the SRLY subgroup principles of Sec.  1.1502-
21(c)(2)) apply with appropriate adjustments.
    (f) Recognition groupings. The term recognition grouping means the 
section 987 gain or loss (including section 987 gain or loss that is 
recognized under Sec.  1.987-5, deferred section 987 gain or loss, 
suspended section 987 loss, or pretransition gain or loss that is 
recognized under Sec.  1.987-10(e)(5)(ii)) described in paragraph 
(f)(1) or (2) of this section, as applicable. If an owner has suspended 
section 987 loss with respect to a terminating QBU in a taxable year 
ending before the transition date described in Sec.  1.987-10(c)(1), 
section 987 gain or loss of the owner (other than section 987 gain or 
loss with respect to the terminating QBU) is assigned to a recognition 
grouping based on the method that is used to determine the source and 
character of section 987 gain or loss for that taxable year.
    (1) Sourcing and section 904 category. Except as provided in 
paragraph (f)(2) of this section, a recognition grouping includes only 
section 987 gain or loss that is initially assigned to one of the 
following statutory and residual groupings--
    (i) U.S. source income; or
    (ii) Foreign source income in a single section 904 category.
    (2) Statutory and residual groupings for CFC owners. In the case of 
an owner that is a controlled foreign corporation, a recognition 
grouping includes only section 987 gain or loss that is initially 
assigned to one of the statutory and residual groupings described in 
paragraph (f)(1) of this section and that is also initially assigned to 
one of the following statutory and residual groupings--
    (i) Tentative tested income;
    (ii) Each separate subpart F income group (as defined in Sec.  
1.960-1(d)(2)(ii)(B));
    (iii) Income described in section 952(b) (ECI that is excluded from 
subpart F income); or
    (iv) Income not described in paragraphs (f)(2)(i) through (iii) of 
this section.

[[Page 100213]]

    (g) Examples. The following examples illustrate the application of 
this section.
    (1) Example 1: Suspension of section 987 loss and recognition of 
suspended section 987 loss--(i) Facts. CFC is a controlled foreign 
corporation that has the U.S. dollar as its functional currency. CFC 
owns three section 987 QBUs, QBU1, QBU2, and QBU3. QBU1 has the euro as 
its functional currency, QBU2 has the pound as its functional currency, 
and QBU3 has the yen as its functional currency. CFC is subject to a 
current rate election but not an annual recognition election. CFC is 
also subject to an election under Sec.  1.987-6(b)(2)(i)(C) (treating 
section 987 gain or loss relating to passive foreign personal holding 
company income as attributable to section 988 transactions). An 
election has not been made under Sec.  1.951A-2(c)(7)(viii) (GILTI 
high-tax exclusion) with respect to CFC. In year 1, CFC did not have 
cumulative suspended section 987 loss with respect to any of its QBUs 
and did not have outstanding deferred section 987 gain or loss. In the 
three years before year 2, CFC did not recognize any section 987 gain 
or loss. In year 2, CFC has net unrecognized section 987 loss of $200 
with respect to QBU1, net unrecognized section 987 loss of $1,000 with 
respect to QBU2, and net unrecognized section 987 gain of $1,000 with 
respect to QBU3. In year 2, each QBU makes a remittance, and CFC's 
remittance proportion (determined under Sec.  1.987-5(b)(1)) is 25% 
with respect to QBU1, 15% with respect to QBU2, and 10% with respect to 
QBU3. For purposes of Sec.  1.987-6(b)(2)(i), all of QBU1's assets 
generate foreign source passive category income that corresponds to one 
or more subpart F income groups described in Sec.  1.960-
1(d)(2)(ii)(B)(2)(i) through (v), and all of QBU2's and QBU3's assets 
generate foreign source general category tested income. Another member 
of CFC's controlled group owns a section 987 QBU with respect to which 
$10 million of net unrecognized section 987 loss becomes suspended 
section 987 loss under paragraph (c)(1) of this section in year 2.
    (ii) Analysis--(A) Application of Sec. Sec.  1.987-5 and 1.987-6 
and paragraph (c) of this section. In year 2, CFC recognizes $100 of 
section 987 gain with respect to QBU3 (10% of $1,000) under Sec.  
1.987-5(a). Under Sec.  1.987-6(b)(2)(i)(A), (B), and (D), the section 
987 gain is initially characterized as foreign source general category 
tentative tested income. If a current rate election was not in effect, 
in year 2 CFC would recognize $50 of section 987 loss with respect to 
QBU1 (25% of $200) and $150 of section 987 loss with respect to QBU2 
(15% of $1,000). However, under paragraph (c) of this section, these 
amounts instead become suspended section 987 loss. The de minimis rule 
under paragraph (c)(2) of this section does not apply because a member 
of CFC's controlled group has more than $3 million of section 987 loss 
that is suspended in year 2 under paragraph (c)(1) of this section. 
Under Sec.  1.987-6(b)(2)(i)(A) and (B), the $50 of suspended section 
987 loss with respect to QBU1 is initially characterized as foreign 
source passive category income assigned to a subpart F income group 
described in Sec.  1.960-1(d)(2)(ii)(B)(2)(i) through (v), and is 
treated as foreign currency loss of the CFC attributable to section 988 
transactions not directly related to the business needs of the CFC 
because an election under Sec.  1.987-6(b)(2)(i)(C) is in effect. Under 
Sec.  1.987-6(b)(2)(i)(A), (B), and (D), the $150 of suspended section 
987 loss with respect to QBU2 is initially characterized as foreign 
source general category tentative tested income.
    (B) Cumulative suspended section 987 loss. Under paragraph (b) of 
this section, in year 2, CFC's cumulative suspended section 987 loss in 
the recognition grouping of foreign source passive category income in a 
separate subpart F income group for foreign currency gains of CFC with 
respect to QBU1 is $50, the amount that became suspended section 987 
loss in the recognition grouping in year 2. In addition, CFC's total 
cumulative suspended section 987 loss in that recognition grouping is 
$50. Similarly, CFC's cumulative suspended section 987 loss in the 
recognition grouping of foreign source general category tentative 
tested income with respect to QBU2 is $150, the amount that became 
suspended section 987 loss in the recognition grouping in year 2. In 
addition, CFC's total cumulative suspended section 987 loss in that 
recognition grouping is $150.
    (C) Current year gain amount and lookback gain amount. Under 
paragraph (e)(3) of this section, in year 2, CFC recognizes suspended 
section 987 loss in a recognition grouping to the extent of the sum of 
the current year gain amount described in paragraph (e)(3)(i) of this 
section and the lookback gain amount described in paragraph (e)(3)(ii) 
of this section. In the recognition grouping of foreign source general 
category tentative tested income, the current year gain amount 
described in paragraph (e)(3)(i) of this section is equal to the 
section 987 gain of $100 recognized by CFC in year 2 with respect to 
QBU3. The current year gain amount for all other recognition groupings 
is zero. During the lookback period (the three years before year 2), 
CFC did not recognize any section 987 gain or loss. Therefore, the 
lookback gain amount described in paragraph (e)(3)(ii) of this section 
is zero for all recognition groupings.
    (D) Recognition of suspended section 987 loss. In year 2, CFC has 
$50 of total cumulative suspended section 987 loss in the recognition 
grouping of foreign source passive category income in a separate 
subpart F income group for foreign currency gains of CFC and $150 of 
total cumulative suspended section 987 loss in the recognition grouping 
of foreign source general category tentative tested income. In the 
recognition grouping of foreign source general category tentative 
tested income, CFC has a current year gain amount of $100 and a 
lookback gain amount of zero ($100 in total). Therefore, CFC recognizes 
$100 of suspended section 987 loss in that recognition grouping. Under 
paragraph (e)(4) of this section, the cumulative suspended section 987 
loss that is recognized by CFC is attributable to QBU2, because QBU2 is 
CFC's only QBU with cumulative suspended section 987 loss in the 
recognition grouping of foreign source general category tentative 
tested income. Because no election under Sec.  1.951A-2(c)(7) applies 
in year 2, both the $100 of recognized section 987 gain and the $100 of 
recognized section 987 loss are allocated to foreign source general 
category tested income. See Sec.  1.987-6(b)(2)(ii). The amounts of 
suspended section 987 loss not recognized (that is, $50 of suspended 
section 987 loss assigned to foreign source passive category income in 
the subpart F income group for foreign currency gains of CFC with 
respect to QBU1 and $50 of suspended section 987 loss assigned to 
foreign source general category tentative tested income with respect to 
QBU2) remain suspended.
    (2) Example 2: Recognition of suspended section 987 loss by reason 
of gain recognized during the lookback period--(i) Facts. CFC is a 
controlled foreign corporation that has the U.S. dollar as its 
functional currency. CFC owns QBU1, a section 987 QBU with the euro as 
its functional currency, and CFC has no other QBUs. Assume that all 
section 987 gain or loss (including suspended section 987 loss) is 
assigned to the same recognition grouping. CFC is subject to a current 
rate election but not an annual recognition election. Before year 1, 
QBU1 does not have cumulative suspended section 987 loss. In year 1, 
CFC recognizes section 987 gain of $10 million with respect to QBU1. In 
year 3, CFC recognizes section 987 gain of $15 million with respect to

[[Page 100214]]

QBU1. In year 4, QBU1 has net unrecognized section 987 loss, and $10 
million of the net unrecognized section 987 loss becomes suspended 
section 987 loss under paragraph (c) of this section. In year 6, an 
additional $10 million of net unrecognized section 987 loss with 
respect to QBU1 becomes suspended section 987 loss under paragraph (c) 
of this section.
    (ii) Analysis--(A) Recognition of suspended section 987 loss in 
year 4. In year 4, CFC's total cumulative suspended section 987 loss is 
$10 million (that is, the loss that becomes suspended in year 4). The 
current year gain amount under paragraph (e)(3)(i) of this section is 
zero, because CFC does not recognize section 987 gain in year 4. The 
lookback period under paragraph (e)(3)(iv)(A) of this section is three 
years (years 1 through 3). The lookback gain amount under paragraph 
(e)(3)(ii) of this section is $25 million (the sum of the $10 million 
of section 987 gain recognized in year 1 and the $15 million of section 
987 gain recognized in year 3). Therefore, under paragraph (e)(3) of 
this section, CFC recognizes suspended section 987 loss of $10 million. 
Under paragraph (e)(3)(iii)(B) of this section, the suspended section 
987 loss is considered to be recognized by reason of the section 987 
gain recognized in year 3, which is the most recent taxable year in 
which section 987 gain was recognized.
    (B) Recognition of suspended section 987 loss in year 6. In year 6, 
CFC's total cumulative suspended section 987 loss is $10 million (that 
is, the loss that becomes suspended in year 6). The current year gain 
amount under paragraph (e)(3)(i) of this section is zero, because CFC 
does not recognize section 987 gain in year 6. The lookback period 
under paragraph (e)(3)(iv)(A) of this section is three years (years 3 
through 5). The lookback gain amount under paragraph (e)(3)(ii) of this 
section is $5 million (the sum of the section 987 gain of $15 million 
recognized in year 3 and the suspended section 987 loss of $10 million 
recognized in year 4 by reason of the section 987 gain recognized in 
year 3). Therefore, under paragraph (e)(3) of this section, CFC 
recognizes $5 million of suspended section 987 loss in year 6.
    (iii) Alternative facts. Assume the facts are the same as described 
in paragraph (g)(2)(i) of this section, with the following 
modifications. In year 1, CFC recognizes section 987 gain of $10 
million with respect to QBU1. CFC does not recognize section 987 gain 
in year 3. In year 4, $10 million of net unrecognized section 987 loss 
with respect to QBU1 becomes suspended section 987 loss under paragraph 
(c) of this section. In year 5, CFC recognizes section 987 gain of $15 
million with respect to QBU1. In year 6, $10 million of net 
unrecognized section 987 loss with respect to QBU1 becomes suspended 
section 987 loss under paragraph (c) of this section.
    (iv) Analysis of alternative facts--(A) Recognition of suspended 
section 987 loss in year 4. In year 4, CFC's total cumulative suspended 
section 987 loss is $10 million (that is, the loss that becomes 
suspended in year 4). The current year gain amount under paragraph 
(e)(3)(i) of this section is zero, because CFC does not recognize 
section 987 gain in year 4. The lookback period under paragraph 
(e)(3)(iv)(A) of this section is three years (years 1 through 3). The 
lookback gain amount under paragraph (e)(3)(ii) of this section is $10 
million (equal to the $10 million of section 987 gain recognized in 
year 1). Therefore, under paragraph (e)(3) of this section, CFC 
recognizes suspended section 987 loss of $10 million in year 4. Under 
paragraph (e)(3)(iii)(B) of this section, the suspended section 987 
loss is considered to be recognized by reason of the section 987 gain 
recognized in year 1, which is the most recent taxable year in which 
section 987 gain was recognized.
    (B) Recognition of suspended section 987 loss in year 6. In year 6, 
CFC's total cumulative suspended section 987 loss is $10 million (that 
is, the loss that becomes suspended in year 6). The current year gain 
amount under paragraph (e)(3)(i) of this section is zero because CFC 
does not recognize section 987 gain in year 6. The lookback period 
under paragraph (e)(3)(iv)(A) of this section is three years (years 3 
through 5). The lookback gain amount under paragraph (e)(3)(ii) of this 
section is $15 million (equal to the section 987 gain of $15 million 
recognized in year 5). Under paragraph (e)(3)(iii)(A) of this section, 
the suspended section 987 loss recognized in year 4 is not taken into 
account in determining the lookback gain amount, because it was 
recognized by reason of the section 987 gain recognized in year 1 
(before the beginning of the lookback period for year 6). Therefore, 
under paragraph (e)(3) of this section, CFC recognizes $10 million of 
suspended section 987 loss in year 6.
    (3) Example 3: Suspension of section 987 loss when a current rate 
election is revoked--(i) Facts. U.S. Corp is a domestic corporation 
that owns all of the interests in DE1. DE1 owns Business A, which is a 
section 987 QBU of U.S. Corp. In year 1, U.S. Corp made a current rate 
election but not an annual recognition election. In year 9, U.S. Corp 
has net unrecognized section 987 loss of $2 million with respect to 
Business A, which is not recognized or suspended in year 9. U.S. Corp 
revokes its current rate election effective for year 10. In year 10, 
before the application of this section, U.S. Corp has net accumulated 
unrecognized section 987 loss of $2 million.
    (ii) Analysis. Under paragraph (d)(2) of this section, U.S. Corp's 
net accumulated unrecognized section 987 loss of $2 million with 
respect to Business A is converted into suspended section 987 loss at 
the beginning of year 10, the first taxable year in which the current 
rate election ceases to be in effect.


Sec.  1.987-12  Deferral of section 987 gain or loss.

    (a) Overview--(1) Scope. This section provides rules that defer the 
recognition of section 987 gain or loss and rules for recognizing (or 
suspending) deferred section 987 gain or loss. This paragraph (a) 
provides an overview of this section and certain instances when this 
section does not apply. Paragraph (b) of this section describes the 
extent to which net unrecognized section 987 gain or loss is recognized 
under Sec.  1.987-5 (or in certain cases, suspended) or becomes 
deferred section 987 gain or loss in connection with a deferral event. 
Paragraph (c) of this section describes the extent to which deferred 
section 987 gain or loss is recognized (or in certain cases, suspended) 
upon the occurrence of subsequent events. Paragraph (d) of this section 
provides a rule relating to the treatment of a successor deferral QBU 
when deferred section 987 loss becomes suspended section 987 loss. 
Paragraph (e) of this section provides an anti-abuse rule. Paragraph 
(f) of this section provides rules for determining the deferred section 
987 gain or loss of combined and separated QBUs. Paragraph (g) of this 
section provides definitions. Paragraph (h) of this section provides 
examples illustrating the rules of this section.
    (2) Exceptions--(i) Annual recognition election. This section does 
not apply to a termination of a section 987 QBU in a taxable year in 
which an annual recognition election is in effect.
    (ii) De minimis rule. This section does not apply in a taxable year 
if the aggregate amount of net unrecognized section 987 gain or loss of 
the owner with respect to all of its section 987 QBUs that would become 
deferred section 987 gain or loss under this section does not exceed $5 
million.
    (b) Treatment of section 987 gain and loss in connection with a 
deferral event.

[[Page 100215]]

Notwithstanding Sec.  1.987-5 (general rule requiring recognition of 
section 987 gain or loss in the taxable year of a remittance), the 
owner of a section 987 QBU with respect to which a deferral event 
occurs (an original deferral QBU) includes in taxable income section 
987 gain or loss in connection with the deferral event only to the 
extent provided in this paragraph (b).
    (1) Gain or loss recognized (or suspended) in the taxable year of a 
deferral event. In the taxable year of a deferral event with respect to 
an original deferral QBU, the owner of the original deferral QBU 
recognizes section 987 gain or loss under Sec.  1.987-5, except that, 
solely for purposes of applying Sec.  1.987-5, all assets and 
liabilities of the original deferral QBU that, immediately after the 
deferral event, are reflected on the books and records of a successor 
deferral QBU are treated as not having been transferred and therefore 
as remaining on the books and records of the original deferral QBU 
notwithstanding the deferral event. Notwithstanding the prior sentence, 
any section 987 loss that would otherwise be recognized under this 
paragraph (b)(1) and Sec.  1.987-5 may instead become suspended loss 
under Sec.  1.987-11(c) if a current rate election is in effect, or 
under Sec.  1.987-13(h) if the deferral event also constitutes an 
outbound loss event.
    (2) Deferred section 987 gain or loss--(i) In general. In the 
taxable year of a deferral event with respect to an original deferral 
QBU, any net unrecognized section 987 gain or loss that is not 
recognized or suspended in the taxable year of the deferral event 
becomes deferred section 987 gain or loss of the original deferral QBU 
owner. Suspended section 987 loss does not become deferred section 987 
loss under this paragraph (b)(2).
    (ii) Deferred section 987 gain or loss attributable to a successor 
deferral QBU. A portion of the deferred section 987 gain or loss 
described in paragraph (b)(2)(i) of this section becomes deferred 
section 987 gain or loss with respect to each successor deferral QBU. 
Such portion is equal to the deferred section 987 gain or loss 
multiplied by a fraction, the numerator of which is the aggregate 
adjusted basis of the gross assets transferred to the successor 
deferral QBU in connection with the deferral event and the denominator 
of which is the aggregate adjusted basis of the gross assets 
transferred to all successor deferral QBUs in connection with the 
deferral event.
    (c) Recognition (or suspension) of deferred section 987 gain or 
loss following a deferral event. An original deferral QBU owner 
recognizes deferred section 987 gain or loss with respect to a 
successor deferral QBU in the taxable year of the deferral event and in 
subsequent taxable years as provided in this paragraph (c).
    (1) Recognition upon a subsequent remittance--(i) In general. 
Except as provided in paragraph (c)(2) of this section, an original 
deferral QBU owner recognizes deferred section 987 gain or loss in the 
taxable year of the deferral event, and in subsequent taxable years, 
upon a remittance from a successor deferral QBU to the owner of the 
successor deferral QBU (successor deferral QBU owner) in the amount 
described in paragraph (c)(1)(ii) of this section. Notwithstanding the 
prior sentence, any deferred section 987 loss that would otherwise be 
recognized under this paragraph (c)(1) may instead become suspended 
section 987 loss under Sec.  1.987-11(c) (if a current rate election is 
in effect with respect to the original deferral QBU owner) or under 
Sec.  1.987-7(d)(1)(ii) (in the case of a partnership).
    (ii) Amount. The amount of deferred section 987 gain or loss that 
is recognized (or suspended) pursuant to this paragraph (c)(1) in a 
taxable year of the original deferral QBU owner is the original 
deferral QBU owner's outstanding deferred section 987 gain or loss 
(that is, the amount of deferred section 987 gain or loss not 
previously recognized or suspended) with respect to the successor 
deferral QBU multiplied by the remittance proportion of the successor 
deferral QBU owner with respect to the successor deferral QBU for the 
taxable year ending with or within the taxable year of the original 
deferral QBU owner, as determined under Sec.  1.987-5(b) without regard 
to any annual recognition election of the successor deferral QBU owner. 
See paragraph (h)(4) of this section (Example 4) for an illustration of 
this rule.
    (iii) Deemed remittance by a successor deferral QBU. For purposes 
of this paragraph (c)(1), in a taxable year of the original deferral 
QBU owner in which a successor deferral QBU ceases to be owned by a 
member of the controlled group that includes the original deferral QBU 
owner, the successor deferral QBU is treated as having a remittance 
proportion of one. Accordingly, if a successor deferral QBU ceases to 
be owned by a member of the controlled group that includes the original 
deferral QBU owner, the original deferral QBU owner's outstanding 
deferred section 987 gain or loss with respect to that successor 
deferral QBU will be recognized (or suspended). For purposes of this 
paragraph (c)(1), if the original deferral QBU owner goes out of 
existence and there is no qualified successor, in the last taxable year 
of the original deferral QBU owner, each successor deferral QBU is 
treated as having a remittance proportion of one. This paragraph 
(c)(1)(iii) does not affect the application of the section 987 
regulations to the successor deferral QBU owner with respect to its 
ownership of the successor deferral QBU.
    (2) Deferral events and outbound loss events with respect to a 
successor deferral QBU. Notwithstanding paragraph (c)(1) of this 
section, if assets of the successor deferral QBU (transferred assets) 
are transferred (or deemed transferred) in a transaction that would 
constitute a deferral event or an outbound loss event if the original 
deferral QBU owner owned the successor deferral QBU directly and the 
original deferral QBU owner had net unrecognized section 987 gain or 
loss with respect to the successor deferral QBU equal to its 
outstanding deferred section 987 gain or loss with respect to the 
successor deferral QBU (the deemed transaction), then, in accordance 
with the rules of this section and Sec.  1.987-13(h)--
    (i) The original deferral QBU owner recognizes its outstanding 
deferred section 987 gain or loss, or suspends its outstanding deferred 
section 987 loss, to the extent it would have recognized or suspended 
net unrecognized section 987 gain or loss as a result of the deemed 
transaction; and
    (ii) Each section 987 QBU is a successor deferral QBU to the extent 
it would have been after the deemed transaction and the original 
deferral QBU owner has deferred section 987 gain or loss with respect 
to the successor deferral QBU to the extent it would have after the 
deemed transaction;
    (iii) Each eligible QBU is a successor suspended loss QBU to the 
extent it would have been after the deemed transaction and the original 
deferral QBU owner has suspended section 987 loss with respect to the 
suspended loss QBU to the extent it would have after the deemed 
transaction.
    (d) Successor deferral QBU becomes a successor suspended loss QBU. 
A successor deferral QBU becomes a successor suspended loss QBU, and an 
original deferral QBU owner becomes an original suspended loss QBU 
owner, if any of the original deferral QBU owner's deferred section 987 
loss with respect to the successor deferral QBU becomes suspended 
section 987 loss. An eligible QBU may be both a successor deferral QBU 
and a successor suspended loss

[[Page 100216]]

QBU and the original deferral QBU owner may also be an original 
suspended loss QBU owner.
    (e) Anti-abuse rule. No section 987 loss is recognized under this 
section, Sec.  1.987-5 or Sec.  1.987-13 in connection with a 
transaction or series of transactions that are undertaken with a 
principal purpose of avoiding the purposes of this section.
    (f) Combinations and separations of successor deferral QBUs. A 
combined QBU is a successor deferral QBU if either combining QBU was a 
successor deferral QBU. A separated QBU is a successor deferral QBU if 
the separating QBU was a successor deferral QBU.
    (1) Combined QBU. The outstanding deferred section 987 gain or loss 
of a combined QBU in each recognition grouping for a taxable year is 
equal to the sum of the combining QBUs' outstanding deferred section 
987 gain or loss in that recognition grouping.
    (2) Separated QBU. The outstanding deferred section 987 gain or 
loss of a separated QBU in each recognition grouping for a taxable year 
is equal to the separating QBU's outstanding deferred section 987 gain 
or loss in each recognition grouping multiplied by the separation 
fraction.
    (g) Definitions. The following definitions apply for purposes of 
this section.
    (1) Deferral event. A deferral event with respect to a section 987 
QBU means any transaction or series of transactions that satisfy the 
conditions described in both paragraphs (g)(1)(i) and (ii) of this 
section.
    (i) Events. The transaction or series of transactions constitutes:
    (A) A termination of the section 987 QBU under Sec.  1.987-8(b)(2) 
(substantially all the assets transferred to the owner), Sec.  1.987-
8(b)(5) (section 987 QBU ceases to be a section 987 QBU), or Sec.  
1.987-8(b)(6) (individual or corporation ceases to be a direct owner of 
a section 987 QBU); or
    (B) [Reserved]
    (ii) Assets on books of successor deferral QBU. Immediately after 
the transaction or series of transactions, assets of the section 987 
QBU are reflected on the books and records of a successor deferral QBU.
    (2) Successor deferral QBU. A section 987 QBU (potential successor 
deferral QBU) is a successor deferral QBU with respect to a section 987 
QBU referred to in paragraph (g)(1)(i) of this section if, immediately 
after the transaction or series of transactions described in that 
paragraph, the potential successor deferral QBU satisfies all of the 
conditions described in paragraphs (g)(2)(i) through (iii) of this 
section.
    (i) The books and records of the potential successor deferral QBU 
reflect assets that, immediately before the transaction or series of 
transactions described in paragraph (g)(1)(i) of this section, were 
reflected on the books and records of the section 987 QBU referred to 
in paragraph (g)(1)(i) of this section.
    (ii) The owner of the potential successor deferral QBU and the 
owner of the section 987 QBU referred to in paragraph (g)(1)(i) of this 
section immediately before the transaction or series of transactions 
described in paragraph (g)(1)(i) of this section are members of the 
same controlled group.
    (iii) If the owner of the section 987 QBU referred to in paragraph 
(g)(1)(i) of this section immediately before the transaction or series 
of transactions described in paragraph (g)(1)(i) of this section was a 
U.S. person, the potential successor deferral QBU is owned by a U.S. 
person.
    (3) Original deferral QBU owner. An original deferral QBU owner 
means, with respect to an original deferral QBU, the owner of the 
original deferral QBU immediately before the deferral event, or the 
owner's qualified successor.
    (4) Qualified successor. A qualified successor with respect to a 
corporation (transferor corporation) means another corporation that 
acquires the assets of the transferor corporation in a transaction 
described in section 381(a) (acquiring corporation), provided that the 
acquiring corporation is a domestic corporation and the transferor 
corporation was a domestic corporation, or the acquiring corporation is 
a controlled foreign corporation and the transferor corporation was a 
controlled foreign corporation. A qualified successor of a person 
includes the qualified successor of a qualified successor.
    (h) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, DC1 is a domestic 
corporation that owns all of the stock of DC2, which is also a domestic 
corporation, and CFC1, a controlled foreign corporation. In addition, 
DC1, DC2, and CFC1 are members of a controlled group, and the de 
minimis rule of paragraph (a)(2)(ii) of this section is not applicable. 
Finally, except as otherwise provided, Business A is a section 987 QBU 
with the euro as its functional currency, there are no transfers 
between Business A and its owner, and Business A's assets are not 
depreciable or amortizable.
    (1) Example 1: Contribution of a section 987 QBU with net 
unrecognized section 987 gain to a member of the controlled group--(i) 
Facts. DC1 owns Business A. The adjusted balance sheet of Business A 
reflects assets with an aggregate adjusted basis of [euro]1,000x and no 
liabilities. DC1 contributes [euro]900x of Business A's assets to DC2 
in exchange for DC2 stock in a transaction to which section 351 
applies. Immediately after the contribution, the remaining [euro]100x 
of Business A's assets are no longer reflected on the books and records 
of a section 987 QBU (but are instead reflected on the books and 
records of DC1's home office). DC2, which has the U.S. dollar as its 
functional currency, uses the Business A assets in a business (Business 
B) that constitutes a section 987 QBU. At the time of the contribution, 
Business A has net unrecognized section 987 gain of $100x.
    (ii) Analysis--(A) Under Sec.  1.987-2(c)(2)(ii), DC1's 
contribution of [euro]900x of Business A's assets to DC2 is treated as 
a transfer of all of the assets of Business A to DC1, immediately 
followed by DC1's contribution of [euro]900x of Business A's assets to 
DC2. The contribution of Business A's assets is a deferral event within 
the meaning of paragraph (g)(1) of this section because:
    (1) The transfer from Business A to DC1 is a transfer of 
substantially all of Business A's assets to DC1, resulting in a 
termination of the Business A QBU under Sec.  1.987-8(b)(2); and
    (2) Immediately after the transaction, assets of Business A are 
reflected on the books and records of Business B, a section 987 QBU 
owned by a member of DC1's controlled group and a successor deferral 
QBU within the meaning of paragraph (g)(2) of this section. 
Accordingly, Business A is an original deferral QBU within the meaning 
of paragraph (b) of this section, and DC1 is an original deferral QBU 
owner of Business A within the meaning of paragraph (g)(3) of this 
section.
    (B) Under paragraph (b)(1) of this section, DC1's taxable income in 
the taxable year of the deferral event includes DC1's section 987 gain 
or loss determined with respect to Business A under Sec.  1.987-5, 
except that, for purposes of applying Sec.  1.987-5, all assets of 
Business A that are reflected on the books and records of Business B 
immediately after Business A's termination are treated as not having 
been transferred and therefore as though they remained on Business A's 
books and records (notwithstanding the deemed transfer of those assets 
under Sec.  1.987-8(e)). Accordingly, in the taxable year of the 
deferral event, Business A is treated as making a remittance of 
[euro]100x, corresponding to the assets of Business A that are no 
longer reflected on the books and records of a section 987 QBU, and is 
treated as having a remittance

[[Page 100217]]

proportion with respect to Business A of 0.1, determined by dividing 
the [euro]100x remittance by the sum of the remittance and the 
[euro]900x aggregate adjusted basis of the gross assets deemed to 
remain on Business A's books and records at the end of the taxable 
year. Thus, DC1 recognizes $10x of section 987 gain in the taxable year 
of the deferral event. DC1's deferred section 987 gain equals $90x, 
which is the amount of its net unrecognized section 987 gain (which is 
$100x) less the amount of section 987 gain recognized by DC1 under 
Sec.  1.987-5 and this section (which is $10x).
    (2) Example 2: Contribution of a section 987 QBU with net 
unrecognized section 987 loss to a member of the controlled group when 
a current rate election is in effect--(i) Facts. The facts are the same 
as in paragraph (h)(1) of this section (Example 1) except that a 
current rate election is in effect for the taxable year (and an annual 
recognition election is not in effect) and, at the time of the 
contribution, Business A has net unrecognized section 987 loss of 
$100x. Business A is engaged in the business of manufacturing Product X 
before the contribution, and Business B is engaged in the same business 
after the contribution. After the contribution, the [euro]100x of 
assets that are reflected on the books and records of DC1's home office 
are not used in the business of manufacturing Product X.
    (ii) Analysis--(A) For the reasons described in paragraph (h)(1) of 
this section (Example 1), the contribution results in a termination of 
the Business A QBU and a deferral event with respect to the Business A 
QBU, an original deferral QBU; DC1 is an original deferral QBU owner 
within the meaning of paragraph (g)(3) of this section; Business B is a 
successor deferral QBU with respect to Business A; and DC2 is a 
successor deferral QBU owner.
    (B) Under paragraph (b)(1) of this section, for purposes of 
applying Sec.  1.987-5, all the assets of Business A that are reflected 
on the books and records of Business B immediately after Business A's 
termination are treated as not having been transferred and therefore as 
though they remained on Business A's books and records (notwithstanding 
the deemed transfer of those assets under Sec.  1.987-8(e)). 
Accordingly, in the taxable year of the deferral event, Business A is 
treated as making a remittance of [euro]100x, corresponding to the 
assets of Business A that are no longer reflected on the books and 
records of a section 987 QBU, and DC1 is treated as having a remittance 
proportion with respect to Business A of 0.1, determined by dividing 
the [euro]100x remittance by the sum of the remittance and the 
[euro]900x aggregate adjusted basis of the gross assets deemed to 
remain on Business A's books and records at the end of the taxable 
year. Thus, but for the application of Sec.  1.987-11(c), DC1 would 
recognize $10x of section 987 loss in the taxable year of the deferral 
event. Under Sec.  1.987-11(c), because a current rate election is in 
effect (and an annual recognition election is not in effect), the loss 
is instead treated as suspended section 987 loss. DC1's deferred 
section 987 loss equals $90x, which is the amount of its net 
unrecognized section 987 loss less the amount of section 987 loss 
suspended under Sec.  1.987-11(c) (which is $10x).
    (C) Under Sec.  1.987-13(b)(1)(i), Business B is a successor 
suspended loss QBU because, immediately after the termination of the 
Business A section 987 QBU, a significant portion of the assets of 
Business A was reflected on the books and records of Business B (an 
eligible QBU), Business B continued to carry on the trade or business 
of Business A, and Business B was owned by DC2, a member of the same 
controlled group as DC1 (which is the original suspended loss QBU owner 
under Sec.  1.987-13(l)(1)). Therefore, under Sec.  1.987-13(b)(1)(ii), 
all of Business A's cumulative suspended section 987 loss (including 
the suspended section 987 loss resulting from the termination of 
Business A) becomes suspended section 987 loss with respect to Business 
B. After the transaction, DC1 may recognize its suspended section 987 
loss with respect to Business B under Sec.  1.987-11(e) or Sec.  1.987-
13(b) through (d), as applicable.
    (3) Example 3: Election to be classified as a corporation--(i) 
Facts. DC1 owns all of the interests in Entity A, a DE. Entity A 
conducts Business A, which has net unrecognized section 987 gain of 
$500x. Entity A elects to be classified as a corporation under Sec.  
301.7701-3(c) of this chapter. As a result of the election and pursuant 
to Sec.  301.7701-3(g)(1)(iv) of this chapter, DC1 is treated as 
contributing all of the assets and liabilities of Business A to newly-
formed CFC1, which has the euro as its functional currency. Immediately 
after the contribution, the assets and liabilities of Business A are 
reflected on CFC1's books and records.
    (ii) Analysis. Under Sec.  1.987-2(c)(2)(ii), DC1's deemed 
contribution of all of the assets and liabilities of Business A to CFC1 
is treated as a transfer of all of the assets and liabilities of 
Business A to DC1, followed immediately by DC1's contribution of those 
assets and liabilities to CFC1. Because the deemed transfer from 
Business A to DC1 is a transfer of substantially all of Business A's 
assets to DC1, the Business A QBU terminates under Sec.  1.987-8(b)(2). 
The contribution of Business A's assets is not a deferral event within 
the meaning of paragraph (b) of this section because, immediately after 
the transaction, no assets of Business A are reflected on the books and 
records of a successor deferral QBU within the meaning of paragraph 
(g)(2) of this section due to the fact that the assets of Business A 
are not reflected on the books and records of a section 987 QBU 
immediately after the termination. In addition, the requirement of 
paragraph (g)(2)(iii) of this section is not met because Business A was 
owned by a U.S. person and the potential successor deferral QBU, which 
is owned by CFC1, is not owned by a U.S. person. Accordingly, DC1 
recognizes section 987 gain of $500x with respect to Business A under 
Sec.  1.987-5 without regard to this section. Because the requirement 
of paragraph (g)(2)(iii) of this section is not met, the result would 
be the same even if the assets of Business A were transferred in a 
section 351 exchange to an existing foreign corporation that had a 
different functional currency than Business A.
    (4) Example 4: Partial recognition of deferred gain or loss--(i) 
Facts. DC1 owns all of the interests in Entity A, a DE that conducts 
Business A in Country X. During year 1, DC1 contributes all of its 
interests in Entity A to DC2 in an exchange to which section 351 
applies. At the time of the contribution, Business A has net 
unrecognized section 987 gain of $100x and cumulative suspended section 
987 loss of $50x. After the contribution, Entity A continues to conduct 
the same trade or business in Country X (Business B). In year 3, as a 
result of a net transfer of property from Business B to DC2, DC2's 
remittance proportion with respect to Business B, as determined under 
Sec.  1.987-5, is 0.25.
    (ii) Analysis--(A) For the reasons described in paragraph (h)(1) of 
this section (Example 1), the contribution of all the interests in 
Entity A by DC1 to DC2 results in a termination of the Business A QBU 
and a deferral event with respect to the Business A QBU, an original 
deferral QBU; DC1 is an original deferral QBU owner within the meaning 
of paragraph (g)(3) of this section; Business B is a successor deferral 
QBU with respect to Business A; DC2 is a successor deferral QBU owner; 
and the $100x of net unrecognized section 987 gain with respect to 
Business A becomes deferred section 987 gain as a result of the 
deferral event.
    (B) Under Sec.  1.987-13(b)(1)(i), Business B is a successor 
suspended loss QBU because, immediately after the

[[Page 100218]]

termination of the Business A section 987 QBU, a significant portion of 
the assets of Business A was reflected on the books and records of 
Business B (an eligible QBU), Business B continued to carry on the 
trade or business of Business A, and Business B was owned by DC2, a 
member of the same controlled group as DC1 (which is the original 
suspended loss QBU owner under Sec.  1.987-13(l)(1)). Therefore, under 
Sec.  1.987-13(b)(1)(ii), all of DC1's cumulative suspended section 987 
loss with respect to Business A becomes suspended section 987 loss of 
DC1 with respect to Business B.
    (C) Under paragraph (c)(1)(i) of this section, DC1 recognizes 
deferred section 987 gain in year 3 as a result of the remittance from 
Business B to DC2. Under paragraph (c)(1)(ii) of this section, the 
amount of deferred section 987 gain that DC1 recognizes is $25x, which 
is DC1's outstanding deferred section 987 gain of $100x with respect to 
Business A multiplied by the remittance proportion of 0.25 of DC2 with 
respect to Business B for the taxable year as determined under Sec.  
1.987-5(b). In addition, under Sec.  1.987-11(e), DC1 recognizes its 
cumulative suspended section 987 loss to the extent of the deferred 
section 987 gain recognized in the same recognition grouping.


Sec.  1.987-13  Suspended section 987 loss upon terminations.

    (a) Overview--(1) In general. This section provides rules relating 
to suspended section 987 loss of an owner with respect to a section 987 
QBU or successor suspended loss QBU that terminates. Paragraph (b) of 
this section provides rules treating suspended section 987 loss as 
recognized or attributable to a successor when a section 987 QBU 
terminates. Paragraph (c) of this section provides rules treating 
suspended section 987 loss as recognized or attributable to a 
subsequent successor when a successor suspended loss QBU terminates. 
Paragraph (d) of this section provides rules regarding the recognition 
of suspended section 987 loss when interests in a successor suspended 
loss QBU owner are transferred. Paragraph (e) of this section provides 
rules that apply when interests in an original suspended loss QBU owner 
are transferred. Paragraph (f) of this section provides rules that 
apply when an original suspended loss QBU owner ceases to exist. 
Paragraph (g) of this section provides rules preventing the carryover 
of suspended section 987 loss in connection with certain inbound 
transactions. Paragraph (h) of this section provides rules that suspend 
section 987 loss in connection with certain outbound transactions. 
Paragraph (i) of this section is reserved. Paragraph (j) of this 
section provides rules relating to the termination of a successor 
suspended loss QBU. Paragraph (k) of this section provides an anti-
abuse rule. Paragraph (l) of this section provides definitions that 
apply for purposes of this section. Paragraph (m) of this section 
provides examples illustrating the rules of this section.
    (2) Ordering rule. Paragraphs (b) through (d) of this section are 
applied after the application of Sec.  1.987-11(e) (loss-to-the-extent-
of-gain rule).
    (b) Termination of a section 987 QBU with suspended loss. If a 
section 987 QBU terminates, and at the time of termination, the owner 
has suspended section 987 loss with respect to the section 987 QBU 
(including because the termination was an outbound loss event or 
because net unrecognized section 987 loss became suspended section 987 
loss upon termination as a result of a current rate election), then 
either paragraph (b)(1) or (2) of this section applies. However, this 
paragraph (b) does not apply to a termination that occurs in connection 
with a transaction described in paragraph (f) or (g) of this section.
    (1) Suspended section 987 loss becomes suspended section 987 loss 
with respect to a successor suspended loss QBU--(i) Successor suspended 
loss QBU. If, immediately after the termination, a significant portion 
of the assets of the terminating section 987 QBU are reflected on the 
books and records of an eligible QBU that carries on a trade or 
business of the section 987 QBU and is owned by the owner of the 
section 987 QBU or a member of its controlled group (determined 
immediately after the transaction), then the eligible QBU is a 
successor suspended loss QBU and the rules provided in paragraph 
(b)(1)(ii) of this section apply.
    (ii) Attribution of suspended section 987 loss to successor 
suspended loss QBU. A portion of the cumulative suspended section 987 
loss with respect to the terminating section 987 QBU that is not 
recognized in the taxable year of the termination under Sec.  1.987-
11(e) becomes suspended section 987 loss with respect to each successor 
suspended loss QBU. Such portion is equal to the suspended section 987 
loss described in the preceding sentence, multiplied by a fraction, the 
numerator of which is the aggregate adjusted basis of the gross assets 
transferred to the successor suspended loss QBU in connection with the 
termination, and the denominator of which is the aggregate adjusted 
basis of the gross assets transferred to all successor suspended loss 
QBUs in connection with the termination.
    (2) Recognition of suspended section 987 loss. If, immediately 
after the termination of the section 987 QBU, there is no successor 
suspended loss QBU under paragraph (b)(1) of this section, then the 
owner recognizes the cumulative suspended section 987 loss with respect 
to the section 987 QBU that is not recognized in the taxable year of 
the termination under Sec.  1.987-11(e).
    (c) Termination of a successor suspended loss QBU. If a successor 
suspended loss QBU terminates (as described in paragraph (j) of this 
section), then either paragraph (c)(1) or (2) of this section applies. 
However, this paragraph (c) does not apply to a termination that occurs 
in connection with a transaction described in paragraph (e), (f), or 
(g) of this section.
    (1) Successor to the successor suspended loss QBU--(i) Successor 
suspended loss QBU. If, immediately after the termination, a 
significant portion of the assets of the terminating successor 
suspended loss QBU (initial successor) are reflected on the books and 
records of an eligible QBU (subsequent successor) that carries on a 
trade or business of the initial successor and is owned by the original 
suspended loss QBU owner or a member of its controlled group 
(determined immediately after the transaction), then the subsequent 
successor is a successor suspended loss QBU and the rules provided in 
paragraph (c)(1)(ii) of this section apply.
    (ii) Attribution of suspended section 987 loss to successor 
suspended loss QBU. A portion of the cumulative suspended section 987 
loss with respect to the initial successor that is not recognized in 
the taxable year of the termination under Sec.  1.987-11(e) becomes 
suspended section 987 loss with respect to each subsequent successor. 
Such portion is equal to the suspended section 987 loss described in 
the preceding sentence, multiplied by a fraction, the numerator of 
which is the aggregate adjusted basis of the gross assets transferred 
to the subsequent successor in connection with the termination, and the 
denominator of which is the aggregate adjusted basis of the gross 
assets transferred to all subsequent successors in connection with the 
termination.
    (2) Recognition of suspended section 987 loss. If, immediately 
after the termination of the initial successor, there is no subsequent 
successor that is a successor suspended loss QBU under paragraph (c)(1) 
of this section, then the

[[Page 100219]]

original suspended loss QBU owner recognizes the cumulative suspended 
section 987 loss with respect to the initial successor that is not 
recognized in the taxable year of the termination under Sec.  1.987-
11(e).
    (d) Transfer of successor suspended loss QBU owner. If a successor 
suspended loss QBU ceases to be owned by a member of the original 
suspended loss QBU owner's controlled group as a result of a direct or 
indirect transfer, or an issuance or redemption, of an ownership 
interest in the successor suspended loss QBU owner, then the original 
suspended loss QBU owner recognizes the cumulative suspended section 
987 loss with respect to the successor suspended loss QBU that is not 
recognized in the taxable year under Sec.  1.987-11(e).
    (e) Transfer of original suspended loss QBU owner. If an original 
suspended loss QBU owner ceases to be a member of the successor 
suspended loss QBU owner's controlled group as a result of a direct or 
indirect transfer, or an issuance or redemption, of an ownership 
interest in the original suspended loss QBU owner, the original 
suspended loss QBU owner's suspended section 987 loss ceases to be 
attributable to any successor suspended loss QBU (but it continues to 
be suspended section 987 loss of the original suspended loss QBU 
owner). As a result, the suspended section 987 loss can be recognized 
by the original suspended loss QBU owner under Sec.  1.987-11(e) but 
cannot be recognized under paragraph (b)(2), (c)(2), or (d) of this 
section.
    (f) Owner ceases to exist. If the owner of a section 987 QBU with 
suspended section 987 loss or an original suspended loss QBU owner 
ceases to exist and there is no successor under paragraph (l)(1)(ii) of 
this section (for example, as a result of a section 331 liquidation), 
then any suspended section 987 loss of the owner that is not recognized 
after application of the loss-to-the-extent-of-gain rule in Sec.  
1.987-11(e) is eliminated and cannot be recognized.
    (g) Inbound nonrecognition transactions--no carryover of suspended 
section 987 loss. If an owner of a section 987 QBU with suspended 
section 987 loss, or an original suspended loss QBU owner, ceases to 
exist in a transaction described in Sec.  1.987-8(c)(1)(ii) (inbound 
section 332 liquidation) or Sec.  1.987-8(c)(2)(ii) (inbound 
reorganization), then any suspended section 987 loss of the owner or 
original suspended loss QBU owner that is not recognized after 
application of the loss-to-the-extent-of-gain rule in Sec.  1.987-11(e) 
is eliminated and cannot be recognized. As a result, the distributee or 
acquiring corporation does not succeed to or take into account any 
suspended section 987 loss of the owner or original suspended loss QBU 
owner under section 381.
    (h) Outbound transactions--recognition or suspension of net 
unrecognized section 987 loss. This paragraph (h) applies to taxable 
years in which neither a current rate election nor an annual 
recognition election is in effect.
    (1) In general. Notwithstanding Sec.  1.987-5, if an outbound loss 
event occurs with respect to a section 987 QBU (an outbound loss QBU), 
the original owner of the section 987 QBU includes in taxable income in 
the taxable year of the outbound loss event section 987 loss with 
respect to the outbound loss QBU only to the extent provided in 
paragraph (h)(3) of this section.
    (2) Outbound loss event. An outbound loss event means, with respect 
to a section 987 QBU:
    (i) Any termination of the section 987 QBU as a result of a 
transfer by a U.S. person of assets of the section 987 QBU to a foreign 
person that is a member of the same controlled group as the U.S. person 
immediately before the transaction or, if the transferee did not exist 
immediately before the transaction, immediately after the transaction 
(related foreign person), provided that the termination would result in 
the recognition of section 987 loss with respect to the section 987 QBU 
under Sec.  1.987-5 but for this paragraph (h); or
    (ii) [Reserved]
    (3) Loss recognition upon an outbound loss event. In the taxable 
year of an outbound loss event with respect to an outbound loss QBU, 
the owner of the outbound loss QBU recognizes section 987 loss as 
determined under Sec. Sec.  1.987-5 and 1.987-12(b), except that, 
solely for purposes of applying Sec.  1.987-5, assets and liabilities 
of the outbound loss QBU that, immediately after the outbound loss 
event, are reflected on the books and records of an eligible QBU owned 
by the related foreign person described in paragraph (h)(2) of this 
section are treated as not having been transferred and therefore as 
remaining on the books and records of the outbound loss QBU 
notwithstanding the outbound loss event.
    (4) Loss suspension upon outbound loss event. Net unrecognized 
section 987 loss or deferred section 987 loss that, as a result of this 
paragraph (h), is not recognized in the taxable year of the outbound 
loss event (outbound section 987 loss) under Sec.  1.987-5 becomes 
suspended section 987 loss.
    (i) [Reserved]
    (j) Termination of a successor suspended loss QBU. For purposes of 
applying paragraph (c) of this section, a successor suspended loss QBU 
terminates if it ceases to be an eligible QBU of its owner.
    (k) Anti-abuse. No section 987 loss is recognized under this 
section, Sec.  1.987-5, or Sec.  1.987-12 in connection with a 
transaction or series of transactions that are undertaken with a 
principal purpose of avoiding the purposes of this section.
    (l) Definitions. The following definitions apply for purposes of 
this section.
    (1) Original suspended loss QBU owner--(i) In general. An original 
suspended loss QBU owner is the person that was the owner of a section 
987 QBU before its termination in a transaction to which paragraph 
(b)(1) of this section applies.
    (ii) Successors. If an original suspended loss QBU owner is a 
corporation (transferor corporation) and another corporation acquires 
the assets of the transferor corporation in a transaction described in 
section 381(a), then the acquiring corporation becomes the original 
suspended loss QBU owner.
    (2) Successor suspended loss QBU. See paragraphs (b)(1) and (c)(1) 
of this section and Sec.  1.987-12(d) for rules regarding when an 
eligible QBU is a successor suspended loss QBU.
    (3) Successor suspended loss QBU owner. A successor suspended loss 
QBU owner is the owner of the assets and liabilities of a successor 
suspended loss QBU.
    (4) Ownership interests. The term ownership interests means stock 
in a corporation and partnership interests in a partnership.
    (5) Significant portion. With respect to the assets of an eligible 
QBU, the term significant portion means a significant portion of the 
operating assets, determined based on all the facts and circumstances, 
provided that more than 30 percent of the operating assets will 
constitute a significant portion in all cases and less than 10 percent 
of the operating assets will not constitute a significant portion in 
all cases.
    (m) Examples. The following examples illustrate the application of 
this section. For purposes of the examples, DC1 is a domestic 
corporation that owns all of the interests in Entity A, a DE. Entity A 
conducts Business A, a section 987 QBU that is engaged in the business 
of selling Product X. Business A has the euro as its functional 
currency.

[[Page 100220]]

    (1) Example 1: Trade or business of a section 987 QBU ceases--(i) 
Facts. Entity A's trade or business of selling Product X ceases, 
resulting in a termination of the Business A section 987 QBU under 
Sec.  1.987-8(b)(1). After the trade or business is wound up, the 
remaining assets are transferred to DC1 and are not used in the trade 
or business of selling Product X immediately following the termination. 
Business A has cumulative suspended section 987 loss under Sec.  1.987-
11(b) of $500x.
    (ii) Analysis. Immediately after the termination of the Business A 
section 987 QBU, a significant portion of Business A's assets is not 
reflected on the books and records of an eligible QBU that carries on a 
trade or business of Business A and is owned by DC1 or a member of its 
controlled group. Therefore, Business A has no successor suspended loss 
QBU under paragraph (b)(1) of this section. Consequently, DC1 
recognizes the cumulative suspended section 987 loss with respect to 
the Business A section 987 QBU under paragraph (b)(2) of this section.
    (2) Example 2: Trade or business of a section 987 QBU is sold to a 
third party--(i) Facts. DC1 sells all the interests in Entity A to a 
third party for cash. Business A has cumulative suspended section 987 
loss under Sec.  1.987-11(b) of $500x.
    (ii) Analysis. Under Sec.  1.987-2(c)(2)(ii), the sale of the 
Business A assets and liabilities for cash that is reflected on the 
books of DC1 is treated as a transfer of all of the assets and 
liabilities of Business A to DC1, followed immediately by DC1's sale of 
those assets and liabilities. Because the deemed transfer from Business 
A to DC1 is a transfer of substantially all of Business A's assets to 
DC1, the Business A section 987 QBU terminates under Sec.  1.987-
8(b)(2). Immediately after the termination of the Business A section 
987 QBU, a significant portion of Business A's assets is not reflected 
on the books and records of an eligible QBU that carries on a trade or 
business of Business A and is owned by DC1 or a member of its 
controlled group. Therefore, Business A has no successor suspended loss 
QBU under paragraph (b)(1) of this section. Consequently, DC1 
recognizes the cumulative suspended section 987 loss with respect to 
the Business A section 987 QBU under paragraph (b)(2) of this section.
    (3) Example 3: Outbound loss event--(i) Facts. Entity A elects to 
be classified as a corporation under Sec.  301.7701-3(c) of this 
chapter. As a result of the election and pursuant to Sec.  301.7701-
3(g)(1)(iv) of this chapter, DC1 is treated as contributing all of the 
assets and liabilities of Business A to newly formed CFC1, which has 
the euro as its functional currency. Immediately after the 
contribution, the assets and liabilities of Business A are reflected on 
CFC1's books and records (which are the only books and records 
maintained by CFC1). CFC1 continues to use those assets in the same 
trade or business after the contribution (Business B). Neither a 
current rate election nor an annual recognition election is in effect. 
Business A has net unrecognized section 987 loss of $500x.
    (ii) Analysis--(A) Under Sec.  1.987-2(c)(2)(ii), DC1's 
contribution of all of the assets and liabilities of Business A to CFC1 
is treated as a transfer of all of the assets and liabilities of 
Business A to DC1, followed immediately by DC1's contribution of those 
assets and liabilities to CFC1. Because the deemed transfer from 
Business A to DC1 is a transfer of substantially all of Business A's 
assets to DC1, the Business A section 987 QBU terminates under Sec.  
1.987-8(b)(2). The contribution of Business A's assets to CFC1 is not a 
deferral event within the meaning of Sec.  1.987-12(g)(1) because, 
immediately after the transaction, no assets of Business A are 
reflected on the books and records of a successor deferral QBU within 
the meaning of Sec.  1.987-12(g)(2) due to the fact that the assets of 
Business A are not reflected on the books and records of a section 987 
QBU immediately after the termination, as well as the fact that the 
requirement of Sec.  1.987-12(g)(2)(iii) is not met because Business A 
was owned by a U.S. person and the potential successor deferral QBU 
(Business B) is not owned by a U.S. person. The termination of the 
Business A section 987 QBU as a result of the transfer of the assets of 
Business A by a U.S. person (DC1) to a foreign person (CFC1) that is a 
member of DC1's controlled group is an outbound loss event described in 
paragraph (h)(2) of this section.
    (B) Under paragraphs (h)(1) and (3) of this section, in the taxable 
year of the outbound loss event, DC1 includes in taxable income section 
987 loss recognized with respect to Business A as determined under 
Sec.  1.987-5, except that, for purposes of applying Sec.  1.987-5, all 
assets and liabilities of Business A that are reflected on the books 
and records of CFC1, a related foreign person described in paragraph 
(h)(2) of this section, are treated as not having been transferred. 
Accordingly, DC1's remittance proportion with respect to Business A is 
0, and DC1 recognizes no section 987 loss with respect to Business A. 
DC1's outbound section 987 loss is $500x, which is the amount of 
section 987 loss that DC1 would have recognized under Sec.  1.987-5 
without regard to paragraph (h) of this section ($500x), less the 
amount of section 987 loss recognized by DC1 under paragraph (h)(3) of 
this section ($0). Under paragraph (h)(4) of this section, the $500x of 
outbound section 987 loss becomes suspended section 987 loss.
    (C) Under paragraph (b)(1)(i) of this section, Business B is a 
successor suspended loss QBU because, immediately after the termination 
of the Business A section 987 QBU, the Business A assets are reflected 
on the books and records of Business B (which is the only set of books 
and records maintained by CFC1), Business B was an eligible QBU that 
continued to carry on the same trade or business as Business A did 
before the contribution, and Business B was owned by CFC1, a member of 
the same controlled group as DC (which is the original suspended loss 
QBU owner under paragraph (l)(1) of this section). See Sec.  1.987-
1(b)(4)(ii) (providing that, if a corporation is solely engaged in 
activities that constitute a trade or business, and the corporation 
maintains only one set of books and records, the activities (but not 
the corporation) are a qualified business unit). Therefore, under 
paragraph (b)(1)(ii) of this section, all of Business A's suspended 
section 987 loss (including the suspended section 987 loss resulting 
from the termination of Business A) is treated as suspended section 987 
loss of DC1 with respect to Business B.


Sec.  1.987-14  Section 987 hedging transactions.

    (a) Overview. This section provides rules relating to section 987 
hedging transactions. Paragraph (b) of this section provides the 
definition of a section 987 hedging transaction. Paragraph (c) of this 
section provides identification requirements for section 987 hedging 
transactions. Paragraph (d) of this section provides rules relating to 
the taxation of section 987 hedging transactions. Paragraph (e) of this 
section provides examples illustrating the rules of this section.
    (b) Section 987 hedging transaction--(1) In general. A section 987 
hedging transaction is a financial instrument or a combination or 
series of financial instruments (a hedge), that is entered into by the 
owner of a section 987 QBU as part of the normal course of the owner's 
trade or business for the purpose of managing exchange rate risk with 
respect to all or part of the owner's net investment in the section 987 
QBU (the hedged QBU), provided that the requirements of paragraph 
(b)(2) of this

[[Page 100221]]

section are met. If only part of a financial instrument (or combination 
or series of financial instruments) is described in the preceding 
sentence, that part is treated as a section 987 hedging transaction for 
purposes of this section.
    (2) Requirements. A transaction is a section 987 hedging 
transaction described in paragraph (b)(1) of this section for a taxable 
year only if the following requirements are met.
    (i) Identification. The hedge must be identified as a section 987 
hedging transaction with respect to the hedged QBU under paragraph (c) 
of this section. The financial instrument or instruments that comprise 
the hedge must not be identified as a section 987 hedging transaction 
with respect to any other section 987 QBU. If only part of a financial 
instrument (or combination or series of financial instruments) is a 
section 987 hedging transaction, that part must be clearly identified.
    (ii) Current rate election. A current rate election must be in 
effect for the taxable year.
    (iii) Mark-to-market method of accounting. Section 988 gain or loss 
of the owner with respect to the hedge must be accounted for under a 
mark-to-market method of accounting (for example, under section 1256). 
In addition, if a member of the owner's controlled group is a party to 
the hedge, any section 988 gain or loss of the controlled group member 
with respect to the hedge must be accounted for under a mark-to-market 
method of accounting.
    (iv) Treatment under U.S. generally accepted accounting principles. 
Foreign currency gain or loss on the hedge must be properly accounted 
for under generally accepted accounting principles as a cumulative 
foreign currency translation adjustment to shareholders' equity.
    (v) Hedge entered into by owner of the hedged QBU. The hedge must 
be entered into by the owner of the hedged QBU (and not by a section 
987 QBU of the owner). In the case of a hedged QBU that is owned by a 
member of a consolidated group, the hedge must be entered into by the 
member that owns the hedged QBU.
    (3) Anti-abuse rule. If a taxpayer enters into a hedge or a related 
transaction with a principal purpose of effectively converting section 
987 gain or loss into section 988 gain or loss (or another type of 
income or loss) of the owner or a related party, the hedge is not 
treated as a section 987 hedging transaction.
    (4) Partial termination of a section 987 hedging transaction. If 
only part of a financial instrument is a section 987 hedging 
transaction, and a part of the financial instrument is terminated or 
disposed of, a proportionate part of the section 987 hedging 
transaction is treated as terminated or disposed of.
    (c) Identification requirements--(1) In general. The owner of a 
hedged QBU must clearly identify the hedge as a section 987 hedging 
transaction with respect to the hedged QBU in its books and records on 
or before the close of the day on which the owner entered into the 
hedge. The identification must meet the requirements of Sec.  1.1221-
2(f)(4) and must include the following information--
    (i) The date on which the hedge is entered into by the owner of the 
hedged QBU and the date on which the hedge is identified as a section 
987 hedging transaction;
    (ii) A description of the hedge; and
    (iii) Identification of the hedged QBU.
    (2) Inadvertent error. If a hedge is not identified under paragraph 
(c)(1) of this section, but the hedge would otherwise qualify as a 
section 987 hedging transaction with respect to a hedged QBU within the 
meaning of paragraph (b) of this section and the taxpayer can 
demonstrate to the satisfaction of the Commissioner that its failure to 
identify the hedge was due to inadvertent error, the taxpayer may treat 
the hedge as a section 987 hedging transaction if all of the owner's 
hedges described in paragraph (b) of this section in all open years are 
being treated on either original or, if necessary, amended returns as 
section 987 hedging transactions subject to the rules of paragraph (d) 
of this section.
    (d) Taxation of section 987 hedging transactions--(1) Hedging gain 
or loss with respect to a hedged QBU. If the owner of a section 987 QBU 
has entered into a section 987 hedging transaction with respect to the 
section 987 QBU, the owner's hedging gain or loss with respect to the 
hedged QBU for a taxable year is equal to the gain or loss that the 
owner would (but for the application of this paragraph (d)) recognize 
under section 988 with respect to the section 987 hedging transaction 
in the taxable year under the mark-to-market method of accounting 
described in paragraph (b)(2)(iii) of this section (including gain or 
loss that would be recognized in connection with a complete or partial 
disposition or termination of the section 987 hedging transaction). If 
only part of a financial instrument is a section 987 hedging 
transaction, a proportionate part of the gain or loss that would (but 
for the application of this paragraph (d)) be recognized under section 
988 with respect to the financial instrument in the taxable year is 
treated as hedging gain or loss with respect to the hedged QBU. See 
paragraph (d)(3) of this section for rules relating to the 
determination of hedging gain or loss in the taxable year in which the 
hedged QBU terminates.
    (2) Adjustment to unrecognized section 987 gain or loss for the 
taxable year--(i) Hedging loss. In a taxable year in which an owner has 
hedging loss with respect to a hedged QBU and has unrecognized section 
987 gain for the taxable year with respect to the hedged QBU (as 
determined under Sec.  1.987-4(d), without regard to this paragraph 
(d)), the unrecognized section 987 gain for the taxable year is reduced 
(but not below zero) by the amount of the hedging loss. The amount of 
hedging loss that reduces unrecognized section 987 gain under this 
paragraph (d)(2)(i) is not recognized under section 988. Any hedging 
loss that does not reduce unrecognized section 987 gain under this 
paragraph (d)(2)(i) is recognized under section 988.
    (ii) Hedging gain. In a taxable year in which an owner has hedging 
gain with respect to a hedged QBU and has unrecognized section 987 loss 
for the taxable year with respect to the hedged QBU (as determined 
under Sec.  1.987-4(d), without regard to this paragraph (d)), the 
unrecognized section 987 loss for the taxable year is reduced (but not 
below zero) by the amount of the hedging gain. The amount of hedging 
gain that reduces unrecognized section 987 loss under this paragraph 
(d)(2)(ii) is not recognized under section 988. Any hedging gain that 
does not reduce unrecognized section 987 loss under this paragraph 
(d)(2)(ii) is recognized under section 988.
    (3) Termination of a hedged QBU. If the owner of a section 987 QBU 
has entered into a section 987 hedging transaction with respect to the 
section 987 QBU and the hedged QBU terminates, the owner's hedging gain 
or loss with respect to the hedged QBU for the taxable year is equal to 
the hedging gain or loss that the owner would (but for the application 
of this paragraph (d)) recognize with respect to the section 987 
hedging transaction under the mark-to-market method of accounting 
described in paragraph (b)(2)(iii) of this section if the taxable year 
ended on the termination date. Appropriate adjustments must be made to 
prevent the section 988 gain or loss from being taken into account 
again after it is applied to reduce unrecognized section 987 gain or 
loss under this paragraph (d).
    (e) Examples. The following examples illustrate the application of 
this section.

[[Page 100222]]

For purposes of the examples, DC1 is a domestic corporation that owns 
Business A, a section 987 QBU that has the euro as its functional 
currency. A current rate election is in effect for years 1 and 2, but 
no other elections are in effect. In year 1, DC1 had net unrecognized 
section 987 loss (determined under Sec.  1.987-4(b)) of $1,000x with 
respect to Business A, and Business A did not make a remittance in year 
1. As a result, in year 2, DC1's net accumulated unrecognized section 
987 loss from prior taxable years (determined under Sec.  1.987-4(c)) 
was $1,000x. In year 2, DC1 had unrecognized section 987 loss for the 
taxable year (determined under Sec.  1.987-4(d) before the application 
of paragraph (d) of this section) of $500x.
    (1) Example 1: Section 987 hedging transaction--(i) Facts. In year 
2, DC1 entered into a six-month foreign currency forward contract with 
an unrelated bank in the normal course of DC1's trade or business for 
the purpose of managing exchange rate risk with respect to DC1's net 
investment in Business A. On the same day, DC1 identified the forward 
contract as a section 987 hedging transaction with respect to Business 
A under paragraph (c) of this section. Under generally accepted 
accounting principles, currency gain or loss from the forward contract 
is accounted for as a cumulative translation adjustment to 
shareholder's equity. For Federal income tax purposes, DC1 accounts for 
section 988 gain or loss with respect to the forward contract under a 
mark-to-market method of accounting. But for the application of 
paragraph (d) of this section, DC1 would recognize $400x of section 988 
gain with respect to the forward contract.
    (ii) Analysis--(A) Qualification of the hedge as a section 987 
hedging transaction. The forward contract qualifies as a section 987 
hedging transaction under paragraph (b) of this section because it is a 
financial instrument that manages DC1's exchange rate risk with respect 
to Business A (the hedged QBU) as part of the normal course of DC1's 
trade or business, and the hedge meets the requirements of paragraph 
(b)(2) of this section.
    (B) Treatment of the section 987 hedging transaction. But for the 
application of paragraph (d) of this section, DC1 would recognize $400x 
of section 988 gain with respect to the forward contract in year 2. 
Therefore, DC1 has $400x of hedging gain in year 2. In year 2, DC1 had 
unrecognized section 987 loss of $500x for the taxable year (determined 
under Sec.  1.987-4(d) before the application of paragraph (d) of this 
section). Therefore, under paragraph (d)(2)(ii) of this section, DC1's 
unrecognized section 987 loss for the taxable year of $500x is reduced 
by the $400x of hedging gain. Accordingly, DC1 has unrecognized section 
987 loss of $100x for the taxable year with respect to Business A. 
Under Sec.  1.987-4(b), DC1 has $1,100x of net unrecognized section 987 
loss in year 2 (equal to the sum of its net accumulated section 987 
loss of $1,000x from prior taxable years and its unrecognized section 
987 loss for the taxable year of $100x). DC1 does not recognize its 
hedging gain under section 988 because all of the hedging gain reduces 
unrecognized section 987 loss for the taxable year.
    (2) Example 2: Excess hedging gain from a section 987 hedging 
transaction--(i) Facts. The facts are the same as in paragraph (e)(1) 
of this section (Example 1) except that, but for the application of 
paragraph (d) of this section, DC1 would recognize $600x of section 988 
gain with respect to the forward contract.
    (ii) Analysis. Under paragraph (d)(2)(ii) of this section, DC1's 
unrecognized section 987 loss for the taxable year of $500x is reduced 
by the hedging gain, but not below zero. Accordingly, $500x of the 
hedging gain is applied to reduce DC1's unrecognized section 987 loss 
for the taxable year to zero. DC1 has $1,000x of net unrecognized 
section 987 loss in year 2 under Sec.  1.987-4(b) (equal to its net 
accumulated section 987 loss of $1,000x from prior taxable years). The 
$500x hedging gain that reduces unrecognized section 987 loss for the 
taxable year is not recognized under section 988. The excess amount of 
hedging gain ($100x) is recognized by DC1 under section 988.


Sec.  1.987-15  Applicability date.

    (a) Applicability date of the section 987 regulations--(1) In 
general. Except as provided in this section, the section 987 
regulations apply to taxable years beginning after December 31, 2024.
    (2) Applicability date for a terminating QBU. The section 987 
regulations apply to the owner of a terminating QBU immediately before 
the section 987 QBU terminates, but only with respect to the section 
987 QBU, any successor deferral QBUs or successor suspended loss QBUs 
(in their capacity as such), and any net unrecognized section 987 gain 
or loss, deferred section 987 gain or loss, or suspended section 987 
loss with respect thereto. See Sec.  1.987-1(h) for the definition of a 
terminating QBU.
    (b) Application of the section 987 regulations to taxable years 
beginning on or before December 31, 2024, and ending after November 9, 
2023. A taxpayer (including a taxpayer that has applied the 2016 and 
2019 section 987 regulations to a prior taxable year under paragraph 
(c) of this section) may choose to apply the section 987 regulations to 
a taxable year beginning on or before December 31, 2024, and ending 
after November 9, 2023, provided the taxpayer and each member of its 
consolidated group and section 987 electing group:
    (1) Consistently apply the section 987 regulations in their 
entirety to the taxable year and all subsequent taxable years beginning 
on or before December 31, 2024; and
    (2) Apply the section 987 regulations on their original timely 
filed (including extensions) returns for the first taxable year to 
which the taxpayer chooses to apply the section 987 regulations.
    (c) Application of the 2016 and 2019 section 987 regulations--(1) 
In general. A taxpayer may choose to apply the 2016 and 2019 section 
987 regulations to a taxable year beginning after December 7, 2016, and 
beginning on or before December 31, 2024, provided the taxpayer and 
each member of its consolidated group and section 987 electing group:
    (i) First apply the 2016 and 2019 section 987 regulations to a 
taxable year ending before November 9, 2023;
    (ii) Consistently apply the 2016 and 2019 section 987 regulations 
in their entirety to all section 987 QBUs (within the meaning of prior 
Sec.  1.987-1(b)(2)) directly or indirectly owned (within the meaning 
of prior Sec.  1.987-1(b)(4)) by the taxpayer and each member of its 
consolidated group and section 987 electing group on the transition 
date for that taxable year and all subsequent taxable years before the 
taxable year in which the taxpayer and each member of its consolidated 
group and section 987 electing group apply the section 987 regulations 
pursuant to paragraph (a) or (b) of this section; and
    (iii) Either--
    (A) First applied the 2016 and 2019 section 987 regulations on 
their returns filed before November 9, 2023; or
    (B) First apply the 2016 and 2019 section 987 regulations on their 
returns filed on or after November 9, 2023 and apply Sec.  1.987-10 in 
lieu of prior Sec.  1.987-10.
    (2) Application to section 987 QBUs not owned on the transition 
date. For any taxable year in which a taxpayer applies the 2016 and 
2019 section 987 regulations pursuant to paragraph (c)(1) of this 
section, the taxpayer may choose

[[Page 100223]]

to apply the 2016 and 2019 section 987 regulations to any section 987 
QBU (within the meaning of prior Sec.  1.987-1(b)(2)) that the taxpayer 
did not directly or indirectly own (within the meaning of prior Sec.  
1.987-1(b)(4)) on the transition date, provided the taxpayer applies 
the 2016 and 2019 section 987 regulations consistently to that QBU for 
that taxable year and all subsequent taxable years before the taxable 
year in which the taxpayer applies the section 987 regulations pursuant 
to paragraph (a) or (b) of this section and the taxpayer either--
    (i) First applied the 2016 and 2019 section 987 regulations to the 
section 987 QBU on its return filed before November 9, 2023; or
    (ii) First applies the 2016 and 2019 section 987 regulations to the 
section 987 QBU on its return filed on or after November 9, 2023, and 
applies Sec.  1.987-10 in lieu of prior Sec.  1.987-10.
    (3) Modifications of defined terms for purposes of this paragraph 
(c). Solely for purposes of this paragraph (c)--
    (i) Application of Sec.  1.987-10 in lieu of prior Sec.  1.987-10. 
For any taxpayer to which paragraph (c)(1)(iii)(B) or (c)(2)(ii) of 
this section applies, the term 2016 and 2019 section 987 regulations 
includes Sec.  1.987-10 and not prior Sec.  1.987-10.
    (ii) Partnerships not included in section 987 electing group. The 
term section 987 electing group does not include foreign partnerships.
    (iii) Transition date. The term transition date has the meaning 
provided in prior Sec.  1.987-10.
    (d) Prior Sec.  1.987-12. For the applicability dates of prior 
Sec.  1.987-12, see prior Sec.  1.987-12(j). Prior Sec.  1.987-12 
applies through the end of the taxable year immediately preceding the 
first taxable year in which a taxpayer applies Sec.  1.987-12 pursuant 
to paragraph (a) or (b) of this section.

0
Par. 9. Section 1.988-1 is amended by:
0
a. Removing and reserving paragraph (a)(4);
0
b. Revising paragraph (a)(10)(i);
0
c. Removing the language ``1988'' in the fourth sentence of paragraph 
(a)(1)(iii) and adding the language ``2025'' in its place; and
0
d. Revising paragraph (i).
    The revisions read as follows:


Sec.  1.988-1  Certain definitions and special rules.

    (a) * * *
    (10) * * *
    (i) In general. Except as provided in paragraph (a)(10)(ii) of this 
section, disregarded transactions between or among the taxpayer and/or 
qualified business units of that taxpayer (``intra-taxpayer 
transactions'') are not section 988 transactions. See section 987 and 
the regulations thereunder.
* * * * *
    (i) Applicability date--(1) In general. Except as otherwise 
provided in this section, this section applies to taxable years 
beginning after December 31, 1986. Thus, except as otherwise provided 
in this section, any payments made or received with respect to a 
section 988 transaction in taxable years beginning after December 31, 
1986, are subject to this section.
    (2) Paragraph (a)(10)(ii). Generally, paragraph (a)(10)(ii) of this 
section applies to taxable years beginning after December 31, 2024. 
However, if pursuant to Sec.  1.987-15(b), a taxpayer chooses to apply 
Sec. Sec.  1.987-1 through 1.987-15 to a taxable year before the first 
taxable year described in Sec.  1.987-15(a)(1), then paragraph 
(a)(10)(ii) of this section applies to that taxable year. See Sec.  
1.988-1(i), as contained in 26 CFR in part 1 in effect on April 1, 
2024, for a prior applicability date for paragraph (a)(10)(ii) of this 
section.

0
Par. 10. Section 1.988-4 is amended by revising paragraph (b)(2) to 
read as follows:


Sec.  1.988-4  Source of gain or loss realized on a section 988 
transfer.

* * * * *
    (b) * * *
    (2) Proper reflection on the books of the taxpayer or qualified 
business unit--(i) In general. For purposes of paragraph (b)(1) of this 
section, the principles of Sec.  1.987-2(b) apply in determining 
whether an asset, liability, or item of income, gain, deduction, or 
loss is reflected on the books and records of a qualified business 
unit.
    (ii) Applicability date. Generally, paragraph (b)(2)(i) of this 
section applies to taxable years beginning after December 31, 2024. 
However, if pursuant to Sec.  1.987-15(b), a taxpayer chooses to apply 
Sec. Sec.  1.987-1 through 1.987-15 to a taxable year before the first 
taxable year described in Sec.  1.987-15(a)(1), then paragraph 
(b)(2)(i) of this section applies to that taxable year.
* * * * *

0
Par. 11. Section 1.989(a)-1 is amended by:
0
a. Removing and reserving paragraph (b)(2)(i)(C).
0
b. Revising paragraphs (b)(4), (d)(3) and (4).
    The revisions read as follows:


Sec.  1.989(a)-1  Definition of a qualified business unit.

* * * * *
    (b) * * *
    (4) Applicability date. Generally, paragraph (b)(2)(i) of this 
section applies to taxable years beginning after December 31, 2024. 
However, if pursuant to Sec.  1.987-15(b), a taxpayer chooses to apply 
Sec. Sec.  1.987-1 through 1.987-15 to a taxable year before the first 
taxable year described in Sec.  1.987-15(a)(1), then paragraph 
(b)(2)(i) of this section applies to that taxable year. See Sec.  
1.989(a)-1(b)(4), as contained in 26 CFR in part 1 in effect on April 
1, 2024, for a prior applicability date for paragraph (b)(2)(i) of this 
section.
* * * * *
    (d) * * *
    (3) Proper reflection on the books of the taxpayer or qualified 
business unit. The principles of Sec.  1.987-2(b) apply in determining 
whether an asset, liability, or item of income, gain, deduction, or 
loss is reflected on the books of a qualified business unit (and 
therefore is attributable to such unit).
    (4) Applicability date. Generally, paragraph (d)(3) of this section 
applies to taxable years beginning after December 31, 2024. However, if 
pursuant to Sec.  1.987-15(b), a taxpayer applies Sec. Sec.  1.987-1 
through 1.987-15 to a taxable year before the first taxable year 
described in Sec.  1.987-15(a)(1), then paragraph (d)(3) of this 
section applies to that taxable year. See Sec.  1.989(a)-1(d)(4), as 
contained in 26 CFR in part 1 in effect on April 1, 2024, for a prior 
applicability date for paragraph (d)(3) of this section.
* * * * *

0
Par. 12. Section 1.1502-13 is amended by revising paragraph (j)(9) and 
adding paragraphs (j)(10) and (l)(7) to read as follows:


Sec.  1.1502-13  Intercompany transactions.

* * * * *
    (j) * * *
    (9) Section 987 QBUs. No intercompany transaction is attributable 
to a section 987 QBU (within the meaning of Sec.  1.987-2(b)). That is, 
in order to produce single entity treatment, an intercompany 
transaction that otherwise would involve the section 987 QBU(s) of one 
or more members is treated instead as occurring directly between the 
members (without the involvement of any section 987 QBUs), and 
transfers are deemed to take place between each section 987 QBU and its 
owner (see Sec.  1.987-2(c)(2)(ii)). For example, if a member (M1) 
lends money to the section 987 QBU of another member (M2), this 
intercompany transaction is treated as a loan from M1 to M2 and a 
contribution from M2 to its section 987 QBU.

[[Page 100224]]

    (10) Examples. The operating rules of this paragraph (j) are 
illustrated generally throughout this section, and by the following 
examples.
    (i) Example 1. Intercompany sale followed by section 351 transfer 
to member--(A) Facts. S holds land for investment with a basis of $70. 
On January 1 of Year 1, S sells the land to M for $100. M also holds 
the land for investment. On July 1 of Year 3, M transfers the land to B 
in exchange for all of B's stock in a transaction to which section 351 
applies. Under section 358, M's basis in the B stock is $100. B holds 
the land for sale to customers in the ordinary course of business and, 
under section 362(b), B's basis in the land is $100. On December 1 of 
Year 5, M sells 20% of the B stock to X for $22. In an unrelated 
transaction on July 1 of Year 8, B sells 20% of the land for $22.
    (B) Definitions. Under paragraph (b)(1) of this section, S's sale 
of the land to M and M's transfer of the land to B are both 
intercompany transactions. S is the selling member and M is the buying 
member in the first intercompany transaction, and M is the selling 
member and B is the buying member in the second intercompany 
transaction. M has no intercompany items under paragraph (b)(2) of this 
section. Because B acquired the land in an intercompany transaction, 
B's items from the land are corresponding items to be taken into 
account under this section. Under the successor asset rule of paragraph 
(j)(1) of this section, references to the land include references to 
M's B stock. Under the successor person rule of paragraph (j)(2) of 
this section, references to M include references to B with respect to 
the land.
    (C) Timing and attributes resulting from the stock sale. Under 
paragraph (c)(3) of this section, M is treated as owning and selling 
B's stock for purposes of the matching rule even though, as divisions, 
M could not own and sell stock in B. Under paragraph (j)(3) of this 
section, both M's B stock and B's land can cause S's intercompany gain 
to be taken into account under the matching rule. Thus, S takes $6 of 
its gain into account in Year 5 to reflect the $6 difference between 
M's $2 gain taken into account from its sale of B stock and the $8 
recomputed gain. Under paragraph (j)(4) of this section, the attributes 
of this gain are determined by treating S, M, and B as divisions of a 
single corporation. Under paragraph (c)(1) of this section, S's $6 gain 
and M's $2 gain are treated as long-term capital gain. The gain would 
be capital on a separate entity basis (assuming that section 341 does 
not apply), and this treatment is not inconsistent with treating S, M, 
and B as divisions of a single corporation because the stock sale and 
subsequent land sale are unrelated transactions and B remains a member 
following the sale.
    (D) Timing and attributes resulting from the land sale. Under 
paragraph (j)(3) of this section, S takes $6 of its gain into account 
in Year 8 under the matching rule to reflect the $6 difference between 
B's $2 gain taken into account from its sale of an interest in the land 
and the $8 recomputed gain. Under paragraph (j)(4) of this section, the 
attributes of this gain are determined by treating S, M, and B as 
divisions of a single corporation and taking into account the 
activities of S, M, and B with respect to the land. Thus, both S's gain 
and B's gain might be ordinary income as a result of B's activities. 
(If B subsequently sells the balance of the land, S's gain taken into 
account is limited to its remaining $18 of intercompany gain.)
    (E) Sale of successor stock resulting in deconsolidation. The facts 
are the same as in paragraph (j)(10)(i)(A) of this section (Example 1), 
except that M sells 60% of the B stock to X for $66 on December 1 of 
Year 5 and B becomes a nonmember. Under the matching rule, M's sale of 
B stock results in $18 of S's gain being taken into account (to reflect 
the difference between M's $6 gain taken into account and the $24 
recomputed gain). Under the acceleration rule, however, the entire $30 
gain is taken into account (to reflect B becoming a nonmember, because 
its basis in the land reflects M's $100 cost basis from the prior 
intercompany transaction). Under paragraph (j)(4) of this section, the 
attributes of S's gain are determined by treating S, M, and B as 
divisions of a single corporation. Because M's cost basis in the land 
will be reflected by B as a nonmember, all of S's gain is treated as 
from the land (rather than a portion being from B's stock), and B's 
activities with respect to the land might therefore result in S's gain 
being ordinary income.
    (ii) Example 2. Intercompany sale of member stock followed by 
recapitalization--(A) Facts. Before becoming a member of the P group, S 
owns P stock with a basis of $70. On January 1 of Year 1, P buys all of 
S's stock. On July 1 of Year 3, S sells the P stock to M for $100. On 
December 1 of Year 5, P acquires M's original P stock in exchange for 
new P stock in a recapitalization described in section 368(a)(1)(E).
    (B) Timing and attributes. Although P's basis in the stock acquired 
from M is eliminated under paragraph (f)(4) of this section, the new P 
stock received by M is exchanged basis property (within the meaning of 
section 7701(a)(44)) having a basis under section 358 equal to M's 
basis in the original P stock. Under the successor asset rule of 
paragraph (j)(1) of this section, references to M's original P stock 
include references to M's new P stock. Because it is still possible to 
take S's intercompany item into account under the matching rule with 
respect to the successor asset, S's gain is not taken into account 
under the acceleration rule as a result of the basis elimination under 
paragraph (f)(4) of this section. Instead, the gain is taken into 
account based on subsequent events with respect to M's new P stock (for 
example, a subsequent distribution or redemption of the new stock).
    (iii) Example 3. Back-to-back intercompany transactions--matching--
(A) Facts. S holds land for investment with a basis of $70. On January 
1 of Year 1, S sells the land to M for $90. M also holds the land for 
investment. On July 1 of Year 3, M sells the land for $100 to B, and B 
holds the land for sale to customers in the ordinary course of 
business. During Year 5, B sells all of the land to customers for $105.
    (B) Timing. Under paragraph (b)(1) of this section, S's sale of the 
land to M and M's sale of the land to B are both intercompany 
transactions. S is the selling member and M is the buying member in the 
first intercompany transaction, and M is the selling member and B is 
the buying member in the second intercompany transaction. Under 
paragraph (j)(4) of this section, S, M and B are treated as divisions 
of a single corporation for purposes of determining the timing of their 
items from the intercompany transactions. See also paragraph (j)(2) of 
this section (B is treated as a successor to M for purposes of taking 
S's intercompany gain into account). Thus, S's $20 gain and M's $10 
gain are both taken into account in Year 5 to reflect the difference 
between B's $5 gain taken into account with respect to the land and the 
$35 recomputed gain (the gain that B would have taken into account if 
the intercompany sales had been transfers between divisions of a single 
corporation, and B succeeded to S's $70 basis).
    (C) Attributes. Under paragraph (j)(4) of this section, the 
attributes of the intercompany items and corresponding items of S, M, 
and B are also determined by treating S, M, and B as divisions of a 
single corporation. For example, the attributes of S's and M's 
intercompany items are determined by taking B's activities into 
account.

[[Page 100225]]

    (iv) Example 4. Back-to-back intercompany transactions--
acceleration--(A) Facts. During Year 1, S performs services for M in 
exchange for $10 from M. S incurs $8 of employee expenses. M 
capitalizes the $10 cost of S's services under section 263 as part of 
M's cost to acquire real property from X. Under its separate entity 
method of accounting, S would take its income and expenses into account 
in Year 1. M holds the real property for investment and, on July 1 of 
Year 5, M sells it to B at a gain. B also holds the real property for 
investment. On December 1 of Year 8, while B still owns the real 
property, P sells all of M's stock to X and M becomes a nonmember.
    (B) M's items. M takes its gain into account immediately before it 
becomes a nonmember. Because the real property stays in the group, the 
acceleration rule redetermines the attributes of M's gain under the 
principles of the matching rule as if B sold the real property to an 
affiliated corporation that is not a member of the group for a cash 
payment equal to B's adjusted basis in the real property, and S, M, and 
B were divisions of a single corporation. Thus, M's gain is capital 
gain.
    (C) S's items. Under paragraph (b)(2)(ii) of this section, S 
includes the $8 of expenses in determining its $2 intercompany income. 
In Year 1, S takes into account $8 of income and $8 of expenses. Under 
paragraph (j)(4) of this section, appropriate adjustments must be made 
to treat both S's performance of services for M and M's sale to B as 
occurring between divisions of a single corporation. Thus, S's $2 of 
intercompany income is not taken into account as a result of M becoming 
a nonmember, but instead will be taken into account based on subsequent 
events (e.g., under the matching rule based on B's sale of the real 
property to a nonmember, or under the acceleration rule based on P's 
sale of the stock of S or B to a nonmember). See the successor person 
rules of paragraph (j)(2) of this section (B is treated as a successor 
to M for purposes of taking S's intercompany income into account).
    (D) Sale of S's stock. The facts are the same as in paragraph 
(j)(9)(iv)(A) of this section (Example 4), except that P sells all of 
S's stock (rather than M's stock) and S becomes a nonmember on July 1 
of Year 5. S's remaining $2 of intercompany income is taken into 
account immediately before S becomes a nonmember. Because S's 
intercompany income is not from an intercompany sale, exchange, or 
distribution of property, the attributes of the intercompany income are 
determined on a separate entity basis. Thus, S's $2 of intercompany 
income is ordinary income. M does not take any of its intercompany gain 
into account as a result of S becoming a nonmember.
    (E) Intercompany income followed by intercompany loss. The facts 
are the same as in paragraph (j)(9)(iv)(A) of this section (Example 4), 
except that M sells the real property to B at a $1 loss (rather than a 
gain). M takes its $1 loss into account under the acceleration rule 
immediately before M becomes a nonmember. But see Sec.  1.267(f)-1 
(which might further defer M's loss if M and B remain in a controlled 
group relationship after M becomes a nonmember). Under paragraph (j)(4) 
of this section appropriate adjustments must be made to treat the group 
as if both intercompany transactions occurred between divisions of a 
single corporation. Accordingly, P's sale of M stock also results in S 
taking into account $1 of intercompany income as capital gain to offset 
M's $1 of corresponding capital loss. The remaining $1 of S's 
intercompany income is taken into account based on subsequent events.
    (v) Example 5. Successor group--(A) Facts. On January 1 of Year 1, 
B borrows $100 from S in return for B's note providing for $10 of 
interest annually at the end of each year, and repayment of $100 at the 
end of Year 20. As of January 1 of Year 3, B has paid the interest 
accruing under the note. On that date, X acquires all of P's stock and 
the former P group members become members of the X consolidated group.
    (B) Successor. Under paragraph (j)(5) of this section, although B's 
note ceases to be an intercompany obligation of the P group, the note 
is not treated as satisfied and reissued under paragraph (g) of this 
section as a result of X's acquisition of P stock. Instead, the X 
consolidated group succeeds to the treatment of the P group for 
purposes of paragraph (g) of this section, and B's note is treated as 
an intercompany obligation of the X consolidated group.
    (vi) Example 6. Liquidation--80% distributee--(A) Facts. X has had 
preferred stock described in section 1504(a)(4) outstanding for several 
years. On January 1 of Year 1, S buys all of X's common stock for $60, 
and B buys all of X's preferred stock for $40. X's assets have a $0 
basis and $100 value. On July 1 of Year 3, X distributes all of its 
assets to S and B in a complete liquidation. Under Sec.  1.1502-34, 
section 332 applies to both S and B. Under section 337, X has no gain 
or loss from its liquidating distribution to S. Under sections 336 and 
337(c), X has a $40 gain from its liquidating distribution to B. B has 
a $40 basis under section 334(a) in the assets received from X, and S 
has a $0 basis under section 334(b) in the assets received from X.
    (B) Intercompany items from the liquidation. Under the matching 
rule, X's $40 gain from its liquidating distribution to B is not taken 
into account under this section as a result of the liquidation (and 
therefore is not yet reflected under Sec. Sec.  1.1502-32 and 1.1502-
33). Under the successor person rule of paragraph (j)(2)(i) of this 
section, S and B are both successors to X. Under section 337(c), X 
recognizes gain or loss only with respect to the assets distributed to 
B. Under paragraph (j)(2)(ii) of this section, to be consistent with 
the purposes of this section, S succeeds to X's $40 intercompany gain. 
The gain will be taken into account by S under the matching and 
acceleration rules of this section based on subsequent events. (The 
allocation of the intercompany gain to S does not govern the allocation 
of any other attributes.)
    (vi) Example 7. Liquidation--no 80% distributee--(A) Facts. X has 
only common stock outstanding. On January 1 of Year 1, S buys 60% of 
X's stock for $60, and B buys 40% of X's stock for $40. X's assets have 
a $0 basis and $100 value. On July 1 of Year 3, X distributes all of 
its assets to S and B in a complete liquidation. Under Sec.  1.1502-34, 
section 332 applies to both S and B. Under sections 336 and 337(c), X 
has a $100 gain from its liquidating distributions to S and B. Under 
section 334(b), S has a $60 basis in the assets received from X and B 
has a $40 basis in the assets received from X.
    (B) Intercompany items from the liquidation. Under the matching 
rule, X's $100 intercompany gain from its liquidating distributions to 
S and B is not taken into account under this section as a result of the 
liquidation (and therefore is not yet reflected under Sec. Sec.  
1.1502-32 and 1.1502-33). Under the successor person rule of paragraph 
(j)(2)(i) of this section, S and B are both successors to X. Under 
paragraph (j)(2)(ii) of this section, to be consistent with the 
purposes of this section, S succeeds to X's $40 intercompany gain with 
respect to the assets distributed to B, and B succeeds to X's $60 
intercompany gain with respect to the assets distributed to S. The gain 
will be taken into account by S and B under the matching and 
acceleration rules of this section based on subsequent events. (The 
allocation of the intercompany gain does not govern the allocation of 
any other attributes.)
    (viii) Example 8: Loan by section 987 QBU--(A) Facts. S owns all 
the interests in DE1, a disregarded entity operating a

[[Page 100226]]

business that is a section 987 QBU (S QBU) whose functional currency is 
the euro. S has net unrecognized section 987 gain with respect to S 
QBU. In year 1, S QBU lends [euro]100 to B with interest due annually. 
B makes interest payments on the loan to S QBU in years 1 through 3. In 
year 3, B repays the loan and recognizes section 988 loss of $12 on the 
loan repayment. All payments are made in euros, and B recognizes no 
section 988 gain or loss on the euros it uses to pay the interest and 
principal. B is never insolvent within the meaning of section 
108(d)(3). Other than with respect to the loan, there are no transfers 
between S and S QBU during years 1 through 3, and neither S nor B had 
any other foreign currency gain or loss. Neither S nor B has made an 
election under section 988 or the section 988 regulations.
    (B) Analysis--(1) Loan. Under paragraph (j)(9) of this section, the 
loan is treated as a transfer from S QBU to S and a loan directly 
between S and B. Specifically, S is treated as receiving a transfer of 
[euro]100 from S QBU in year 1; S is then treated as lending [euro]100 
directly to B. For purposes of Sec.  1.987-2, the loan is attributable 
to S, not to S QBU. As an intercompany loan, S's loan to B is subject 
to the rules of this section. Because there is a remittance from S QBU 
to S in year 1, S recognizes section 987 gain under Sec.  1.987-5.
    (2) Interest payments. While the loan is outstanding, each of B's 
interest payments to S QBU is treated as an interest payment from B to 
S, followed by a transfer from S to S QBU. Under the matching rule in 
paragraph (c) of this section, S's intercompany interest income offsets 
B's corresponding interest expense. See paragraph (g)(7)(ii)(A)(2) of 
this section (Example 1). Since the functional currency of both S and B 
is the dollar, if B recognizes any section 988 gain or loss on the 
interest payments, S will recognize an offsetting amount of section 988 
loss or gain. Because the only transfer between S and S QBU in year 2 
is from S to S QBU, there is no remittance from S QBU to S and S does 
not recognize section 987 gain under Sec.  1.987-5.
    (3) Repayment. Upon the year 3 repayment of the loan, B is treated 
as repaying [euro]100 to S, and S is treated as transferring [euro]100 
to S QBU. Since the functional currency of both S and B is the dollar, 
and B recognizes section 988 loss of $12 on the loan repayment, S will 
recognize an offsetting section 988 gain of $12. Because the only 
transfers between S and S QBU in year 3 are from S to S QBU, there is 
no remittance from S QBU to S and S does not recognize section 987 gain 
under Sec.  1.987-5.
    (4) Summary. Overall, the group's taxable income includes S's 
section 987 gain in year 1 (the section 988 inclusions offset). This 
result is consistent with the treatment of a single corporation that 
borrows from its section 987 QBU.
    (C) Loan sold to non-member. The facts are the same as in paragraph 
(j)(10)(viii)(A) of this section, except that, in year 3, S QBU sells 
the loan to unrelated X for [euro]90, reflecting an increase in 
prevailing market interest rates. Up until the sale, the analysis is 
the same as in paragraphs (j)(10)(viii)(B)(1) and (2) of this section. 
Because the loan is attributable to S (see paragraphs (j)(9) and 
(j)(10)(viii)(B)(1) of this section), the sale is treated as a sale by 
S. Under paragraph (g)(3) of this section, immediately before the sale, 
B is deemed to satisfy and reissue the loan for its fair market value 
of [euro]90. As a result, B takes into account cancellation of 
indebtedness income, and S takes into account an offsetting amount of 
ordinary loss. See paragraph (g)(7)(ii) (Example 2) of this section. If 
there is currency gain or loss, S and B take into account offsetting 
amounts of gain and loss under section 988 (subject to the limitation 
of Sec.  1.988-2(b)(8)). Because S has a basis of [euro]90 in the new 
loan, S recognizes no gain or loss on the sale to X. S is then treated 
as transferring the [euro]90 to S QBU.
    (D) Party becomes a nonmember. The facts are the same as in 
paragraph (j)(10)(viii)(A) of this section, except that, in year 3, B 
becomes a nonmember. Up until B leaves the group, the analysis is the 
same as in paragraphs (j)(10)(viii)(B)(1) and (2) of this section. 
Immediately before B becomes a nonmember, B is deemed to satisfy and 
reissue the loan for its fair market value under paragraph (g)(3) of 
this section, with the same consequences as described in paragraph 
(j)(10)(viii)(C) of this section. When B becomes a nonmember, the loan 
(which is no longer an intercompany obligation) ceases to be subject to 
paragraph (j)(9) of this section. If the loan is attributable to S QBU 
under Sec.  1.987-2, S is treated as transferring the loan to S QBU.
    (ix) Example 9: Sale of property by section 987 QBU--(A) Facts. M1 
owns all the interests in DE1, a disregarded entity operating a 
business that is a section 987 QBU (M1 QBU) whose functional currency 
is the euro. M1 has net unrecognized section 987 gain with respect to 
M1 QBU. M1 QBU sells property to M2 for [euro]100 in year 1.
    (B) Analysis--(1) In general. Under paragraph (j)(9) of this 
section, the sale of property is treated as a transfer of the property 
from M1 QBU to M1, followed by an exchange of the property for 
[euro]100 directly between M1 and M2, and a transfer of the [euro]100 
from M1 to M1 QBU.
    (2) Distribution. M1 QBU is treated as transferring the property to 
M1.
    (3) Exchange. M1 is then treated as selling the property to M2 for 
[euro]100. M1 takes into account its intercompany gain or loss on the 
property under the rules of this section. M2 recognizes intercompany 
section 988 gain or loss on its exchange of [euro]100 for the property. 
See paragraph (b)(1)(iii) of this section for property exchanges 
between members.
    (4) Contribution. Finally, M1 is treated as transferring the 
[euro]100 to M1 QBU. Because M1's basis in the [euro]100 equals its 
fair market value, M1 has a corresponding section 988 gain or loss of 
zero upon the contribution. See Sec.  1.988-1(a)(10). Both the transfer 
of the property from M1 QBU to M1 and the transfer of the [euro]100 
from M1 to M1 QBU are taken into account in determining whether there 
is a remittance from M1 QBU to M1 in year 1 and whether M1 recognizes 
section 987 gain under Sec.  1.987-5.
    (5) Summary. Overall, in year 1, M1 may take into account section 
987 gain if the transfers between M1 and M1 QBU result in a remittance, 
and M2 takes into account section 988 gain or loss on the [euro]100. 
This result is consistent with the treatment of a single corporation 
that purchases property from its section 987 QBU.
    (l) * * *
    (7) Applicability date. Generally, paragraph (j)(9) of this section 
applies to taxable years beginning after December 31, 2024, for which 
the original Federal income tax return is due (without extensions) 
after December 11, 2024. However, if pursuant to Sec.  1.987-15(b), a 
taxpayer chooses to apply Sec. Sec.  1.987-1 through 1.987-15 to a 
taxable year before the first taxable year described in Sec.  1.987-
15(a)(1), then paragraph (j)(9) of this section applies to that taxable 
year and subsequent years.

Douglas W. O'Donnell,
Deputy Commissioner.
    Approved: November 20, 2024
Aviva R. Aron-Dine,
Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2024-28372 Filed 12-10-24; 8:45 am]
BILLING CODE 4830-01-P