[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 1999 Edition]
[From the U.S. Government Printing Office]
26
Internal Revenue
[[Page i]]
Part 1 (Secs. 1.0-1 TO 1.60)
Revised as of April 1, 1999
CONTAINING
A CODIFICATION OF DOCUMENTS OF GENERAL APPLICABILITY
AND FUTURE EFFECT
AS OF APRIL 1, 1999
With Ancillaries
Published by
the Office of the Federal Register
National Archives and Records
Administration
as a Special Edition of
the Federal Register
[[Page ii]]
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1999
For sale by U.S. Government Printing Office
Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328
[[Page iii]]
Table of Contents
Page
Explanation................................................. v
Title 26:
Chapter I--Internal Revenue Service, Department of
the Treasury 5
Findings Aids:
Table of CFR Titles and Chapters.......................... 523
Alphabetical List of Agencies Appearing in the CFR........ 541
Table of OMB Control Numbers.............................. 551
List of CFR Sections Affected............................. 569
[[Page iv]]
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Cite this Code: CFR
To cite the regulations in
this volume use title,
part and section number.
Thus, 26 CFR 1.0-1 refers
to title 26, part 1,
section 0-1.
----------------------------
[[Page v]]
EXPLANATION
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
departments and agencies of the Federal Government. The Code is divided
into 50 titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the
name of the issuing agency. Each chapter is further subdivided into
parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1
The appropriate revision date is printed on the cover of each
volume.
LEGAL STATUS
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HOW TO USE THE CODE OF FEDERAL REGULATIONS
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EFFECTIVE AND EXPIRATION DATES
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OMB CONTROL NUMBERS
The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires
Federal agencies to display an OMB control number with their information
collection request.
[[Page vi]]
Many agencies have begun publishing numerous OMB control numbers as
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requirements.
OBSOLETE PROVISIONS
Provisions that become obsolete before the revision date stated on
the cover of each volume are not carried. Code users may find the text
of provisions in effect on a given date in the past by using the
appropriate numerical list of sections affected. For the period before
January 1, 1986, consult either the List of CFR Sections Affected, 1949-
1963, 1964-1972, or 1973-1985, published in seven separate volumes. For
the period beginning January 1, 1986, a ``List of CFR Sections
Affected'' is published at the end of each CFR volume.
CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
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The Federal Register Index is issued monthly in cumulative form.
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the revision dates of the 50 CFR titles.
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[[Page vii]]
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Raymond A. Mosley,
Director,
Office of the Federal Register.
April 1, 1999.
[[Page ix]]
THIS TITLE
Title 26--Internal Revenue is composed of nineteen volumes. The
contents of these volumes represent all current regulations issued by
the Internal Revenue Service, Department of the Treasury, as of April 1,
1999. The first twelve volumes comprise part 1 (Subchapter A--Income
Tax) and are arranged by sections as follows: Secs. 1.0-1-1.60;
Secs. 1.61-1.169; Secs. 1.170-1.300; Secs. 1.301-1.400; Secs. 1.401-
1.440; Secs. 1.441-1.500; Secs. 1.501-1.640; Secs. 1.641-1.850;
Secs. 1.851-1.907; Secs. 1.908-1.1000; Secs. 1.1001-1.1400 and
Sec. 1.1401 to end. The thirteenth volume containing parts 2-29,
includes the remainder of subchapter A and all of Subchapter B--Estate
and Gift Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49;
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter
G--Regulations under Tax Conventions); and part 600 to end (Subchapter
H--Internal Revenue Practice).
The OMB control numbers for Title 26 appear in Sec. 602.101 of this
chapter. For the convenience of the user, Sec. 602.101 appears in the
Finding Aids section of the volumes containing parts 1 to 599.
For this volume, Carol Conroy was Chief Editor. The Code of Federal
Regulations publication program is under the direction of Frances D.
McDonald, assisted by Alomha S. Morris.
[[Page x]]
[[Page 1]]
TITLE 26--INTERNAL REVENUE
(This book contains Part 1, Secs. 1.0-1 to 1.60)
Part
chapter i--Internal Revenue Service, Department of the
Treasury.................................................. 1
[[Page 3]]
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(Part 1, Secs. 1.0-1 to 1.60)
--------------------------------------------------------------------
Editorial Note: IRS published a document at 45 FR 6088, Jan. 25, 1980,
deleting statutory sections from their regulations. In chapter I cross-
references to the deleted material have been changed to the
corresponding sections of the IRS Code of 1954 or to the appropriate
regulations sections. When either such change produced a redundancy, the
cross-reference has been deleted. For further explanation, see 45 FR
20795, March 31, 1980.
SUBCHAPTER A--INCOME TAX
Part Page
1 Income taxes................................ 5
Supplementary Publications: Internal Revenue Service Looseleaf
Regulations System, Alcohol and Tobacco Tax Regulations, and
Regulations Under Tax Conventions.
Editorial Note: Treasury Decision 6091, 19 FR 5167, Aug. 17, 1954,
provides in part as follows:
Paragraph 1. All regulations (including all Treasury decisions)
prescribed by, or under authority duly delegated by, the Secretary of
the Treasury, or jointly by the Secretary and the Commissioner of
Internal Revenue, or by the Commissioner of Internal Revenue with the
approval of the Secretary of the Treasury, or jointly by the
Commissioner of Internal Revenue and the Commissioner of Customs or the
Commissioner of Narcotics with the approval of the Secretary of the
Treasury, applicable under any provision of law in effect on the date of
enactment of the Code, to the extent such provision of law is repealed
by the Code, are hereby prescribed under and made applicable to the
provisions of the Code corresponding to the provision of law so repealed
insofar as any such regulation is not inconsistent with the Code. Such
regulations shall become effective as regulations under the various
provisions of the Code as of the dates the corresponding provisions of
law are repealed by the Code, until superseded by regulations issued
under the Code.
Par. 2. With respect to any provision of the Code which depends for
its application upon the promulgation of regulations or which is to be
applied in such manner as may be prescribed by regulations, all
instructions or rules in effect immediately prior to the enactment of
the Code, to the extent such instructions or rules could be prescribed
as regulations under authority of such provision of the Code, shall be
applied as regulations under such provision insofar as such instructions
or rules are not inconsistent with the Code. Such instructions or rules
shall be applied as regulations under the applicable provision of the
Code as of the date such provision takes effect.
Par. 3. If any election made or other act done pursuant to any
provision of the Internal Revenue Code of 1939 or prior internal revenue
laws would (except for the enactment of the Code) be effective for any
period subsequent to such enactment, and if corresponding provisions are
contained in the Code, such election or other act shall be given the
same effect under the corresponding provisions of the Code to the extent
not inconsistent therewith. The term ``act'' includes, but is not
limited to, an allocation, identification, declaration, agreement,
option, waiver, relinquishment, or renunciation.
Par. 4. The limits of the various internal revenue districts have not
been changed by the enactment of the Code. Furthermore, delegations of
authority made pursuant to the provisions of Reorganization Plan No. 26
of 1950 and Reorganization Plan No. 1 of 1952 (as well as redelegations
thereunder), including those governing the authority of the Commissioner
of
[[Page 4]]
Internal Revenue, the Regional Commissioners of Internal Revenue, or the
District Directors of Internal Revenue, are applicable to the provisions
of the Code to the extent consistent therewith.
[[Page 5]]
SUBCHAPTER A--INCOME TAX
PART 1--INCOME TAXES--Table of Contents
Sec.
1.0-1 Internal Revenue Code of 1954 and regulations.
Normal Taxes and Surtaxes
DETERMINATION OF TAX LIABILITY
Tax on Individuals
1.1-1 Income tax on individuals.
1.1-2 Limitation on tax.
1.1-3 Change in rates applicable to taxable year.
1.1(i)-1T Questions and answers relating to the tax on unearned income
certain minor children (Temporary).
1.2-1 Tax in case of joint return of husband and wife or the return of
a surviving spouse.
1.2-2 Definitions and special rules.
1.3-1 Application of optional tax.
1.4-1 Number of exemptions.
1.4-2 Elections.
1.4-3 Husband and wife filing separate returns.
1.4-4 Short taxable year caused by death.
Tax on Corporations
1.11-1 Tax on corporations.
Changes in Rates During a Taxable Year
1.21-1 Changes in rate during a taxable year.
1.23-1 Residential energy credit.
1.23-2 Definitions.
1.23-3 Special rules.
1.23-4 Performance and quality standards. [Reserved]
1.23-5 Certification procedures.
1.23-6 Procedure and criteria for additions to the approved list of
energy-conserving components or renewable energy sources.
1.25-1T Credit for interest paid on certain home mortgages (Temporary).
1.25-2T Amount of credit (Temporary).
1.25-3 Qualified mortgage credit certificate.
1.25-3T Qualified mortgage credit certificate (Temporary).
1.25-4T Qualified mortgage credit certificate program (Temporary).
1.25-5T Limitation on aggregate amount of mortgage credit certificates
(Temporary).
1.25-6T Form of qualified mortgage credit certificate (Temporary).
1.25-7T Public notice (Temporary).
1.25-8T Reporting requirements (Temporary).
1.28-0 Credit for clinical testing expenses for certain drugs for rare
diseases or conditions; table of contents.
1.28-1 Credit for clinical testing expenses for certain drugs for rare
diseases or conditions.
Credits Against Tax
credits allowable
1.30-1 Definition of qualified electric vehicle and recapture of credit
for qualified electric vehicle.
1.31-1 Credit for tax withheld on wages.
1.31-2 Credit for ``special refunds'' of employee social security tax.
1.32-2 Earned income credit for taxable years beginning after December
31, 1978.
1.32-3T Eligibility requirements (Temporary).
1.34-1 Credit against tax and exclusion from gross income in case of
dividends received by individuals.
1.34-2 Limitations on amount of credit.
1.34-3 Dividends to which the credit and exclusion apply.
1.34-4 Taxpayers not entitled to credit and exclusion.
1.34-5 Effective date; taxable years ending after July 31, 1954,
subject to the Internal Revenue Code of 1939.
1.34-6 Dividends received after December 31, 1964.
1.35-1 Partially tax-exempt interest received by individuals.
1.35-2 Taxpayers not entitled to credit.
1.37-1 General rules for the credit for the elderly.
1.37-2 Credit for individuals age 65 or over.
1.37-3 Credit for individuals under age 65 who have public retirement
system income.
1.38-1 Investment in certain depreciable property.
1.40-1 Questions and answers relating to the meaning of the term
``qualified mixture'' in section 40(b)(1).
Taxable Years Beginning After December 31, 1986
1.41-0 Table of contents.
1.41-1 Introduction to regulations under section 41.
1.41-2 Qualified Research Expenses.
1.41-3 Base period research expense.
1.41-4 Qualified research for taxable years beginning after December
31, 1985. [Reserved]
1.41-5 Qualified research for taxable years beginning before January 1,
1986.
1.41-6 Basic research for taxable years beginning after December 31,
1985. [Reserved]
[[Page 6]]
1.41-7 Basic research for taxable years beginning before January 1,
1986.
1.41-8 Aggregation of expenditures.
1.41-9 Special rules.
Taxable Years Beginning Before January 1, 1987
1.41-0 A Credit or deduction for political and newsletter fund
contributions--scope and note.
1.41-1A Same--definitions of certain items.
1.41-2A Same--limitations and special rules.
1.41-3A Same--unspent contributions.
1.41-4A Same--procedure for electing a credit or deduction.
1.41-5A Same--verifications.
1.41-6A Same--taxation of certain organizations.
1.41-7A Same--transitional rule for past contributions.
1.41-8A Same--effective dates.
1.42-0 Table of contents.
1.42-1 [Reserved]
1.42-1T Limitation on low-income housing credit allowed with respect to
qualified low-income buildings receiving housing credit
allocations from a State or local housing credit agency
(temporary).
1.42-2 Waiver of requirement that an existing building eligible for the
low-income housing credit was last placed in service more than
10 years prior to acquisition by the taxpayer.
1.42-3 Treatment of buildings financed with proceeds from a loan under
an Affordable Housing Program established pursuant to section
721 of the Financial Institutions Reform, Recovery, and
Enforcement Act of 1989 (FIRREA).
1.42-4 Application of not-for-profit rules of section 183 to low-income
housing credit activities.
1.42-5 Monitoring compliance with low-income housing credit
requirements.
1.42-6 Buildings qualifying for carryover allocations.
1.42-7 Substantially bond-financed buildings. [Reserved]
1.42-8 Election of appropriate percentage month.
1.42-9 For use by the general public.
1.42-10 Utility allowances.
1.42-11 Provision of services.
1.42-12 Effective dates and transitional rules.
1.42-13 Rules necessary and appropriate; housing credit agencies'
correction of administrative errors and omissions.
1.42-14 Allocation rules for post-1989 State housing credit ceiling
amounts.
1.42-15 Available unit rule.
1.42-16 Eligible basis reduced by federal grants.
1.42A-1 General tax credit for taxable years ending after December 31,
1975, and before January 1, 1979.
1.43-0 Table of contents.
1.43-1 The enhanced oil recovery credit--general rules.
1.43-2 Qualified enhanced oil recovery project.
1.43-3 Certification.
1.43-4 Qualified enhanced oil recovery costs.
1.43-5 At-risk limitation. [Reserved]
1.43-6 Election out of section 43.
1.43-7 Effective date of regulations.
1.44-1 Allowance of credit for purchase of new principal residence
after March 12, 1975, and before January 1, 1977.
1.44-2 Property to which credit for purchase of new principal residence
applies.
1.44-3 Certificate by seller.
1.44-4 Recapture for certain dispositions.
1.44-5 Definitions.
1.44A-1 Expenses for household and dependent care services necessary
for gainful employment.
1.44A-2 Limitations on amount creditable.
1.44A-3 Special rules applicable to married individuals.
1.44A-4 Other special rules relating to employment-related expenses.
1.44B-1 Credit for employment of certain new employees.
rules for computing credit for investment in certain depreciable
property
1.46-1 Determination of amount.
1.46-2 Carryback and carryover of unused credit.
1.46-3 Qualified investment.
1.46-4 Limitations with respect to certain persons.
1.46-5 Qualified progress expenditures.
1.46-6 Limitation in case of certain regulated companies.
1.46-7 Statutory provisions; plan requirements for taxpayers electing
additional investment credit, etc.
1.46-8 Requirements for taxpayers electing additional one-percent
investment credit (TRASOP's).
1.46-9 Requirements for taxpayers electing an extra one-half percent
additional investment credit.
1.46-10 [Reserved]
1.46-11 Commuter highway vehicles.
1.47-1 Recomputation of credit allowed by section 38.
1.47-2 ``Disposition'' and ``cessation''.
1.47-3 Exceptions to the application of Sec. 1.47-1.
1.47-4 Electing small business corporation.
1.47-5 Estates and trusts.
1.47-6 Partnerships.
1.48-1 Definition of section 38 property.
1.48-2 New section 38 property.
1.48-3 Used section 38 property.
1.48-4 Election of lessor of new section 38 property to treat lessee as
purchaser.
1.48-5 Electing small business corporations.
1.48-6 Estates and trusts.
1.48-9 Definition of energy property.
[[Page 7]]
1.48-10 Single purpose agricultural or horticultural structures.
1.48-11 Qualified rehabilitated building; expenditures incurred before
January 1, 1982.
1.48-12 Qualified rehabilitated building; expenditures incurred after
December 31, 1981.
1.48-12T Tax-exempt entity leasing (Temporary).
1.50-1 Restoration of credit.
rules for computing credit for expenses of work incentive programs
1.50A-1 Determination of amount.
1.50A-2 Carryback and carryover of unused credit.
1.50A-3 Recomputation of credit allowed by section 40.
1.50A-4 Exceptions to the application of Sec. 1.50A-3.
1.50A-5 Electing small business corporations.
1.50A-6 Estates and trusts.
1.50A-7 Partnerships.
1.50B-1 Definitions of WIN expenses and WIN employees.
1.50B-2 Electing small business corporations.
1.50B-3 Estates and trusts.
1.50B-4 Partnerships.
1.50B-5 Limitations with respect to certain persons.
1.51-1 Amount of credit.
Tax Surcharge
1.52-1 Trades or businesses that are under common control.
1.52-2 Adjustments for acquisitions and dispositions.
1.52-3 Limitations with respect to certain persons.
1.53-1 Limitation based on amount of tax.
1.53-2 Carryback and carryover of unused credit.
1.53-3 Separate rule for pass-through of jobs credit.
1.55-1 Alternative minimum taxable income.
1.56-0 Table of contents to Sec. 1.56-1, adjustment for book income of
corporations.
1.56-1 Adjustment for the book income of corporations.
Regulations Applicable to Taxable Years Beginning in 1969 and Ending in
1970
1.56A-1 Imposition of tax.
1.56A-2 Deferral of tax liability in case of certain net operating
losses.
1.56A-3 Effective date.
1.56A-4 Certain taxpayers.
1.56A-5 Tax carryovers.
1.56(g)-0 Table of contents.
1.56(g)-1 Adjusted current earnings.
Tax Preference Regulations
1.57-0 Scope.
1.57-1 Items of tax preference defined.
1.57-2--1.57-3 [Reserved]
1.57-4 Limitation on amounts treated as items of tax preference for
taxable years beginning before January 1, 1976.
1.57-5 Records to be kept.
1.58-1 Minimum tax exemption.
1.58-2 General rules for conduit entities; partnerships and partners.
1.58-3 Estates and trusts.
1.58-3T Treatment of non-alternative tax itemized deductions by trusts
and estates and their beneficiaries in taxable years beginning
after December 31, 1982 (temporary).
1.58-4 Electing small business corporations.
1.58-5 Common trust funds.
1.58-6 Regulated investment companies; real estate investment trusts.
1.58-7 Tax preferences attributable to foreign sources; preferences
other than capital gains and stock options.
1.58-8 Capital gains and stock options.
1.58-9 Application of the tax benefit rule to the minimum tax for
taxable years beginning prior to 1987.
1.59--1.60 [Reserved]
Authority: 26 U.S.C 7805, unless otherwise noted.
Sections 1.23-1--1.23-6 also issued under 26 U.S.C. 23;
Section 1.25-1T also issued under 26 U.S.C. 25.
Section 1.25-2T also issued under 26 U.S.C. 25.
Section 1.25-3 also issued under 26 U.S.C. 25.
Section 1.25-3T also issued under 26 U.S.C. 25.
Section 1.25-4T also issued under 26 U.S.C. 25.
Section 1.25-5T also issued under 26 U.S.C. 25.
Section 1.25-6T also issued under 26 U.S.C. 25.
Section 1.25-7T also issued under 26 U.S.C. 25.
Section 1.25-8T also issued under 26 U.S.C. 25.
Section 1.28-0 also issued under 26 U.S.C. 28(d)(5);
Section 1.28-1 also issued under 26 U.S.C. 28(d)(5);
Section 1.30-1 also issued under 26 U.S.C. 30(d)(2).
Sections 1.42-1T and 1.42-2T also issued under 26 U.S.C. 42(m);
Section 1.42-2 also issued under 26 U.S.C. 42(m);
Section 1.42-3 is also issued under 26 U.S.C. 42(n);
Section 1.42-4 is also issued under 26 U.S.C. 42(n);
Section 1.42-5 is also issued under 26 U.S.C. 42(n);
Sections 1.42-6, 1.42-8, 1.42-9, 1.42-10, 1.42-11, and 1.42-12, also
issued under 26 U.S.C. 42(n);
Section 1.42-13 also issued under 26 U.S.C. 42(n);
Section 1.42-14 also issued under 26 U.S.C. 42(n);
[[Page 8]]
Section 1.42-15 also issued under 26 U.S.C. 42(n);
Section 1.42-16 also issued under 26 U.S.C. 42(n);
Sections 1.43-0 through 1.43-7 also issued under section 26 U.S.C. 43;
Section 1.46-5 also issued under 26 U.S.C. 46(d)(6) and 26 U.S.C.
47(a)(3)(C);
Section 1.46-6 also issued under 26 U.S.C. 46(f)(7);
Section 1.47-1 also issued under 26 U.S.C. 47(a);
Section 1.48-9 also issued under 26 U.S.C. 38(b) (as in effect before
the amendments made by subtitle F of the Tax Reform Act of 1984);
Sections 1.50A--1.50B also issued under 85 Stat. 553 (26 U.S.C. 40(b));
Section 1.52-1 also issued under 26 U.S.C. 52(b);
Section 1.56-1 also issued under 26 U.S.C. 56(f)(2)(H);
Section 1.56(g)-1 also issued under section 7611(g)(3) of the Omnibus
Budget Reconciliation Act of 1989 (Pub. L. 101-239, 103 Stat. 2373); and
Section 1.58-9 is also issued under 26 U.S.C. 58(h).
Source: T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 21,
1960, unless otherwise noted.
Sec. 1.0-1 Internal Revenue Code of 1954 and regulations.
(a) Enactment of law. The Internal Revenue Code of 1954 which became
law upon enactment of Public Law 591, 83d Congress, approved August 16,
1954, provides in part as follows:
Be it enacted by the Senate and House of Representatives of the
United States of America in Congress assembled, That
(a) Citation. (1) The provisions of this Act set forth under the
heading ``Internal Revenue Title'' may be cited as the ``Internal
Revenue Code of 1954''
(2) The Internal Revenue Code enacted on February 10, 1939, as
amended, may be cited as the ``Internal Revenue Code of 1939''.
(b) Publication. This Act shall be published as volume 68A of the
United States Statutes at Large, with a comprehensive table of contents
and an appendix; but without an index or marginal references. The date
of enactment, bill number, public law number, and chapter number, shall
be printed as a headnote.
(c) Cross reference. For saving provisions, effective date
provisions, and other related provisions, see chapter 80 (sec. 7801 and
following) of the Internal Revenue Code of 1954.
(d) Enactment of Internal Revenue Title into law. The Internal
Revenue Title referred to in subsection (a)(1) is as follows:
* * * * *
In general, the provisions of the Internal Revenue Code of 1954 are
applicable with respect to taxable years beginning after December 31,
1953, and ending after August 16, 1954. Certain provisions of that Code
are deemed to be included in the Internal Revenue Code of 1939. See
section 7851.
(b) Scope of regulations. The regulations in this part deal with (1)
the income taxes imposed under subtitle A of the Internal Revenue Code
of 1954, and (2) certain administrative provisions contained in subtitle
F of such Code relating to such taxes. In general, the applicability of
such regulations is commensurate with the applicability of the
respective provisions of the Internal Revenue Code of 1954 except that
with respect to the provisions of the Internal Revenue Code of 1954
which are deemed to be included in the Internal Revenue Code of 1939,
the regulations relating to such provisions are applicable to certain
fiscal years and short taxable years which are subject to the Internal
Revenue Code of 1939. Those provisions of the regulations which are
applicable to taxable years subject to the Internal Revenue Code of 1939
and the specific taxable years to which such provisions are so
applicable are identified in each instance. The regulations in 26 CFR
(1939) part 39 (Regulations 118) are continued in effect until
superseded by the regulations in this part. See Treasury Decision 6091,
approved August 16, 1954 (19 FR 5167, C.B. 1954-2, 47).
Normal Taxes and Surtaxes
DETERMINATION OF TAX LIABILITY
Tax on Individuals
Sec. 1.1-1 Income tax on individuals.
(a) General rule. (1) Section 1 of the Code imposes an income tax on
the income of every individual who is a citizen or resident of the
United States and, to the extent provided by section 871(b) or 877(b),
on the income of a nonresident alien individual. For optional tax in the
case of taxpayers with adjusted gross income of less than $10,000 (less
than $5,000 for taxable years beginning before January 1, 1970) see
section 3. The tax imposed is upon taxable income (determined by
subtracting the allowable deductions from gross income). The tax is
determined in accordance with the table contained in
[[Page 9]]
section 1. See subparagraph (2) of this paragraph for reference guides
to the appropriate table for taxable years beginning on or after January
1, 1964, and before January 1, 1965, taxable years beginning after
December 31, 1964, and before January 1, 1971, and taxable years
beginning after December 31, 1970. In certain cases credits are allowed
against the amount of the tax. See part IV (section 31 and following),
subchapter A, chapter 1 of the Code. In general, the tax is payable upon
the basis of returns rendered by persons liable therefor (subchapter A
(sections 6001 and following), chapter 61 of the Code) or at the source
of the income by withholding. For the computation of tax in the case of
a joint return of a husband and wife, or a return of a surviving spouse,
for taxable years beginning before January 1, 1971, see section 2. The
computation of tax in such a case for taxable years beginning after
December 31, 1970, is determined in accordance with the table contained
in section 1(a) as amended by the Tax Reform Act of 1969. For other
rates of tax on individuals, see section 5(a). For the imposition of an
additional tax for the calendar years 1968, 1969, and 1970, see section
51(a).
(2)(i) For taxable years beginning on or after January 1, 1964, the
tax imposed upon a single individual, a head of a household, a married
individual filing a separate return, and estates and trusts is the tax
imposed by section 1 determined in accordance with the appropriate table
contained in the following subsection of section 1:
----------------------------------------------------------------------------------------------------------------
Taxable years beginning
after Dec. 31, 1970
Taxable years beginning Taxable years beginning (references in this
in 1964 after 1964 but before column are to the Code
1971 as amended by the Tax
Reform Act of 1969)
----------------------------------------------------------------------------------------------------------------
Single individual.................... Sec. 1(a)(1)........... Sec. 1(a)(2)........... Sec. 1(c).
Head of a household.................. Sec. 1(b)(1)........... Sec. 1(b)(2)........... Sec. 1(b).
Married individual filing a separate Sec. 1(a)(1)........... Sec. 1(a)(2)........... Sec. 1(d).
return.
Estates and trusts................... Sec. 1(a)(1)........... Sec. 1(a)(2)........... Sec. 1(d).
----------------------------------------------------------------------------------------------------------------
(ii) For taxable years beginning after December 31, 1970, the tax
imposed by section 1(d), as amended by the Tax Reform Act of 1969, shall
apply to the income effectively connected with the conduct of a trade or
business in the United States by a married alien individual who is a
nonresident of the United States for all or part of the taxable year or
by a foreign estate or trust. For such years the tax imposed by section
1(c), as amended by such Act, shall apply to the income effectively
connected with the conduct of a trade or business in the United States
by an unmarried alien individual (other than a surviving spouse) who is
a nonresident of the United States for all or part of the taxable year.
See paragraph (b)(2) of Sec. 1.871-8.
(3) The income tax imposed by section 1 upon any amount of taxable
income is computed by adding to the income tax for the bracket in which
that amount falls in the appropriate table in section 1 the income tax
upon the excess of that amount over the bottom of the bracket at the
rate indicated in such table.
(4) The provisions of section 1 of the Code, as amended by the Tax
Reform Act of 1969, and of this paragraph may be illustrated by the
following examples:
Example 1. A, an unmarried individual, had taxable income for the
calendar year 1964 of $15,750. Accordingly, the tax upon such taxable
income would be $4,507.50, computed as follows from the table in section
1(a)(1):
Tax on $14,000 (from table)................................. $3,790.00
Tax on $1,750 (at 41 percent as determined from the table).. 717.50
-----------
Total tax on $15,750.................................... 4,507.50
Example 2. Assume the same facts as in example (1), except the
figures are for the calendar year 1965. The tax upon such taxable income
would be $4,232.50, computed as follows from the table in section
1(a)(2):
Tax on $14,000 (from table)................................. $3,550.00
Tax on $1,750 (at 39 percent as determined from the table).. 682.50
-----------
Total tax on $15,750.................................... 4,232.50
[[Page 10]]
Example 3. Assume the same facts as in example (1), except the
figures are for the calendar year 1971. The tax upon such taxable income
would be $3,752.50, computed as follows from the table in section 1(c),
as amended:
Tax on $14,000 (from table)................................. $3,210.00
Tax on $1,750 (at 31 percent as determined from the table).. 542.50
-----------
Total tax on $15,750.................................... 3,752.50
(b) Citizens or residents of the United States liable to tax. In
general, all citizens of the United States, wherever resident, and all
resident alien individuals are liable to the income taxes imposed by the
Code whether the income is received from sources within or without the
United States. Pursuant to section 876, a nonresident alien individual
who is a bona fide resident of Puerto Rico during the entire taxable
year is, except as provided in section 933 with respect to Puerto Rican
source income, subject to taxation in the same manner as a resident
alien individual. As to tax on nonresident alien individuals, see
sections 871 and 877.
(c) Who is a citizen. Every person born or naturalized in the United
States and subject to its jurisdiction is a citizen. For other rules
governing the acquisition of citizenship, see chapters 1 and 2 of title
III of the Immigration and Nationality Act (8 U.S.C. 1401-1459). For
rules governing loss of citizenship, see sections 349 to 357, inclusive,
of such Act (8 U.S.C. 1481-1489), Schneider v. Rusk, (1964) 377 U.S.
163, and Rev. Rul. 70-506, C.B. 1970-2, 1. For rules pertaining to
persons who are nationals but not citizens at birth, e.g., a person born
in American Samoa, see section 308 of such Act (8 U.S.C. 1408). For
special rules applicable to certain expatriates who have lost
citizenship with a principal purpose of avoiding certain taxes, see
section 877. A foreigner who has filed his declaration of intention of
becoming a citizen but who has not yet been admitted to citizenship by a
final order of a naturalization court is an alien.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7332, 39 FR
44216, Dec. 23, 1974]
Sec. 1.1-2 Limitation on tax.
(a) Taxable years ending before January 1, 1971. For taxable years
ending before January 1, 1971, the tax imposed by section 1 (whether by
subsection (a) or subsection (b) thereof) shall not exceed 87 percent of
the taxable income for the taxable year. For purposes of determining
this limitation the tax under section 1 (a) or (b) and the tax at the
87-percent rate shall each be computed before the allowance of any
credits against the tax. Where the alternative tax on capital gains is
imposed under section 1201(b), the 87-percent limitation shall apply
only to the partial tax computed on the taxable income reduced by 50
percent of the excess of net long-term capital gains over net short-term
capital losses. Where, for purposes of computations under the income
averaging provisions, section 1201(b) is treated as imposing the
alternative tax on capital gains computed under section 1304(e)(2), the
87-percent limitation shall apply only to the tax equal to the tax
imposed by section 1, reduced by the amount of the tax imposed by
section 1 which is attributable to capital gain net income for the
computation year.
(b) Taxable years beginning after December 31, 1970. If, for any
taxable year beginning after December 31, 1970, an individual has earned
taxable income which exceeds his taxable income as defined by section
1348, the tax imposed by section 1, as amended by the Tax Reform Act of
1969, shall not exceed the sum computed under the provisions of section
1348. For imposition of minimum tax for tax preferences see sections 56
through 58.
[T.D. 7117, 36 FR 9397, May 25, 1971]
Sec. 1.1-3 Change in rates applicable to taxable year.
For computation of the tax for a taxable year during which a change
in the tax rates occurs, see section 21 and the regulations thereunder.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960. Redesignated by T.D. 7117, 36 FR
9397, May 25, 1971]
Sec. 1.1(i)-1T Questions and answers relating to the tax on unearned income certain minor children (Temporary).
In General
Q-1. To whom does section 1(i) apply?
[[Page 11]]
A-1. Section 1(i) applies to any child who is under 14 years of age
at the close of the taxable year, who has at least one living parent at
the close of the taxable year, and who recognizes over $1,000 of
unearned income during the taxable year.
Q-2. What is the effective date of section 1(i)?
A-2. Section 1(i) applies to taxable years of the child beginning
after December 31, 1986.
Computation of Tax
Q-3. What is the amount of tax imposed by section 1 on a child to
whom section 1(i) applies?
A-3. In the case of a child to whom section 1(i) applies, the amount
of tax imposed by section 1 equals the greater of (A) the tax imposed by
section 1 without regard to section 1(i) or (B) the sum of the tax that
would be imposed by section 1 if the child's taxable income was reduced
by the child's net unearned income, plus the child's share of the
allocable parental tax.
Q-4. What is the allocable parental tax?
A-4. The allocable parental tax is the excess of (A) the tax that
would be imposed by section 1 on the sum of the parent's taxable income
plus the net unearned income of all children of such parent to whom
section 1(i) applies, over (B) the tax imposed by section 1 on the
parent's taxable income. Thus, the allocable parental tax is not
computed with reference to unearned income of a child over 14 or a child
under 14 with less than $1,000 of unearned income. See A-10 through A-13
for rules regarding the determination of the parent(s) whose taxable
income is taken into account under section 1(i). See A-14 for rules
regarding the determination of children of the parent whose net unearned
income is taken into account under section 1(i).
Q-5. What is the child's share of the allocable parental tax?
A-5. The child's share of the allocable parental tax is an amount
that bears the same ratio to the total allocable parental tax as the
child's net unearned income bears to the total net unearned income of
all children of such parent to whom section 1(i) applies. See A-14.
Example 1. During 1988, D, and a 12 year old, receives $5,000 of
unearned income and no earned income. D has no itemized deductions and
is not eligible for a personal exemption. D's parents have two other
children, E, a 15 year old, and F, a 10 year old. E has $10,000 of
unearned income and F has $100 of unearned income. D's parents file a
joint return for 1988 and report taxable income of $70,000. Neither D's
nor his parent's taxable income is attributable to net capital gain. D's
tax liability for 1988, determined without regard to section 1(i), is
$675 on $4,500 of taxable income ($5,000 less $500 allowable standard
deduction). In applying section 1(i), D's tax would be equal to the sum
of (A) the tax that would be imposed on D's taxable income if it were
reduced by any net unearned income, plus (B) D's share of the allocable
parental tax. Only D's unearned income is taken into account in
determining the allocable parental tax because E is over 14 and F has
less than $1,000 of unearned income. See A-4. D's net unearned income is
$4,000 ($4,500 taxable unearned income less $500). The tax imposed on
D's taxable income as reduced by D's net unearned income is $75
($500 x 15%). The allocable parental tax is $1,225, the excess of
$16,957.50 (the tax on $74,000, the parent's taxable income plus D's net
unearned income) over $15,732.50 (the tax on $70,000, the parent's
taxable income). See A-4. Thus, D's tax under section 1(i)(1)(B) is
$1,300 ($1,225+$75). Since this amount is greater than the amount of D's
tax liability as determined without regard to section 1(i), the amount
of tax imposed on D for 1988 is $1,300. See A-3.
Example 2. H and W have 3 children, A, B, and C, who are all under
14 years of age. For the taxable year 1988, H and W file a joint return
and report taxable income of $129,750. The tax imposed by section 1 on H
and W is $35,355. A has $5,000 of net unearned income and B and C each
have $2,500 of net unearned income during 1988. The allocable parental
tax imposed on A, B, and C's combined net unearned income of $10,000 is
$3,300. This tax is the excess of $38,655, which is the tax imposed by
section 1 on $139,750 ($129,750+10,000), over $35,355 (the tax imposed
by section 1 on H and W's taxable income of $129,750). See A-4. Each
child's share of the allocable parental tax is an amount that bears the
same ratio to the total allocable parental tax as the child's net
unearned income bears to the total net unearned income of A, B, and C.
Thus, A's share of the allocable parental tax is $1,650
(5,00010,000 x 3,300) and B and C's share of the tax is $825
(2,50010,000 x 3,300) each. See A-5.
Definition of Net Unearned Income
Q-6. What is net unearned income?
A-6. Net unearned income is the excess of the portion of adjusted
gross income for the taxable year that is not
[[Page 12]]
``earned income'' as defined in section 911(d)(2) (income that is not
attributable to wages, salaries, or other amounts received as
compensation for personal services), over the sum of the standard
deduction amount provided for under section 63 (c)(5)(A) ($500 for 1987
and 1988; adjusted for inflation thereafter), plus the greater of (A)
$500 (adjusted for inflation after 1988) or (B) the amount of allowable
itemized deductions that are directly connected with the production of
unearned income. A child's net unearned income for any taxable year
shall not exceed the child's taxable income for such year.
Example 3. A is a child who is under 14 years of age at the end of
the taxable year 1987. Both of A's parents are alive at this time.
During 1987, A receives $3,000 of interest from a bank savings account
and earns $1,000 from a paper route and performing odd jobs. A has no
itemized deductions for 1987. A's standard deduction is $1,000, which is
an amount equal to A's earned income for 1987. Of this amount, $500 is
applied against A's unearned income and the remaining $500 is applied
against A's earned income. Thus, A's $500 of taxable earned income
($1,000 less the remaining $500 of the standard deduction) is taxed
without regard to section 1 (i); A has $2,500 of taxable unearned income
($3,000 gross unearned income less $500 of the standard deduction) of
which $500 is taxed without regard to section 1(i). The remaining $2,000
of taxable unearned income is A's net unearned income and is taxed under
section 1(i).
Example 4. B is a child who is subject to tax under section 1(i). B
has $400 of earned income and $2,000 of unearned income. B has itemized
deductions of $800 (net of the 2 percent of adjusted gross income (AGI)
floor on miscellaneous itemized deductions under section 67) of which
$200 are directly connected with the production of unearned income. The
amount of itemized deductions that B may apply against unearned income
is equal to the greater of $500 or the deductions directly connected
with the production of unearned income. See A-6. Thus, $500 of B's
itemized deductions are applied against the $2,000 of unearned income
and the remaining $300 of deductions are applied against earned income.
As a result, B has taxable earned income of $100 and taxable unearned
income of $1,500. Of these amounts, all of the earned income and $500 of
the unearned income are taxed without regard to section 1(i). The
remaining $1,000 of unearned income is net unearned income and is taxed
under section 1(i).
Unearned Income Subject to tax Under Section 1(i)
Q-7. Will a child be subject to tax under section 1(i) on net
unearned income (as defined in section 1(i) (4) and A-6 of this section)
that is attributable to property transferred to the child prior to 1987?
A-7. Yes. The tax imposed by section 1(i) on a child's net unearned
income applies to any net unearned income of the child for taxable years
beginning after December 31, 1986, regardless of when the underlying
assets were transferred to the child.
Q-8. Will a child be subject to tax under section 1(i) on net
unearned income that is attributable to gifts from persons other than
the child's parents or attributable to assets resulting from the child's
earned income?
A-8. Yes. The tax imposed by section 1(i) applies to all net
unearned income of the child, regardless of the source of the assets
that produced such income. Thus, the rules of section 1(i) apply to
income attributable to gifts not only from the parents but also from any
other source, such as the child's grandparents. Section 1(i) also
applies to unearned income derived with respect to assets resulting from
earned income of the child, such as interest earned on bank deposits.
Example 5. A is a child who is under 14 years of age at the end of
the taxable year beginning on January 1, 1987. Both of A's parents are
alive at the end of the taxable year. During 1987, A receives $2,000 in
interest from his bank account and $1,500 from a paper route. Some of
the interest earned by A from the bank account is attributable to A's
paper route earnings that were deposited in the account. The balance of
the account is attributable to cash gifts from A's parents and
grandparents and interest earned prior to 1987. Some cash gifts were
received by A prior to 1987. A has no itemized deductions and is
eligible to be claimed as a dependent on his parent's return. Therefore,
for the taxable year 1987, A's standard deduction is $1,500, the amount
of A's earned income. Of this standard deduction amount, $500 is
allocated against unearned income and $1,000 is allocated against earned
income. A's taxable unearned income is $1,500 of which $500 is taxed
without regard to section 1(i). The remaining taxable unearned income of
$1,000 is net unearned income and is taxed under section 1(i). The fact
that some of A's unearned income is attributable to interest on
principal created by earned income and gifts from persons other than A's
parents or that
[[Page 13]]
some of the unearned income is attributable to property transferred to A
prior to 1987, will not affect the tax treatment of this income under
section 1(i). See A-8.
Q-9. For purposes of section 1(i), does income which is not earned
income (as defined in section 911(d)(2)) include social security
benefits or pension benefits that are paid to the child?
A-9. Yes. For purposes of section 1(i), earned income (as defined in
section 911(d)(2)) does not include any social security or pension
benefits paid to the child. Thus, such amounts are included in unearned
income to the extent they are includible in the child's gross income.
Determination of the Parent's Taxable Income
Q-10. If a child's parents file a joint return, what is the taxable
income that must be taken into account by the child in determining tax
liability under section 1(i)?
A-10. In the case of parents who file a joint return, the parental
taxable income to be taken into account in determining the tax liability
of a child is the total taxable income shown on the joint return.
Q-11. If a child's parents are married and file separate tax
returns, which parent's taxable income must be taken into account by the
child in determining tax liability under section 1(i)?
A-11. For purposes of determining the tax liability of a child under
section 1(i), where such child's parents are married and file separate
tax returns, the parent whose taxable income is the greater of the two
for the taxable year shall be taken into account.
Q-12. If the parents of a child are divorced, legally separated, or
treated as not married under section 7703(b), which parent's taxable
income is taken into account in computing the child's tax liability?
A-12. If the child's parents are divorced, legally separated, or
treated as not married under section 7703(b), the taxable income of the
custodial parent (within the meaning of section 152(e)) of the child is
taken into account under section 1(i) in determining the child's tax
liability.
Q-13. If a parent whose taxable income must be taken into account in
determining a child's tax liability under section 1(i) files a joint
return with a spouse who is not a parent of the child, what taxable
income must the child take into account?
A-13. The amount of a parent's taxable income that a child must take
into account for purposes of section 1(i) where the parent files a joint
return with a spouse who is not a parent of the child is the total
taxable income shown on such joint return.
Children of the Parent
Q-14. In determining a child's share of the allocable parental tax,
is the net unearned income of legally adopted children, children related
to such child by half-blood, or children from a prior marriage of the
spouse of such child's parent taken into account in addition to the
natural children of such child's parent?
A-14. Yes. In determining a child's share of the allocable parental
tax, the net unearned income of all children subject to tax under
section 1(i) and who use the same parent's taxable income as such child
to determine their tax liability under section 1(i) must be taken into
account. Such children are taken into account regardless of whether they
are adopted by the parent, related to such child by half-blood, or are
children from a prior marriage of the spouse of such child's parent.
Rules Regarding Income From a Trust or Similar Instrument
Q-15. Will the unearned income of a child who is subject to section
1(i) that is attributable to gifts given to the child under the Uniform
Gift to Minors Act (UGMA) be subject to tax under section 1(i)?
A-15. Yes. A gift under the UGMA vests legal title to the property
in the child although an adult custodian is given certain rights to deal
with the property until the child attains majority. Any unearned income
attributable to such a gift is the child's unearned income and is
subject to tax under section 1(i), whether distributed to the child or
not.
Q-16. Will a child who is a beneficiary of a trust be required to
take into account the income of a trust in determining the child's tax
liability under section 1(i)?
[[Page 14]]
A-16. The income of a trust must be taken into account for purposes
of determining the tax liability of a beneficiary who is subject to
section 1(i) only to the extent it is included in the child's gross
income for the taxable year under sections 652(a) or 662(a). Thus,
income from a trust for the fiscal taxable year of a trust ending during
1987, that is included in the gross income of a child who is subject to
section 1(i) and who has a calendar taxable year, will be subject to tax
under section 1(i) for the child's 1987 taxable year.
Subsequent Adjustments
Q-17. What effect will a subsequent adjustment to a parent's taxable
income have on the child's tax liability if such parent's taxable income
was used to determine the child's tax liability under section 1(i) for
the same taxable year?
A-17. If the parent's taxable income is adjusted and if, for the
same taxable year as the adjustment, the child paid tax determined under
section 1(i) with reference to that parent's taxable income, then the
child's tax liability under section 1(i) must be recomputed using the
parent's taxable income as adjusted.
Q-18. In the case where more than one child who is subject to
section 1(i) uses the same parent's taxable income to determine their
allocable parental tax, what effect will a subsequent adjustment to the
net unearned income of one child have on the other child's share of the
allocable parental tax?
A-18. If, for the same taxable year, more than one child uses the
same parent's taxable income to determine their share of the allocable
parental tax and a subsequent adjustment is made to one or more of such
children's net unearned income, each child's share of the allocable
parental tax must be recomputed using the combined net unearned income
of all such children as adjusted.
Q-19. If a recomputation of a child's tax under section 1(i), as a
result of an adjustment to the taxable income of the child's parents or
another child's net unearned income, results in additional tax being
imposed by section 1(i) on the child, is the child subject to interest
and penalties on such additional tax?
A-19. Any additional tax resulting from an adjustment to the taxable
income of the child's parents or the net unearned income of another
child shall be treated as an underpayment of tax and interest shall be
imposed on such underpayment as provided in section 6601. However, the
child shall not be liable for any penalties on the underpayment
resulting from additional tax being imposed under section 1(i) due to
such an adjustment.
Example 6. D and M are the parents of C, a child under the age of
14. D and M file a joint return for 1988 and report taxable income of
$69,900. C has unearned income of $3,000 and no itemized deductions for
1988. C properly reports a total tax liability of $635 for 1988. This
amount is the sum of the allocable parental tax of $560 on C's net
unearned income of $2,000 (the excess of $3,000 over the sum of $500
standard deduction and the first $500 of taxable unearned income) plus
$75 (the tax imposed on C's first $500 of taxable unearned income). See
A-3. One year later, D and M's 1988 tax return is adjusted on audit by
adding an additional $1,000 of taxable income. No adjustment is made to
the amount reported as C's net unearned income for 1988. However, the
adjustment to D and M's taxable income causes C's tax liability under
section 1(i) for 1988 to be increased by $50 as a result of the phase-
out of the 15 percent rate bracket. See A-20. In addition to this
further tax liability, C will be liable for interest on the $50.
However, C will not have to pay any penalty on the delinquent amount.
Miscellaneous Rules
Q-20. Does the phase-out of the parent's 15 percent rate bracket and
personal exemptions under section 1(g), if applicable, have any effect
on the calculation of the allocable parental tax imposed on a child's
net unearned income under section 1(i)?
A-20. Yes. Any phase-out of the parent's 15 percent rate bracket or
personal exemptions under section 1(g) is given full effect in
determining the tax that would be imposed on the sum of the parent's
taxable income and the total net unearned income of all children of the
parent. Thus, any additional tax on a child's net unearned income
resulting from the phase-out of the 15 percent rate bracket and the
personal exemptions is reflected in the tax liability of the child.
Q-21. For purposes of calculating a parent's tax liability or the
allocable parental
[[Page 15]]
tax imposed on a child, are other phase-outs, limitations, or floors on
deductions or credits, such as the phase-out of the $25,000 passive loss
allowance for rental real estate activities under section 469(i)(3) or
the 2 percent of AGI floor on miscellaneous itemized deductions under
section 67, affected by the addition of a child's net unearned income to
the parent's taxable income?
A-21. No. A child's net unearned income is not taken into account in
computing any deduction or credit for purposes of determining the
parent's tax liability or the child's allocable parental tax. Thus, for
example, although the amounts allowable to the parent as a charitable
contribution deduction, medical expense deduction, section 212
deduction, or a miscellaneous itemized deduction are affected by the
amount of the parent's adjusted gross income, the amount of these
deductions that is allowed does not change as a result of the
application of section 1(i) because the amount of the parent's adjusted
gross income does not include the child's net unearned income.
Similarly, the amount of itemized deductions that is allowed to a child
does not change as a result of section 1(i) because section 1(i) only
affects the amount of tax liability and not the child's adjusted gross
income.
Q-22. If a child is unable to obtain information concerning the tax
return of the child's parents directly from such parents, how may the
child obtain information from the parent's tax return which is necessary
to determine the child's tax liability under section 1(i)?
A-22. Under section 6103(e)(1)(A)(iv), a return of a parent shall,
upon written request, be open to inspection or disclosure to a child of
that individual (or the child's legal representative) to the extent
necessary to comply with section 1(i). Thus, a child may request the
Internal Revenue Service to disclose sufficient tax information about
the parent to the child so that the child can properly file his or her
return.
[T.D. 8158, 52 FR 33579, Sept. 4, 1987; 52 FR 36133, Sept. 25, 1987]
Sec. 1.2-1 Tax in case of joint return of husband and wife or the return of a surviving spouse.
(a) Taxable year ending before January 1, 1971. (1) For taxable
years ending before January 1, 1971, in the case of a joint return of
husband and wife, or the return of a surviving spouse as defined in
section 2(b), the tax imposed by section 1 shall be twice the tax that
would be imposed if the taxable income were reduced by one-half. For
rules relating to the filing of joint returns of husband and wife, see
section 6013 and the regulations thereunder.
(2) The method of computing, under section 2(a), the tax of husband
and wife in the case of a joint return, or the tax of a surviving
spouse, is as follows:
(i) First, the taxable income is reduced by one-half. Second, the
tax is determined as provided by section 1 by using the taxable income
so reduced. Third, the tax so determined, which is the tax that would be
determined if the taxable income were reduced by one-half, is then
multiplied by two to produce the tax imposed in the case of the joint
return or the return of a surviving spouse, subject, however, to the
allowance of any credits against the tax under the provisions of
sections 31 through 38 and the regulations thereunder.
(ii) The limitation under section 1(c) of the tax to an amount not
in excess of a specified percent of the taxable income for the taxable
year is to be applied before the third step above, that is, the
limitation to be applied upon the tax is determined as the applicable
specified percent of one-half of the taxable income for the taxable year
(such one-half of the taxable income being the actual aggregate taxable
income of the spouses, or the total taxable income of the surviving
spouse, as the case may be, reduced by one-half). For the percent
applicable in determining the limitation of the tax under section 1(c),
see Sec. 1.1-2(a). After such limitation is applied, then the tax so
limited is multiplied by two as provided in section 2(a) (the third step
above).
(iii) The following computation illustrates the method of
application of section 2(a) in the determination of the
[[Page 16]]
tax of a husband and wife filing a joint return for the calendar year
1965. If the combined gross income is $8,200, and the only deductions
are the two exemptions of the taxpayers under section 151(b) and the
standard deduction under section 141, the tax on the joint return for
1965, without regard to any credits against the tax, is $1,034.20
determined as follows:
1. Gross income................................. $8,200.00
2. Less:
Standard deduction, section 141............. $820 ..........
Deduction for personal exemption, section 1,200 2,020.00
151........................................
-----------------------
3. Taxable income............................... 6,180.00
4. Taxable income reduced by one-half........... 3,090.00
5. Tax computed by the tax table provided under 517.10
section 1(a)(2) ($310 plus 19 percent of excess
over $2,000)...................................
6. Twice the tax in item 5...................... 1,034.20
(b) Taxable years beginning after December 31, 1970. (1) For taxable
years beginning after December 31, 1970, in the case of a joint return
of husband and wife, or the return of a surviving spouse as defined in
section 2(a) of the Code as amended by the Tax Reform Act of 1969, the
tax shall be determined in accordance with the table contained in
section 1(a) of the Code as so amended. For rules relating to the filing
of joint returns of husband and wife see section 6013 as amended and the
regulations thereunder.
(2) The following computation illustrates the method of computing
the tax of a husband and wife filing a joint return for calendar year
1971. If the combined gross income is $8,200, and the only deductions
are the two exemptions of the taxpayers under section 151(b), as
amended, and the standard deduction under section 141, as amended, the
tax on the joint return for 1971, without regard to any credits against
the tax, is $968.46, determined as follows:
1. Gross income................................. $8,200.00
2. Less:
Standard deduction, section 141............... $1,066.00
Deduction for personal exemption, section 151. 1,300.00 2,366.00
-----------------------
3. Taxable income............................... 5,834.00
4. Tax computed by the tax table provided under 968.46
section 1(a) ($620 plus 19 percent of excess
over $4,000)...................................
(3) The limitation under section 1348 with respect to the maximum
rate of tax on earned income shall apply to a married individual only if
such individual and his spouse file a joint return for the taxable year.
(c) Death of a spouse. If a joint return of a husband and wife is
filed under the provisions of section 6013 and if the husband and wife
have different taxable years solely because of the death of either
spouse, the taxable year of the deceased spouse covered by the joint
return shall, for the purpose of the computation of the tax in respect
of such joint return, be deemed to have ended on the date of the closing
of the surviving spouse's taxable year.
(d) Computation of optional tax. For computation of optional tax in
the case of a joint return or the return of a surviving spouse, see
section 3 and the regulations thereunder.
(e) Change in rates. For treatment of taxable years during which a
change in the tax rates occurs see section 21 and the regulations
thereunder.
[T.D. 7117, 36 FR 9398, May 25, 1971]
Sec. 1.2-2 Definitions and special rules.
(a) Surviving spouse. (1) If a taxpayer is eligible to file a joint
return under the Internal Revenue Code of 1954 without regard to section
6013(a) (3) thereof for the taxable year in which his spouse dies, his
return for each of the next 2 taxable years following the year of the
death of the spouse shall be treated as a joint return for all purposes
if all three of the following requirements are satisfied:
(i) He has not remarried before the close of the taxable year the
return for which is sought to be treated as a joint return, and
(ii) He maintains as his home a household which constitutes for the
taxable year the principal place of abode as a member of such household
of a person who is (whether by blood or adoption) a son, stepson,
daughter, or stepdaughter of the taxpayer, and
(iii) He is entitled for the taxable year to a deduction under
section 151 (relating to deductions for dependents) with respect to such
son, stepson, daughter, or stepdaughter.
[[Page 17]]
(2) See paragraphs (c)(1) and (d) of this section for rules for the
determination of when the taxpayer maintains as his home a household
which constitutes for the taxable year the principal place of abode, as
a member of such household, of another person.
(3) If the taxpayer does not qualify as a surviving spouse he may
nevertheless qualify as a head of a household if he meets the
requirements of Sec. 1.2-2(b).
(4) The following example illustrates the provisions relating to a
surviving spouse:
Example: Assume that the taxpayer meets the requirements of this
paragraph for the years 1967 through 1971, and that the taxpayer, whose
wife died during 1966 while married to him, remarried in 1968. In 1969,
the taxpayer's second wife died while married to him, and he remained
single thereafter. For 1967 the taxpayer will qualify as a surviving
spouse, provided that neither the taxpayer nor the first wife was a
nonresident alien at any time during 1966 and that she (immediately
prior to her death) did not have a taxable year different from that of
the taxpayer. For 1968 the taxpayer does not qualify as a surviving
spouse because he remarried before the close of the taxable year. The
taxpayer will qualify as a surviving spouse for 1970 and 1971, provided
that neither the taxpayer nor the second wife was a nonresident alien at
any time during 1969 and that she (immediately prior to her death) did
not have a taxable year different from that of the taxpayer. On the
other hand, if the taxpayer, in 1969, was divorced or legally separated
from his second wife, the taxpayer will not qualify as a surviving
spouse for 1970 or 1971, since he could not have filed a joint return
for 1969 (the year in which his second wife died).
(b) Head of household. (1) A taxpayer shall be considered the head
of a household if, and only if, he is not married at the close of his
taxable year, is not a surviving spouse (as defined in paragraph (a) of
this section, and (i) maintains as his home a household which
constitutes for such taxable year the principal place of abode, as a
member of such household, of at least one of the individuals described
in subparagraph (3), or (ii) maintains (whether or not as his home) a
household which constitutes for such taxable year the principal place of
abode of one of the individuals described in subparagraph (4).
(2) Under no circumstances shall the same person be used to qualify
more than one taxpayer as the head of a household for the same taxable
year.
(3) Any of the following persons may qualify the taxpayer as a head
of a household:
(i) A son, stepson, daughter, or stepdaughter of the taxpayer, or a
descendant of a son or daughter of the taxpayer. For the purpose of
determining whether any of the stated relationships exist, a legally
adopted child of a person is considered a child of such person by blood.
If any such person is not married at the close of the taxable year of
the taxpayer, the taxpayer may qualify as the head of a household by
reason of such person even though the taxpayer may not claim a deduction
for such person under section 151, for example, because the taxpayer
does not furnish more than half of the support of such person. However,
if any such person is married at the close of the taxable year of the
taxpayer, the taxpayer may qualify as the head of a household by reason
of such person only if the taxpayer is entitled to a deduction for such
person under section 151 and the regulations thereunder. In applying the
preceding sentence there shall be disregarded any such person for whom a
deduction is allowed under section 151 only by reason of section 152(c)
(relating to persons covered by a multiple support agreement).
(ii) Any other person who is a dependent of the taxpayer, if the
taxpayer is entitled to a deduction for the taxable year for such person
under section 151 and paragraphs (3) through (8) of section 152(a) and
the regulations thereunder. Under section 151 the taxpayer may be
entitled to a deduction for any of the following persons:
(a) His brother, sister, stepbrother, or stepsister;
(b) His father or mother, or an ancestor of either;
(c) His stepfather or stepmother;
(d) A son or a daughter of his brother or sister;
(e) A brother or sister of his father or mother; or
(f) His son-in-law, daughter-in-law, father-in-law, mother-in-law,
brother- in-law, or sister-in-law;
[[Page 18]]
if such person has a gross income of less than the amount determined
pursuant to Sec. 1.151-2 applicable to the calendar year in which the
taxable year of the taxpayer begins, if the taxpayer supplies more than
one-half of the support of such person for such calendar year and if
such person does not make a joint return with his spouse for the taxable
year beginning in such calendar year. The taxpayer may not be considered
to be a head of a household by reason of any person for whom a deduction
is allowed under section 151 only by reason of sections 152 (a)(9), 152
(a)(10), or 152(c) (relating to persons not related to the taxpayer,
persons receiving institutional care, and persons covered by multiple
support agreements).
(4) The father or mother of the taxpayer may qualify the taxpayer as
a head of a household, but only if the taxpayer is entitled to a
deduction for the taxable year for such father or mother under section
151 (determined without regard to section 152(c)). For example, an
unmarried taxpayer who maintains a home for his widowed mother may not
qualify as the head of a household by reason of his maintenance of a
home for his mother if his mother has gross income equal to or in excess
of the amount determined pursuant to Sec. 1.151-2 applicable to the
calendar year in which the taxable year of the taxpayer begins, or if he
does not furnish more than one-half of the support of his mother for
such calendar year. For this purpose, a person who legally adopted the
taxpayer is considered the father or mother of the taxpayer.
(5) For the purpose of this paragraph, the status of the taxpayer
shall be determined as of the close of the taxpayer's taxable year. A
taxpayer shall be considered as not married if at the close of his
taxable year he is legally separated from his spouse under a decree of
divorce or separate maintenance, or if at any time during the taxable
year the spouse to whom the taxpayer is married at the close of his
taxable year was a nonresident alien. A taxpayer shall be considered
married at the close of his taxable year if his spouse (other than a
spouse who is a nonresident alien) dies during such year.
(6) If the taxpayer is a nonresident alien during any part of the
taxable year he may not qualify as a head of a household even though he
may comply with the other provisions of this paragraph. See the
regulations prescribed under section 871 for a definition of nonresident
alien.
(c) Household. (1) In order for a taxpayer to be considered as
maintaining a household by reason of any individual described in
paragraph (a)(1) or (b)(3) of this section, the household must actually
constitute the home of the taxpayer for his taxable year. A physical
change in the location of such home will not prevent a taxpayer from
qualifying as a head of a household. Such home must also constitute the
principal place of abode of at least one of the persons specified in
such paragraph (a)(1) or (b)(3) of this section. It is not sufficient
that the taxpayer maintain the household without being its occupant. The
taxpayer and such other person must occupy the household for the entire
taxable year of the taxpayer. However, the fact that such other person
is born or dies within the taxable year will not prevent the taxpayer
from qualifying as a head of household if the household constitutes the
principal place of abode of such other person for the remaining or
preceding part of such taxable year. The taxpayer and such other person
will be considered as occupying the household for such entire taxable
year notwithstanding temporary absences from the household due to
special circumstances. A nonpermanent failure to occupy the common abode
by reason of illness, education, business, vacation, military service,
or a custody agreement under which a child or stepchild is absent for
less than 6 months in the taxable year of the taxpayer, shall be
considered temporary absence due to special circumstances. Such absence
will not prevent the taxpayer from being considered as maintaining a
household if (i) it is reasonable to assume that the taxpayer or such
other person will return to the household, and (ii) the taxpayer
continues to maintain such household or a substantially equivalent
household in anticipation of such return.
(2) In order for a taxpayer to be considered as maintaining a
household by
[[Page 19]]
reason of any individual described in paragraph (b)(4) of this section,
the household must actually constitute the principal place of abode of
the taxpayer's dependent father or mother, or both of them. It is not,
however, necessary for the purposes of such subparagraph for the
taxpayer also to reside in such place of abode. A physical change in the
location of such home will not prevent a taxpayer from qualifying as a
head of a household. The father or mother of the taxpayer, however, must
occupy the household for the entire taxable year of the taxpayer. They
will be considered as occupying the household for such entire year
notwithstanding temporary absences from the household due to special
circumstances. For example, a nonpermanent failure to occupy the
household by reason of illness or vacation shall be considered temporary
absence due to special circumstances. Such absence will not prevent the
taxpayer from qualifying as the head of a household if (i) it is
reasonable to assume that such person will return to the household, and
(ii) the taxpayer continues to maintain such household or a
substantially equivalent household in anticipation of such return.
However, the fact that the father or mother of the taxpayer dies within
the year will not prevent the taxpayer from qualifying as a head of a
household if the household constitutes the principal place of abode of
the father or mother for the preceding part of such taxable year.
(d) Cost of maintaining a household. A taxpayer shall be considered
as maintaining a household only if he pays more than one-half the cost
thereof for his taxable year. The cost of maintaining a household shall
be the expenses incurred for the mutual benefit of the occupants thereof
by reason of its operation as the principal place of abode of such
occupants for such taxable year. The cost of maintaining a household
shall not include expenses otherwise incurred. The expenses of
maintaining a household include property taxes, mortgage interest, rent,
utility charges, upkeep and repairs, property insurance, and food
consumed on the premises. Such expenses do not include the cost of
clothing, education, medical treatment, vacations, life insurance, and
transportation. In addition, the cost of maintaining a household shall
not include any amount which represents the value of services rendered
in the household by the taxpayer or by a person qualifying the taxpayer
as a head of a household or as a surviving spouse.
(e) Certain married individuals living apart. For taxable years
beginning after December 31, 1969, an individual who is considered as
not married under section 143(b) shall be considered as not married for
purposes of determining whether he or she qualifies as a single
individual, a married individual, a head of household or a surviving
spouse under sections 1 and 2 of the Code.
[T.D. 7117, 36 FR 9398, May 25, 1971]
Sec. 1.3-1 Application of optional tax.
(a) General rules. (1) For taxable years ending before January 1,
1970, an individual whose adjusted gross income is less than $5,000 (or
a husband and wife filing a joint return whose combined adjusted gross
income is less than $5,000) may elect to pay the tax imposed by section
3 in place of the tax imposed by section 1 (a) or (b). For taxable years
beginning after December 31, 1969 and before January 1, 1971 an
individual whose adjusted gross income is less than $10,000 (or a
husband and wife filing a joint return whose combined adjusted gross
income is less than $10,000) may elect to pay the tax imposed by section
3 as amended by the Tax Reform Act of 1969 in place of the tax imposed
by section 1 (a) or (b). For taxable years beginning after December 31,
1970 an individual whose adjusted gross income is less than $10,000 (or
a husband and wife filing a joint return whose combined adjusted gross
income is less than $10,000) may elect to pay the tax imposed by section
3 as amended in place of the tax imposed by section 1 as amended. See
Sec. 1.4-2 for the manner of making such election. A taxpayer may make
such election regardless of the sources from which his income is derived
and regardless of whether his income is computed by the cash method or
the accrual method. See section 62 and the regulations thereunder for
the determination of adjusted gross income. For the purpose of
determining whether a taxpayer may
[[Page 20]]
elect to pay the tax under section 3, the amount of the adjusted gross
income is controlling, without reference to the number of exemptions to
which the taxpayer may be entitled. See section 4 and the regulations
thereunder for additional rules applicable to section 3.
(2) The following examples illustrate the rule that section 3
applies only if the adjusted gross income is less than $10,000 ($5,000
for taxable years ending before January 1, 1970).
Example 1. A is employed at a salary of $9,200 for the calendar year
1970. In the course of such employment, he incurred travel expenses of
$1,500 for which he was reimbursed during the year. Such items
constitute his sole income for 1970. In such case the gross income is
$10,700 but the amount of $1,500 is deducted from gross income in the
determination of adjusted gross income and thus A's adjusted gross
income for 1970 is $9,200. Hence, the adjusted gross income being less
than $10,000, he may elect to pay his tax for 1970 under section 3.
Similarly, in the case of an individual engaged in trade or business
(excluding from the term ``engaged in trade or business'' the
performance of personal services as an employee), there may be deducted
from gross income in ascertaining adjusted gross income those expenses
directly relating to the carrying on of such trade or business.
Example 2. If B has, as his only income for 1970, a salary of
$11,600 and his spouse has no gross income, then B's adjusted gross
income is $11,600 (not $11,600 reduced by exemptions of $1,250) and he
is not for such year, entitled to pay his tax under section 3. If,
however, B has for 1970 a salary of $13,000 and incident to his
employment he incurs expenses in the amount of $3,400 for travel, meals,
and lodging while away from home, for which he is not reimbursed, the
adjusted gross income is $13,000 minus $3,400 or $9,600. In such case
his adjusted gross income being less than $10,000, B may elect to pay
the tax under section 3. However, if B's wife has adjusted gross income
of $400, the total adjusted gross income is $10,000. In such case, if B
and his wife file a joint return, they may not elect to pay the optional
tax since the combined adjusted gross income is not less than $10,000. B
may nevertheless elect to pay the optional tax, but if he makes this
election he must file a separate return and, since his wife has gross
income, he may not claim an exemption for her in computing the optional
tax.
(b) Surviving spouse. The return of a surviving spouse is treated as
a joint return for purposes of section 3. See section 2, and the
regulations thereunder, with respect to the qualifications of a taxpayer
as a surviving spouse. Accordingly, if the taxpayer qualifies as a
surviving spouse and elects to pay the optional tax, he shall use the
column in the tax table, appropriate to his number of exemptions,
provided for cases in which a joint return is filed.
(c) Use of tax table. (1) To determine the amount of the tax, the
individual ascertains the amount of his adjusted gross income, refers to
the appropriate table set forth in section 3 or the regulations
thereunder, ascertains the income bracket into which such income falls,
and, using the number of exemptions applicable to his case, finds the
tax in the vertical column having at the top thereof a number
corresponding to the number of exemptions to which the taxpayer is
entitled.
(2) Section 3(b) (relating to taxable years beginning after Dec. 31,
1964 and ending before Jan. 1, 1970) contains 5 tables for use in
computing the tax. Table I is to be used by a single person who is not a
head of household. Table II is to be used by a head of household. Table
III is to be used by married persons filing joint returns and by a
surviving spouse. Table IV is to be used by married persons filing
separate returns using the 10 percent standard deduction. Table V is to
be used by married persons filing separate returns using the minimum
standard deduction. For an explanation of the standard deduction see
section 141 and the regulations thereunder.
(3) 30 tables are provided for use in computing the tax under the
Tax Reform Act of 1969. Tables I through XV apply for taxable years
beginning after December 31, 1969 and ending before January 1, 1971.
Tables XVI through XXX apply for taxable years beginning after December
31, 1970. The standard deduction for Tables I through XV, applicable to
taxable years beginning in 1970, is 10 percent. The standard deduction
for Tables XVI through XXX, applicable to taxable years beginning in
1971, is 13 percent. For an explanation of the standard deduction and
the low income allowance see section 141 as amended by the Tax Reform
Act of 1969.
[[Page 21]]
(4) In the case of married persons filing separate returns who
qualify to use the optional tax imposed by section 3, such persons shall
use the tax imposed by the table for the applicable year in accordance
with the rules prescribed by sections 4(c) and 141 and the regulations
thereunder governing the use and application of the standard deduction
and the low income allowance.
(5) The tax shown in the tax tables set forth in section 3 or the
regulations thereunder reflects full income splitting in the case of a
joint return (including the return of a surviving spouse) and lesser
income splitting in the case of a head of household. Therefore, it is
possible for the tax shown in the tables relating to joint returns, or
relating to a return of a head of a household, to be lower than that
shown in the table for separate returns even though the amounts of
adjusted gross income and the number of exemptions are the same.
[T.D. 7117, 36 FR 9420, May 25, 1971]
Sec. 1.4-1 Number of exemptions.
(a) For the purpose of determining the optional tax imposed under
section 3, the taxpayer shall use the number of exemptions allowable to
him as deductions under section 151. See sections 151, 152, and 153, and
the regulations thereunder. In general, one exemption is allowed for the
taxpayer; one exemption for his spouse if a joint return is made, or if
a separate return is made by the taxpayer and his spouse has no gross
income for the calendar year in which the taxable year of the taxpayer
begins and is not the dependent of another taxpayer for such calendar
year; and one exemption for each dependent whose gross income for the
calendar year in which the taxable year of the taxpayer begins is less
than the applicable amount determined pursuant to Sec. 1.151-2. No
exemption is allowed for any dependent who has made a joint return with
his spouse for the taxable year beginning in the calendar year in which
the taxable year of the taxpayer begins. The taxpayer may, in certain
cases, be allowed an exemption for a dependent child of the taxpayer
notwithstanding the fact that such child has gross income equal to or in
excess of the amount determined pursuant to Sec. 1.151-2 applicable to
the calendar year in which the taxable year of the taxpayer begins. The
requirements for the allowance of such an exemption are set forth in
paragraph (c) of Sec. 1.152-1. See paragraphs (c) and (d) of Sec. 1.151-
1 with respect to additional exemptions for a taxpayer or spouse who has
attained the age 65 years and for a blind taxpayer or blind spouse
(b) The application of this section may be illustrated by the
following examples:
Example 1. A, a married man whose duties as an employee require
traveling away from his home, has as his sole gross income a salary of
$5,600 for the calendar year 1954. His traveling expenses, including
cost of meals and lodging, amount in such year to $750, and hence, his
adjusted gross income is $4,850. His wife, B, has as her sole income
interest in the amount of $85, and thus the aggregate adjusted gross
income of A and B is $4,935. A has two dependent children neither of
whom has any income. A and B file a joint return for 1954 on Form 1040.
In such case four exemptions are allowable. The adjusted gross income
falls within the tax bracket $4,900-4,950. By referring to such tax
bracket in the tax table in section 3 and to the column headed ``4''
therein, the tax is found to be $407.
Example 2. C, a married man, has as his sole income in 1954 wages of
$4,600, and has two dependent children neither of whom has any income.
His wife, D, has adjusted gross income of $400. C files a separate
return for 1954 and is entitled to claim three exemptions. C's income
falls within the tax bracket $4,600-4,650 and hence, with three
exemptions his tax is $480. No exemption is allowed with respect to
since D has gross income and a joint return was not filed.
Example 3. D, a married man with no dependents, attains the age of
65 on September 1, 1954. The aggregate adjusted gross income of D and
his wife for 1954 is $4,840. D and his wife file a joint return for 1954
and are entitled to three exemptions, one for each taxpayer and one
additional exemption for D because of his age. Since the adjusted gross
income of D and his wife falls within the tax bracket $4,800-4,850, the
tax on a joint return is $509.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7114, 36 FR
9018, May 18, 1971]
Sec. 1.4-2 Elections.
(a) Making of election. The election to pay the optional tax imposed
under section 3 shall be made by (1) filing a
[[Page 22]]
return on Form 1040A, or (2) filing a return on Form 1040 and electing
in such return, in accordance with the provisions of section 144 and the
regulations thereunder, to take the standard deduction provided by
section 141.
(b) Election under section 3 and election of standard deduction.
Section 144 (a) and the regulations thereunder provide rules for
treating an election to pay the tax under section 3 as an election to
take the standard deduction, and for treating an election to take the
standard deduction as an election to pay the tax under section 3. For
example, if the taxpayer's return shows $5,000 or more of adjusted gross
income and he elects to take the standard deduction, he will be deemed
to have elected to pay the tax under section 3 if it is subsequently
determined that his correct adjusted gross income is less than $5,000.
(c) [Reserved]
(d) Change of election. For rules relating to a change of election
to pay, or not to pay, the optional tax imposed under section 3, see
section 144 (b) and the regulations thereunder.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6581, 26 FR
11677, Dec. 6, 1961; T.D. 7269, 38 FR 9295, April 13, 1973]
Sec. 1.4-3 Husband and wife filing separate returns.
(a) In general. If the separate adjusted gross income of a husband
is less than $5,000 and the separate adjusted gross income of his wife
is less than $5,000, and if each is required to file a return, the
husband and the wife must each elect to pay the optional tax imposed
under section 3 or neither may so elect. If the separate adjusted gross
income of each spouse is $5,000 or more, then neither spouse can elect
to pay the optional tax imposed under section 3. If the adjusted gross
income of one spouse is $5,000 or more and that of the other spouse is
less than $5,000, the election to pay the optional tax imposed under
section 3 may be exercised by the spouse having adjusted gross income of
less than $5,000 only if the spouse having adjusted gross income of
$5,000 or more, in computing taxable income, uses the standard deduction
provided by section 141. If the spouse having adjusted gross income of
$5,000 or more does not use the standard deduction, then the spouse
having adjusted gross income of less than $5,000 may not elect to pay
the optional tax and must compute taxable income without regard to the
standard deduction. Accordingly, if the spouse having adjusted gross
income of $5,000 or more itemizes the deductions allowed by sections 161
and 211 in computing taxable income, the spouse having adjusted gross
income of less than $5,000 must also compute taxable income by itemizing
the deductions allowed by sections 161 and 211, and must pay the tax
imposed by section 1. For rules relative to the election to take the
standard deduction by husband and wife, see part IV (section 141 and
following), subchapter B, chapter 1 of the Code, and the regulations
thereunder.
(b) Taxable years beginning after December 31, 1963, and before
January 1, 1970. (1) In the case of a husband and wife filing a separate
return for a taxable year beginning after December 31, 1963, and before
January 1, 1970, the optional tax imposed by section 3 shall be--
(i) For taxable years beginning in 1964, the lesser of the tax shown
in Table IV (relating to the 10-percent standard deduction for married
persons filing separate returns) or Table V (relating to the minimum
standard deduction for married persons filing separate returns) of
section 3(a), and
(ii) For a taxable year beginning after December 31, 1964, and
before January 1, 1970, the lesser of the tax shown in Table IV
(relating to the 10-percent standard deduction for married persons
filing separate returns) or Table V (relating to minimum standard
deduction for married persons filing separate returns) of section 3(b).
(2) If the tax of one spouse is determined with regard to the 10-
percent standard deduction provided for in Table IV of section 3(a) or
3(b) or if such spouse in computing taxable income uses the 10-percent
standard deduction provided for in section 141(b), then the minimum
standard deduction provided for in Table V of section 3(a) or 3(b) shall
not apply in the case of the other spouse, if such spouse elects to pay
the optional tax imposed under section (3). Thus, if a husband and wife
compute their tax with reference to the
[[Page 23]]
standard deduction, one cannot elect to use the 10-percent standard
deduction and the other elect to use the minimum standard deduction.
However, an individual described in section 141(d)(2) may elect pursuant
to such section and the regulations thereunder to pay the tax shown in
Table V of section 3(a) or 3(b) in lieu of the tax shown in Table IV of
section 3(a) or 3(b). See section 141(d) and the regulations thereunder
for rules relating to the standard deduction in the case of married
individuals filing separate returns.
(c) Taxable years beginning after December 31, 1969. (1) In the case
of a husband and wife filing a separate return for a taxable year
beginning after December 31, 1969, the optional tax imposed by section 3
shall be the lesser of the tax shown in--
(i) The table prescribed under section 3 applicable to such taxable
year in the case of married persons filing separate returns which
applies the percentage standard deduction, or
(ii) The table prescribed under section 3 applicable to such taxable
year in the case of married persons filing separate returns which
applies the low income allowance.
(2) If the tax of one spouse is determined by the table described in
subparagraph (1)(i) of this paragraph or if such spouse in computing
taxable income uses the percentage standard deduction provided for in
section 141(b), then the table described in subparagraph (1)(ii) of this
paragraph shall not apply in the case of the other spouse, if such other
spouse elects to pay the optional tax imposed under section 3. Thus, if
a husband and wife compute the tax with reference to the standard
deduction, one cannot elect to use the percentage standard deduction and
the other elect to use the low income allowance. A married individual
described in section 141(d)(2) may elect pursuant to such section and
the regulations thereunder to pay the tax shown in the table described
by subparagraph (1)(ii) of this paragraph in lieu of the tax shown in
the table described by subparagraph (1)(i) of this paragraph. See
section 141(d) and the regulations thereunder for rules relating to the
standard deduction in the case of married individuals filing separate
returns.
(d) Determination of marital status. For the purpose of applying the
restrictions upon the right of a married person to elect to pay the tax
under section 3, (1) the determination of marital status is made as of
the close of the taxpayer's taxable year or, if his spouse died during
such year, as of the date of death; (2) a person legally separated from
his spouse under a decree of divorce or separate maintenance on the last
day of his taxable year (or the date of death of his spouse, whichever
is applicable) is not considered as married; and (3) with respect to
taxable years beginning after December 31, 1969, a person, although
considered as married within the meaning of section 143(a), is
considered as not married if he lives apart from his spouse and
satisfies the requirements set forth in section 143(b). See section 143
and the regulations thereunder.
[T.D. 6792, 30 FR 529, Jan. 15, 1965, as amended by T.D. 7123, 36 FR
11084, June 9, 1971]
Sec. 1.4-4 Short taxable year caused by death.
An individual making a return for a period of less than 12 months on
account of a change in his accounting period may not elect to pay the
optional tax under section 3. However, the fact that the taxable year is
less than 12 months does not prevent the determination of the tax for
the taxable year under section 3 if the short taxable year results from
the death of the taxpayer.
Tax on Corporations
Sec. 1.11-1 Tax on corporations.
(a) Every corporation, foreign or domestic, is liable to the tax
imposed under section 11 except (1) corporations specifically excepted
under such section from such tax; (2) corporations expressly exempt from
all taxation under subtitle A of the Code (see section 501); and (3)
corporations subject to tax under section 511(a). For taxable years
beginning after December 31, 1966, foreign corporations engaged in trade
or business in the United States shall be taxable under section 11 only
on their taxable income which is effectively
[[Page 24]]
connected with the conduct of a trade or business in the United States
(see section 882(a)(1)). For definition of the terms ``corporations,''
``domestic,'' and ``foreign,'' see section 7701(a) (3), (4), and (5),
respectively. It is immaterial that a domestic corporation, and for
taxable years beginning after December 31, 1966, a foreign corporation
engaged in trade or business in the United States, which is subject to
the tax imposed by section 11 may derive no income from sources within
the United States. The tax imposed by section 11 is payable upon the
basis of the returns rendered by the corporations liable thereto, except
that in some cases a tax is to be paid at the source of the income. See
subchapter A (sections 6001 and following), chapter 61 of the Code, and
section 1442.
(b) The tax imposed by section 11 consists of a normal tax and a
surtax. The normal tax and the surtax are both computed upon the taxable
income of the corporation for the taxable year, that is, upon the gross
income of the corporation minus the deductions allowed by chapter 1 of
the Code. However, the deduction provided in section 242 for partially
tax-exempt interest is not allowed in computing the taxable income
subject to the surtax.
(c) The normal tax is at the rate of 22 percent and is applied to
the taxable income for the taxable year. However, in the case of a
taxable year ending after December 31, 1974, and before January 1, 1976,
the normal tax is at the rate of 20 percent of so much of the taxable
income as does not exceed $25,000 and at the rate of 22 percent of so
much of the taxable income as does exceed $25,000 and is applied to the
taxable income for the taxable year.
(d) The surtax is at the rate of 26 percent and is upon the taxable
income (computed without regard to the deduction, if any, provided in
section 242 for partially tax-exempt interest) in excess of $25,000.
However, in the case of a taxable year ending after December 31, 1974,
and before January 1, 1976, the surtax is upon the taxable income
(computed as provided in the preceding sentence) in excess of $50,000.
In certain circumstances the exemption from surtax may be disallowed in
whole or in part. See sections 269, 1551, 1561, and 1564 and the
regulations thereunder. For purposes of sections 244, 247, 804, 907, 922
and Secs. 1.51-1 and 1.815-4, when the phrase ``the sum of the normal
tax rate and the surtax rate for the taxable year'' is used in any such
section, the normal tax rate for all taxable years beginning after
December 31, 1963, and ending before January 1, 1976, shall be
considered to be 22 percent.
(e) The computation of the tax on corporations imposed under section
11 may be illustrated by the following example:
Example. The X Corporation, a domestic corporation, has gross income
of $86,000 for the calendar year 1964. The gross income includes
interest of $5,000 on United States obligations for which a deduction
under section 242 is allowable in determining taxable income subject to
the normal tax. It has other deductions of $11,000. The tax of the X
Corporation under section 11 for the calendar year is $28,400 ($15,400
normal tax and $13,000 surtax) computed as follows:
Computation of Normal Tax
Gross income.................................... $86,000
Deductions:
Partially tax-exempt interest................. $5,000 ..........
Other......................................... 11,000 16,000
-----------------------
Taxable income.................................. 70,000
Normal tax (22 percent of $70,000).............. 15,400
Computation of Surtax
Taxable income.................................. 70,000
Add: Amount of partially tax-exempt interest 5,000
deducted in computing taxable income...........
-------------
Taxable income subject to surtax................ 75,000
Less: Exemption from surtax..................... 25,000
-------------
Excess of taxable income subject to surtax over 50,000
exemption......................................
Surtax (26 percent of $50,000).................. 13,000
(f) For special rules applicable to foreign corporations engaged in
trade or business within the United States, see section 882 and the
regulations thereunder. For additional tax on personal holding
companies, see part II (section 541 and following), subchapter G,
chapter 1 of the Code, and the regulations thereunder. For additional
tax on corporations improperly accumulating surplus, see part I (section
531 and following), subchapter G, chapter 1 of the Code, and the
regulations thereunder. For treatment of China Trade Act corporations,
see sections 941 and 942 and the regulations thereunder. For treatment
of Western Hemisphere trade corporations, see sections 921 and 922 and
[[Page 25]]
the regulations thereunder. For treatment of capital gains and losses,
see subchapter P (section 1201 and following), chapter 1 of the Code.
For computation of the tax for a taxable year during which a change in
the tax rates occurs, see section 21 and the regulations thereunder.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 7293, 38 FR
32792, Nov. 28, 1973; T.D. 74-13, 41 FR 12639, Mar. 26, 1976]
Changes in Rates During a Taxable Year
Sec. 1.21-1 Changes in rate during a taxable year.
(a) Section 21 applies to all taxpayers, including individuals and
corporations. It provides a general rule applicable in any case where
(1) any rate of tax imposed by chapter 1 of the Code upon the taxpayer
is increased or decreased, or any such tax is repealed, and (2) the
taxable year includes the effective date of the change, except where
that date is the first day of the taxable year. For example, the normal
tax on corporations under section 11(b) was decreased from 30 percent to
22 percent in the case of a taxable year beginning after December 31,
1963. Accordingly, the tax for a taxable year of a corporation beginning
on January 1, 1964, would be computed under section 11(b) at the new
rate without regard to section 21. However, for any taxable year
beginning before January 1, 1964, and ending on or after that date, the
tax would be computed under section 21. For additional circumstances
under which section 21 is not applicable, see paragraph (k) of this
section.
(b) In any case in which section 21 is applicable, a tentative tax
shall be computed by applying to the taxable income for the entire
taxable year the rate for the period within the taxable year before the
effective date of change, and another tentative tax shall be computed by
applying to the taxable income for the entire taxable year the rate for
the period within the taxable year on or after such effective date. The
tax imposed on the taxpayer is the sum of--
(1) An amount which bears the same ratio to the tentative tax
computed at the rate applicable to the period within the taxable year
before the effective date of the change that the number of days in such
period bears to the number of days in the taxable year, and
(2) An amount which bears the same ratio to the tentative tax
computed at the rate applicable to the period within the taxable year on
and after the effective date of the change that the number of days in
such period bears to the number of days in the taxable year.
(c) If the rate of tax is changed for taxable years ``beginning
after'' or ``ending after'' a certain date, the following day is
considered the effective date of the change for purposes of section 21.
If the rate is changed for taxable years ``beginning on or after'' a
certain date, that date is considered the effective date of the change
for purposes of section 21. This rule may be illustrated by the
following examples:
Example 1. Assume that the law provides that a change in a certain
rate of tax shall be effective only with respect to taxable years
beginning after December 31, 1969. The effective date of change for
purposes of section 21 is January 1, 1970, and section 21 must be
applied to any taxable year which begins before and ends on or after
January 1, 1970.
Example 2. Assume that the law provides that a change in a certain
rate of tax shall be applicable only with respect to taxable years
ending after December 31, 1970. For purposes of section 21, the
effective date of change is January 1, 1971, and section 21 must be
applied to any taxable year which begins before and ends on or after
January 1, 1971.
Example 3. Assume that the law provides that a change in a certain
rate of tax shall be effective only with respect to taxable years
beginning on or after January 1, 1971. The effective date of change for
purposes of section 21 is January 1, 1971, and section 21 must be
applied to any taxable year which begins before and ends on or after
January 1, 1971.
(d) If a tax is repealed, the repeal will be treated as a change of
rate for purposes of section 21, and the rate for the period after the
repeal (for purposes of computing the tentative tax with respect to that
period) will be considered zero. For example, the Tax Reform Act of 1969
repealed section 1562, which imposed a 6 percent additional tax on
controlled corporations electing multiple surtax exemptions, effective
for taxable years beginning after December 31,
[[Page 26]]
1974. For such controlled corporations having taxable years beginning in
1974 and ending in 1975, the rate for the period ending before January
1, 1975, would be 6 percent; the rate for the period beginning after
December 31, 1974, would be zero. However, subject to the rules stated
in this section, section 21 does not apply to the imposition of a new
tax. For example, if a new tax is imposed for taxable years beginning on
or after July 1, 1972, a computation under section 21 would not be
required with respect to such new tax in the case of taxable years
beginning before July 1, 1972, and ending on or after that date. If the
effective date of the imposition of a new tax and the effective date of
a change in rate of such tax fall in the same taxable year, section 21
is not applicable in computing the taxpayer's liability for such tax for
such year unless the new tax is expressly imposed upon the taxpayer for
a portion of his taxable year prior to the change in rate.
(e) If a husband and wife have different taxable years because of
the death of either spouse, and if a joint return is filed with respect
to the taxable year of each, then, for purposes of section 21, the joint
return shall be treated as if the taxable years of both spouses ended on
the date of the closing of the surviving spouse's taxable year. See
section 6013 (c), relating to treatment of joint return after death of
either spouse. Accordingly, if a change in the rate of tax is effective
during the taxable year of the surviving spouse, the tentative taxes
with respect to the joint return shall be computed on the basis of the
number of days during which each rate of tax was in effect for the
taxable year of the surviving spouse.
(f) Section 21 applies whether or not the taxpayer has a taxable
year of less than 12 months. Moreover, section 21 applies whether or not
the taxable income for a taxable year of less than 12 months is required
to be placed on an annual basis under section 443. If the taxable income
is required to be computed under section 443(b) then the tentative taxes
under section 21 are computed as provided in paragraph (1) or (2) of
section 443(b) and are reduced as provided in those paragraphs. The
tentative taxes so computed and reduced are then apportioned as provided
in section 21(a)(2) to determine the tax for such taxable year as
computed under section 21.
(g) If a taxpayer has made the election under section 441(f)
(relating to computation of taxable income on the basis of an annual
accounting period varying from 52 to 53 weeks), the rules provided in
section 441(f)(2) shall be applicable for purposes of determining
whether section 21 applies to the taxable year of the taxpayer. Where a
taxpayer has made the election under section 441(f) and where section 21
applies to the taxable year of the taxpayer the computation under
section 21(a)(2) shall be made upon the basis of the actual number of
days in the taxable year and in each period thereof.
(h)(1) Section 21 is applicable only if the rate of tax imposed by
chapter 1 changes. Sections in which rates of tax are specified or
incorporated by reference include the following: 1, 2, 3, 11, 511, 531,
541, 821, 831, 871, 881, 1201, and 1348 (for taxable years beginning
after December 31, 1970). Except as provided in subparagraph (3) of this
paragraph, section 21 is not applicable with respect to changes in the
law relating to deductions from gross income, exclusions from or
inclusions in gross income, or other items taken into account in
determining the amount or character of income subject to tax. Moreover,
section 21 is not applicable with respect to changes in the law relating
to credits against the tax or with respect to changes in the law
relating to limitations on the amount of tax. Section 21 is applicable,
however, to all those computations specified in the section providing
the rate of tax which are implicit in determining the rate. For example,
if one of the tax brackets in the tax tables under section 3 were to be
changed, section 21 would be applicable to that change. Thus, if the
bracket relating to ``at least $4,200 but not less than $4,250'' for
heads of households should be changed to increase or decrease the last
sum specified, with corresponding changes being made in subsequent
brackets, section 21 would be applicable. The enactment of sections 1561
and 1562 is considered a change in section 11(d)
[[Page 27]]
which constitutes a change in rate for the period ending after December
31, 1963. The amendment of section 1561 and the repeal of section 1562
by the Tax Reform Act of 1969 is considered a change in section 11(d)
which constitutes a change in rate for the period ending after December
31, 1974. The repeal of the 2 percent additional tax imposed under
section 1503 on corporations filing consolidated returns constitutes a
change in rate for the period ending after December 31, 1963. The
addition to the Code of section 1348 (relating to 50 percent maximum
rate on earned income) is a change in rate to which section 21(a) is
applicable. The amendment of section 11(d) by the Tax Reduction Act of
1975 which increases to $50,000 the surtax exemption for a taxable year
ending during 1975 constitutes a change in rate for such portion of the
taxable year (if less than the entire taxable year) as follows December
31, 1974. Similarly, the return of the surtax exemption to $25,000 for a
taxable year ending during 1976 constitutes a change in rate for such
portion of the taxable year (if less than the entire taxable year) as
follows December 31, 1975.
(2) Ordinarily, both the old and the new rates are applied to the
same amount of taxable income. However, where the rate of tax is itself
taken into account in determining taxable income (for example, the
special deduction for Western Hemisphere trade corporations under
section 922), the taxable income used in determining the tentative tax
employing the rate before the effective date of change shall be
determined by reference to that rate of tax, and the taxable income for
the purpose of determining the tentative tax employing the rate for the
period on and after the effective date of the change shall be determined
by reference to the new tax rate.
(3) Section 21 is applicable with respect to changes in the law
relating to the standard deduction for individuals provided in part IV
of subchapter B and to the deduction for personal exemptions for
individuals provided in part V of subchapter B.
(i) If the rate of tax changes more than once during the taxable
year, section 21 is applicable to each change in rate. For example, if
the rate of normal tax changed for taxable years beginning on or after
March 1, 1954, and changed again for taxable years beginning on or after
June 1, 1954, section 21 requires computation of 3 tentative taxes for
any taxable year which began before March 1, 1954, and ended on or after
June 1, 1954: One tentative tax at the rate in effect before the March 1
change; another tentative tax at the rate in effect from March 1 to May
31; and a third tentative tax at the rate in effect from June 1 to the
end of the taxable year. The proportion of each such tentative tax taken
into account in determining the tax imposed on the taxpayer is computed
by reference to the portion of the taxable year before March 1, 1954, by
reference to the portion of the taxable year from March 1, 1954, through
May 31, 1954, and by reference to the portion of the taxable year from
June 1, 1954, to the end of the taxable year, respectively.
(j)(1) If a change in the rate of one tax imposed by chapter 1 of
the Code does not affect the amount of other taxes imposed by chapter 1
of the Code the other taxes may be determined without regard to section
21 and section 21 will be applied only to the tax for which a change in
rate is made. However, if the change of rate of one tax does affect the
amount of other taxes imposed under chapter 1 of the Code, then the
computation of the taxes under chapter 1 of the Code so affected shall
be made by applying section 21. For example, if section 1201 applies to
an individual taxpayer for a taxable year containing the effective date
of a change in a rate of tax provided in section 1, then under section
21 the taxpayer must compute a tentative tax for each period for which a
different rate of tax is effective under section 1. The tentative tax
for each such period as computed under section 1201 will reflect the
rate of tax provided by section 1 for such period.
(2) In certain cases chapter 1 of the Code provides that the
particular tax to be imposed upon the taxpayer shall be one of several
taxes, the basis of selection being the tax that is greater or lesser.
See, for example, sections 821 and 1201. If in any such case the rate of
any one of these taxes changes, then
[[Page 28]]
the tentative taxes computed as provided by section 21 for each period
shall be computed employing the tax selected in accordance with the
general rule of selection for such a case, at the rate of tax in effect
for such period. Thus, if a change in the rate of the alternative tax
under section 1201 is such that the alternative tax under section 1201
is applicable if the old rate is used and is not applicable if the new
rate is used, one tentative tax will consist of the alternative tax
under section 1201 and the other tentative tax will consist of the tax
imposed by the other applicable sections of chapter 1 of the Code. The
two tentative taxes so computed are then prorated in accordance with
section 21(a)(2) and the sum of the proportionate amounts is the tax
imposed for the taxable year under chapter 1 of the Code. See the
examples in paragraph (n) of this section.
(k) Section 21 does not apply in the following situations:
(1) The provisions of section 21 do not apply to the imposition of
the tax surcharge by section 51. The proration rules of section 51(a)
apply in the case of a taxable year ending on or after the effective
date of the surcharge and beginning before July 1, 1970.
(2) The provisions of section 21 do not apply to the imposition of
the minimum tax for tax preferences by section 56. The proration rules
of section 301(c) of the Tax Reform Act of 1969 (83 Stat. 586) apply in
the case of a taxable year beginning in 1969 and ending in 1970.
(l) In computing the number of days each rate of tax is in effect
during the taxable year for purposes of section 21(a)(2), the effective
date of the change in rate shall be counted in the period for which the
new rate is in effect.
(m) Any credits against tax, and any limitation in any credit
against tax, shall be based upon the tax computed under section 21. For
credits against tax, see part IV (section 31 and following), subchapter
A, chapter 1 of the Code.
(n) The application of section 21 may be illustrated by the
following examples: (See also the examples in Sec. 1.1561-2A(a)(3).)
Example 1. A, a married taxpayer filing a joint return, reports his
income on the basis of a fiscal year ending June 30. For his fiscal year
ending June 30, 1970, A reports taxable income (exclusive of capital
gains and losses) of $50,000 and net long-term capital gain (section
1201 gain (net capital gain for taxable years beginning after December
31, 1976)) of $75,000. The rate of tax on capital gains under section
1201(b) relating to the alternative tax has been increased from 25
percent to a maximum rate of 29\1/2\ percent with respect to gain in
excess of $50,000 and the effective date of the change in rate is
January 1, 1970. The income tax for the taxable year ended June 30,
1970, would be computed under section 21 as follows:
Tentative Tax
Taxable income exclusive of capital $50,000
gains and losses...................
Long-term capital gain.............. 75,000
-------------
125,000
Deduct 50% of long-term capital gain 37,500
-------------
Taxable income................ 87,500
=============
Tax under section 1 (1969 and 1970 37,690
rates).............................
=============
Alternative Tax Under Section 1201(b) (1969 Rates)
Taxable income ($50,000+50% of $87,500
$75,000)...........................
Less 50% of long-term capital gain.. 37,500
-------------
Taxable income exclusive of capital 50,000
gains..............................
=============
Partial tax (tax on $50,000)........ 17,060
Plus 25% of $75,000................. 18,750
-------------
Alternative tax under section 35,810
1201(b) at 1969 rates..............
Alternative Tax Under Section 1201(b) (1970 Rates)
step i
Taxable income ($50,000 + 50% of $87,500
$75,000)...........................
Deduct 50% of net section 1201 gain 37,500
(net capital gain for taxable years
beginning after December 31, 1976).
------------
50,000
============
Tax on $50,000 (taxable income .......... $17,060
exclusive of capital gains)........
[[Page 29]]
step ii
(a) Net section 1201 gain (net 75,000
capital gain for taxable years
beginning after December 31, 1976).
(b) Subsection (d) gain............. 50,000
25% of $50,000 (lesser of (a) or .......... 12,500
(b))...............................
step iii
(c) 29\1/2\% of $25,000 (excess of 7,375
(a) over (b))......................
============
(d) Ordinary income................. $50,000
50% of net section 1201 gain (net 37,500
capital gain for taxable years
beginning after December 31, 1976).
------------
87,500
============
Tax on $87,500...................... $37,690
Ordinary income..................... $50,000
50% of subsection (d) gain.......... 25,000
------------
75,000
============
Tax on $75,000...................... 30,470
------------
Difference.......................... 7,220
============
Lesser of (c) or (d)................ $7,220
-------------
Alternative tax (total of 3 steps) 36,780
at rates effective on and after
January 1, 1970....................
=============
Since the alternative tax is less than the tax imposed under section 1
for both the period in 1969 and the period in 1970, the alternative tax
applies for both periods. Thus, since the effective date of the change
in the rate of tax on capital gains is January 1, 1970, the old rate of
alternative tax is effective for 184 days of the taxable year and the
new rate of alternative tax is effective for 181 days of the taxable
year. The alternative taxes are apportioned as follows:
1969--184/365 of $35,810.................................... $18,052.16
1970--181/365 of $36,780.................................... 18,238.85
-----------
36,291.01
Tax surcharge (See Sec. 1.51-1(d)(1)(i))................... 2,729.28
-----------
Total tax for the taxable year........................ 39,020.29
Example 2. B, a single individual not a head of a household, has a
taxable year ending March 31. For the taxable year ending March 31,
1971, B has adjusted gross income of $18,500. His computation of the tax
imposed is as follows:
1970 Tentative Tax
Adjusted gross income........................... $18,500.00
Less:
Standard deduction.......................... $1,000.00
Personal exemption.......................... 625.00 1,625.00
-----------------------
Taxable income under 1970 deduction provisions.. 16,875.00
=============
Tax on $16,875 (1970 rates):
Tax on first $16,000.......................... 4,330.00
42 percent of $875............................ 367.50
------------
Tentative tax at rates and deduction provisions 4,697.50
effective on or after January 1, 1970..........
=============
1971 Tentative Tax
Adjusted gross income........................... $18,500.00
Less:
Standard deduction.......................... $1,500
Personal exemption.......................... 650 2,150.00
-----------------------
Taxable income under 1971 deduction provisions.. 16,350.00
=============
Tax on $16,350 (1971 rates):
Tax on first $16,000.......................... 3,830
34 percent of $350............................ 119
------------
Tentative tax at rates and deduction provisions 3,949.00
effective on or after Januray 1, 1971..........
=============
The 1970 and 1971 tentative taxes are
apportioned as follows:
1970--275/365 of $4,697.50.................... 3,539.21
1971--90/365 of $3,949.00..................... 973.73
-------------
4,512.94
Tax surcharge (see Sec. 1.51-1(d)(1)(i))....... 56.26
-------------
Total tax for the taxable year............ 4,569.20
=============
Example 3. H and W, husband and wife, have a foster child, C, who
qualifies as a dependent under section 152(b)(2) for the period
beginning after December 31, 1969. H and W file a joint return on the
basis of a taxable year ending August 31. For the taxable year ending
August 31, 1970, H and W have adjusted gross income of $12,500. Their
computation of the tax imposed is as follows:
1969 Tentative Tax
Adjusted gross income........................... $12,500.00
Less:
Standard deduction...................... $1,000.00
Personal exemption (2).................. 1,200.00 2,200.00
-----------------------
Taxable income under 1969 deduction provisions.. 10,300.00
=============
Taxable income reduced by one-half.............. .......... 5,150.00
===========
Tax on $5,150 (1969 rates):
Tax on first $4,000........................... $690.00
22 percent of $1,150.......................... 253.00 943.00
-----------------------
Twice the tax on $5,150......................... $1,886.00
============
[[Page 30]]
Tentative tax at rates and deduction provisions 1,886.00
effective on or after January 1, 1969..........
=============
1970 Tentative Tax
Adjusted gross income........................... $12,500.00
Less:
Standard deduction.......................... $1,000.00
Personal exemption (3)...................... 1,875.00 2,875.00
-----------------------
Taxable income under 1970 deduction provisions.. $9,625.00
=============
Tax on $9,625 (1970 rates):
Tax on first $8,000........................... $1,380.00
22 percent of $1,625.......................... 357.50
------------
Tentative tax at rates and deduction provisions 1,737.50
effective on or after January 1, 1970..........
=============
The 1969 and 1970 tentative taxes are
apportioned as follows:
1969--122/365 of $1,886....................... $630.39
1970--243/365 of $1,737.50.................... 1,156.75
-------------
1,787.14
Tax surcharge (see Sec. 1.51-1(d)(1)(i))....... 104.05
-------------
Total tax for the taxable year................ 1,891.19
=============
Example 4. B, a single individual with one exemption, reports his
income on the basis of a fiscal year ending June 30. For fiscal year
ending June 30, 1971, B reports adjusted gross income of $250,000,
consisting of earned net income of $240,000 and investment income of
$10,000. In addition, on April 24, 1971, stock was transferred to B
pursuant to his exercise of a qualified stock option, and the fair
market value of such stock at that time exceeded the option price by
$175,000. This $175,000 constitutes an item of tax preference described
in section 57(a)(6). B claims itemized deductions in the amount of
$34,000. By reason of section 1348, the maximum rate of tax on earned
taxable income for a taxable year beginning after 1970 but before 1972
is 60 percent. The income tax for the taxable year ending June 30, 1971,
would be computed under section 21 as follows:
1970 Tentative Tax
Adjusted gross income................... $250,000.00
Less:
Itemized deductions................. $34,000.00
Personal exemption.................. 625.00 34,625.00
-------------------------------
Taxable income under 1970 deduction 215,375.00
provisions.............................
=================
Tax on $215,375 (1970 rates)
Tax on first $100,000................... $55,490.00
70 percent of $115,375.................. 80,762.50
----------------
Tentative tax at rates and deduction 136,252.50
provisions effective on or after
January 1, 1970........................
=================
Minimum tax:
Total tax preference items............ 175,000.00
Less:
Exemption........................... $30,000.00
Income tax.......................... 136,252.50 166,252.50
-------------------------------
Subject to 10 percent tax............... 8,747.50
=================
10 percent tax.......................... 874.75
=================
Total tentative tax ($136,252.50 + 137,127.25
$874.75).........................
=================
1971 Tentative Tax
Adjusted gross income................... $250,000.00
Less:
Itemized deductions................. $34,000.00
Personal exemption.................. 650.00 34,650.00
-------------------------------
Taxable income under 1971 deduction 215,350.00
provisions.............................
=================
(a) Tax on highest amount of taxable 20,190.00
income on which rate does not exceed 60
percent ($50,000) (1971 rates).........
(b) Earned taxable
income:
($215,350 x
$240,000/
$250,000)............................. $206,736.00
Less: Tax
preference offset:
($175,000
-$30,000)............................... 145,000.00
-----------------
61,736.00
================
(c) 60% of the amount by which $61,736 7,041.60
exceeds $50,000........................
(d) Tax on $215,350 (1971 rates)
Tax on first $100,000................. 53,090.00
70% of $115,350....................... 80,745.00
----------------
Total............................. 133,835.00
================
(e) Tax on $61,736 (1971 rates)
Tax on first $60,000.................. 26,390.00
64% of $1,736......................... 1,111.04
----------------
Total............................. 27,501.04
================
(f) Excess of $133,835 over $27,501.04.. 106,333.96
-----------------
Tentative tax (total of Steps (a), (c), 133,565.56
and (f)) at rates and deduction
provisions effective on or after
January 1, 1971........................
=================
Minimum tax:
Total tax preference items............ 175,000.00
Less:
Exemption........................... $30,000.00
Income tax.......................... 133,565.56 163,565.56
-------------------------------
Subject to 10 percent tax............. $11,434.44
=================
[[Page 31]]
10 percent tax........................ 1,143.44
=================
Total tentative tax ($133,565.56 + 134,709.00
$1,143.44).........................
=================
The 1970 and 1971 tentative taxes are
apportioned as follows:
1970--184/365 of $137,127.25.......... 69,127.16
1971--181/365 of $134,709............. 66,800.90
=================
Total tax for the taxable year...... 135,928.06
=================
Example 5. The surtax exemption of corporation M (one of 4
subsidiary corporations of W corporation), which files its income tax
returns on the basis of a fiscal year ending March 31, 1964, is less
than $25,000, by reason of section 1561 of the Code applicable to
taxable years ending after December 31, 1963, and beginning before
January 1, 1975. The taxable income of corporation M is $100,000, and
the amount of the surtax exemption determined under the new rule for the
1964 taxable year is $5,000 ($25,0005). M's income tax liability
for the taxable year ending March 31, 1964, is computed as follows:
1963 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1963 rates) 30 $30,000
percent of $100,000....................
Surtax on $75,000 (1963 rates and 16,500
$25,000 surtax exemption) 22 percent of
$75,000................................
-----------------
Total tentative tax at rates and 46,500
surtax exemption effective before
January 1, 1964..................
=================
1964 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1964 rates) 22 $22,000
percent of $100,000....................
Surtax on $95,000 (1964 rates and a 26,600
$5,000 surtax exemption) 28 percent of
$95,000................................
----------------
Total tentative tax at rates and 48,600
surtax exemption effective after
January 1, 1964..................
=================
The 1963 and 1964 tentative taxes are
apportioned as follows:
1963--275/366 of $46,500.............. 34,938.52
1964--91/366 of $48,600............... 12,083.61
-----------------
Total tax for the taxable year.... 47,022.13
=================
M has the same amount of taxable income in 1965. Its income tax
liability for the fiscal year ending March 31, 1965, is computed as
follows:
1964 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1964 rates) 22 $22,000
percent of $100,000....................
Surtax on $95,000 (1964 rates and a 26,600
$5,000 surtax exemption) 28 percent of
$95,000................................
-----------------
Total tentative tax at the 1964 48,600
rates............................
=================
1965 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1965 rates) 22 $22,000
percent of $100,000....................
Surtax on $95,000 (1965 rates and a 24,700
$5,000 surtax exemption) 26 percent of
$95,000................................
----------------
Total tentative tax at the 1965 46,700
rates............................
=================
The 1964 and 1965 tentative taxes are
apportioned as follows:
1964--275/365 of $48,600.............. $36,616.44
1965--90/365 of $46,700............... 11,515.07
-----------------
Total tax for the taxable year.... 48,131.51
=================
Example 6. Assume the same facts as in example (5), except that M
elected the additional tax under section 1562 for its fiscal year ending
March 31, 1964. M's tax liability is completed as follows:
1963 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1963 rates) 30 $30,000
percent of $100,000....................
Surtax on $75,000 (1963 rates and 16,500
$25,000 surtax exemption) 22 percent of
$75,000................................
----------------
Total tentative tax at rates and 46,500
surtax exemption effective before
January 1, 1964..................
=================
1964 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1964 rates) 22 $22,000
percent of $100,000....................
[[Page 32]]
Surtax on $75,000 (1964 rates and 21,000
$25,000 surtax exemption) 28 percent of
$75,000................................
Additional tax on $25,000 6 percent of 1,500
$25,000................................
----------------
Total tentative tax at rates and 44,500
surtax exemption effective on and
after January 1, 1964............
=================
The 1963 and 1964 tentative taxes are
apportioned as follows:
1963--275/366 of $46,500.............. $34,938.52
1964--91/366 of $44,500............... 11,064.21
-----------------
Total tax for the taxable year.... 46,002.73
=================
Example 7. Corporation N files its income tax returns on the basis
of a fiscal year ending June 30. For its taxable year ending in 1976,
the taxable income of N is $100,000. N's income tax liability is
determined for the period July 1, 1975, through December 31, 1975, by
taking into account two rates of normal tax under section 11(b)(2) (A)
and (B) and the increase to $50,000 in the surtax exemption under
section 11(d). For the period January 1, 1976, through June 30, 1976,
N's income tax liability is determined by taking into account the single
normal tax rate under section 11(b)(1) and the $25,000 surtax exemption
under section 11(d). N's tax liability for the taxable year ending June
30, 1976, is computed as follows:
1975 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1975 rates) 20 $5,000
percent of $25,000...................
22 percent of $75,000................. 16,500
Surtax on $50,000 (1975 rates and 13,000
$50,000 surtax exemption) 26 percent
of $50,000...........................
----------------
Total tentative tax at rates and 34,500
surtax exemption effective on and
after January 1, 1975............
=================
1976 Tentative Tax
Taxable income.......................... $100,000
=================
Normal tax on $100,000 (1976 rates) 22 $22,000
percent of $100,000..................
Surtax on $75,000 (1976 rates and 19,500
$25,000 surtax exemption) 26 percent
of $75,000...........................
----------------
Total tentative tax at rates and 41,500
surtax exemption effective on and
after January 1, 1976............
=================
The 1975 and 1976 tentative taxes are
apportioned as follows:
1975--184/366 of $34,500.............. $17,344
1976--182/366 of $41,500.............. 20,637
-----------------
Total tax for the taxable year.... 37,981
(Secs. 1561(a) (83 Stat. 599; 26 U.S.C. 1561(a)) of the Internal Revenue
Code)
[T.D. 6500, 25 FR 11402, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as
amended by T.D. 7164, 37 FR 4190, Feb. 29, 1972; T.D. 74-13, 41 FR
12639, Mar. 26, 1976; T.D. 7528, 42 FR 64694, Dec. 28, 1977; T.D. 7728,
45 FR 72651, Nov. 3, 1980]
Sec. 1.23-1 Residential energy credit.
(a) General rule. Section 23 or former section 44C provides a
residential energy credit against the tax imposed by chapter 1 of the
Internal Revenue Code. The credit is an amount equal to the individual's
qualified energy conservation expenditures (set out in paragraph (b))
plus the individual's qualified renewable energy source expenditures
(set out in paragraph (c)) for the taxable year. However, the credit is
subject to the limitations described in paragraph (d) and the special
rules contained in Sec. 1.23-3. The credit is nonrefundable (that is,
the credit may not exceed an individual's tax liability for the taxable
year). However, any unused credit may be carried over to succeeding
years to the extent permitted under paragraph (e). Renters as well as
owners of a dwelling unit may qualify for the credit. See Sec. 1.23-3(h)
for the rules relating to the allocation of the credit in the case of
joint occupants of a dwelling unit.
(b) Qualified energy conservation expenditures. In the case of any
dwelling unit, the qualified energy conservation expenditures are 15
percent of the energy conservation expenditures made by the taxpayer
with respect to the dwelling unit during the taxable year, but not in
excess of $2,000 of such expenditures. See Sec. 1.23-2(a) for the
definition of energy conservation expenditures.
[[Page 33]]
(c) Qualified renewable energy source expenditures. In the case of
taxable years beginning after December 31, 1979, the qualified renewable
energy source expenditures are 40 percent of the renewable energy source
expenditures made by the taxpayer during the taxable year (and before
January 1, 1986) with respect to the dwelling units that do not exceed
$10,000. In the case of taxable years beginning before January 1, 1980,
the qualified renewable energy source expenditures are the renewable
energy source expenditures made by the taxpayer with respect to the
dwelling unit during the taxable year, but not in excess of--
(1) 30 percent of the expenditures up to $2,000, plus
(2) 20 percent of the expenditures over $2,000, but not more than
$10,000.
See Sec. 1.23-2(b) for the definition of renewable energy source
expenditures.
(d) Limitations--(1) Minimum dollar amount. No residential energy
credit shall be allowed with respect to any return (whether joint or
separate) for any taxable year if the amount of the credit otherwise
allowable (determined without regard to the tax liability limitation
imposed by paragraph (d)(3) of this section) is less than $10.
(2) Prior expenditures taken into account--(i) In general. For
purposes of determining the credit for expenditures made during a
taxable year, the taxpayer must reduce the maximum amount of allowable
expenditures with respect to the dwelling until in computing qualified
energy conservation expenditures (under paragraph (b)) or qualified
renewable energy conservation expenditures (under paragraph (c)) by
prior expenditures which were made by the taxpayer or by joint occupants
(see Sec. 1.23-3(h)) with respect to the same dwelling unit, and which
were taken into account in computing the credit for prior taxable years.
In the case of expenditures made during taxable years beginning before
January 1, 1980, the reduction of the maximum amount under paragraph (c)
must first be made with respect to the first $2,000 of expenditures (to
which a 30 percent rate applies) and then with respect to the next
$8,000 of expenditures (to which a 20 percent rate applies). This
reduction must be made if all or any part of the credit was allowed in
or was carried over from a prior taxable year.
(ii) Change of principal residence. A taxpayer is eligible for the
maximum credit for qualifying expenditures made with respect to a new
principal residence notwithstanding the allowance of a credit for
qualifying expenditures made with respect to the taxpayer's previous
principal residence. Furthermore, except in certain cases involving
joint occupancy (see Sec. 1.23-3(h)), a taxpayer is eligible for the
maximum credit notwithstanding the allowance of a credit to a prior
owner of the taxpayer's new principal residence.
(iii) Example. The rules with respect to the reduction for prior
expenditures are illustrated by the following example:
Example. In 1978, A has $1,000 of energy conservation expenditures
and $5,000 of renewable energy source expenditures in connection with
A's principal residence. A's residential energy credit for 1978 is
$1,350, made up of $150 of qualified energy conservation expenditures
(15 percent of $1,000) plus $1,200 of qualified renewable energy source
expenditures (30 percent of the first $2,000 plus 20 percent of the next
$3,000). In 1979 A has an additional $2,000 of energy conservation
expenditures and $3,000 of renewable energy source expenditures in
connection with the same principal residence. A's residential energy
credit for 1979 is $750, made up of $150 of qualified energy
conservation expenditures (15 percent of the new maximum $1,000, which
was reduced from $2,000 by $1,000 of energy conservation expenditures
taken into account in 1978) plus $600 of qualified renewable energy
source expenditures (20 percent of $3,000, which reflects the reduction
of the maximum allowable expenditures by the $5,000 of renewable energy
source expenditures taken into account in 1978). The maximum residential
energy credit allowable to A with respect to the same principal
residence in subsequent years in which the credit is allowable is $400
(20 percent of the new maximum of $2,000 for renewable energy source
expenditures and none for energy conservation expenditures).
(3) Effects of grants and subsidized energy financing--(i) In
general. Qualified expenditures financed with Federal, State, or local
grants shall be taken into account for purposes of computing the
residential energy credit only if the amount of such grants is taxable
as gross income to the taxpayer under section 61 (relating to the
definition of gross income) and the regulations
[[Page 34]]
thereunder. In the case of taxable years beginning after December 31,
1980, qualified expenditures made from subsidized energy financing (as
defined in Sec. 1.23-2(i)) shall not be taken into account (except as
provided in the following sentence) for purposes of computing the
residential energy credit. In addition, the taxpayer must reduce the
maximum amount allowable expenditures (reduced as provided in paragraph
(d)(2) of this section) with respect to the dwelling unit in computing
qualified energy conservation expenditures (under paragraph (b) of this
section) or qualified renewable energy source expenditures (under
paragraph (c) of this section), whichever is appropriate, by an amount
equal to the sum of--
(A) The amount of expenditures from subsidized energy financing (as
defined in Sec. 1.23-2(i)) that were made by the taxpayer during the
taxable year or any prior taxable year beginning after December 31,
1980, with respect to the same dwelling unit, and
(B) The amount of any funds received by the taxpayer during the
taxable year or any prior taxable year beginning after December 31,
1980, as a Federal, State, or local government grant made in taxable
years beginning after December 31, 1980, that were used to make
qualified expenditures with respect to the same dwelling unit and that
were not included in the gross income of the taxpayer.
(ii) Example. The provisions of this paragraph (d)(3) may be
illustrated by the following example:
Example. A had in 1979 made a renewable energy source expenditure of
$2,000 in connection with A's residence for which he took the then
allowed credit of $600. In 1981 A made additional renewable energy
source expenditures of $9,000 with respect to which he received a loan
of $5,000 from the Federal Solar-Energy and Energy Conservation Bank.
Assume that the loan is subsidized energy financing. A computes the
credit as follows: The initial maximum allowable dollar limit is $10,000
which is reduced by the sum of the prior year expenditures of $2,000 and
the subsidized energy financing loan of $5,000 leaving a dollar limit of
$3,000 ($10,000-($2,000+$5,000)). The $5,000 portion of the $9,000
funded by the subsidized energy financing loan is not allowed as a
renewable energy source expenditure. The remaining expenditures in 1981
are $4,000 ($9,000-$5,000). However, this amount exceeds the allowed
maximum dollar limit of $3,000. Therefore, A's creditable expenses for
1981 are only $3,000 on which the credit is $1,200 (40 percent of
$3,000).
(4) Tax liability limitation--(i) For taxable years beginning after
December 31, 1983. For taxable years beginning after December 31, 1983,
the credit allowed by this section shall not exceed the amount of tax
imposed by chapter 1 of the Internal Revenue Code of 1954 for the
taxable year, reduced by the sum of credits allowable under--
(A) Section 21 (relating to expenses for household and dependent
care services necessary for gainful employment),
(B) Section 22 (relating to credit for the elderly and the
permanently and totally disabled), and
(C) Section 24 (relating to contributions to candidates for public
office).
See section 26 (b) and (c) for certain taxes that are not treated as
imposed by chapter 1.
(ii) For taxable years beginning before January 1, 1984. For taxable
years beginning before January 1, 1984, the credit allowed by this
section shall not exceed the amount of the tax imposed by chapter 1 of
the Internal Revenue Code of 1954 for the taxable year, reduced by the
sum of the credits allowable under--
(A) Section 32 (relating to tax withheld at source on nonresident
aliens and foreign corporations and on tax-free covenant bonds),
(B) Section 33 (relating to the taxes of foreign countries and
possessions of the United States),
(C) Section 37 (relating to retirement income),
(D) Section 38 (relating to investment in certain depreciable
property),
(E) Section 40 (relating to expenses of work incentive programs),
(F) Section 41 (relating to contributions to candidates for public
office),
(G) Section 42 (relating to the general tax credit),
(H) Section 44 (relating to purchase of new personal residence),
(I) Section 44A (relating to expenses for household and dependent
care services), and
(J) Section 44B (relating to employment of certain new employees).
[[Page 35]]
(e) Carryforward of unused credit. If the credit allowable by this
section exceeds the tax liability limitation imposed by section 23(b)(5)
(or former section 44C(b)(5)) and paragraph (d)(4) of this section, the
excess credit shall be carried forward to the succeeding taxable year
and added to the credit allowable under this section for the succeeding
taxable year. A carryforward that is not used in the succeeding year
because it exceeds the tax liability limitation shall be carried forward
to later taxable years until used, except that no excess credit may be
carried forward to any taxable year beginning after December 31, 1987.
[T.D. 7717, 45 FR 57715, Aug. 29, 1980. Redesignated and amended by T.D.
8146, 52 FR 26669, July 16, 1987]
Sec. 1.23-2 Definitions.
For purposes of section 23 or former section 44C and regulations
thereunder--
(a) Energy conservation expenditures--(1) In general. The term
``energy conservation expenditure'' means an expenditure made on or
after April 20, 1977, and before January 1, 1986, by a taxpayer for
insulation or any other energy-conserving component, or for labor costs
allocable to the original installation of such insulation or other
component, if all of the following conditions are satisfied:
(i) The insulation (as defined in paragraph (c)) or other energy-
conserving component (as defined in paragraph (d)) is installed in or on
a dwelling unit that is used as the taxpayer's principal residence when
the installation is completed. See Sec. 1.23-3(e) for the definition of
principal residence.
(ii) The dwelling unit is located in the United States (as defined
in section 7701(a)(9)).
(iii) The construction of the dwelling unit was substantially
completed before April 20, 1977. See Sec. 1.23-3(f) for the definition
of the terms ``construction'' and ``substantially completed''. In the
case of expenditures made with respect to the enlargement of a dwelling
unit, the construction of the enlargement must have been substantially
completed before April 20, 1977.
(2) Examples. The application of this paragraph may be illustrated
by the following examples:
Example 1. In 1978, A spent $500 for the purchase and installation
of new storm windows to replace old storm windows, $100 to reinstall old
storm windows, and $150 to transfer a A's house insulation which had
been installed in A's garage. Only the $500 spent for new storm windows
qualifies as an energy conservation expenditure. The $100 spent to
reinstall storm windows and the $150 spent to transfer insulation to A's
house do not qualify since the only installation costs that qualify are
those for the original installation of energy conservation property the
original use of which commences with the taxpayer.
Example 2. In June 1977, B purchased for B's principal residence a
new house that was substantially completed before April 20, 1977.
Pursuant to B's request the builder installed storm windows on May 1,
1977, the cost of this option being included in the purchase price of
the house. The portion of the purchase price of the residence allocable
to the storm windows constitutes an energy conservation expenditure.
However, no other part of the purchase price may be allocated to energy
conservation property (insulation and other energy conserving
components) installed before April 20, 1977. To qualify as an energy
conservation expenditure, an expenditure must be made (i.e.,
installation of the energy conservation property must be completed) on
or after April 20, 1977.
(b) Renewable energy source expenditures. The term ``renewable
energy source expenditures'' means an expenditure made on or after April
20, 1977, and before January 1, 1986, by a taxpayer for renewable energy
source property (as defined in paragraph (e)), or for labor costs
properly allocable to the on-site preparation, assembly, or original
installation such property, if both of the following conditions are
satisfied:
(1) The renewable energy source property is installed in connection
with a dwelling unit that is used as the taxpayer's principal residence
when the installation is completed. See Sec. 1.23-3(e).
(2) The dwelling unit is located in the United States (as defined in
section 7701(a)(9)).
Additionally, the term ``renewable energy source expenditures'' includes
expenditures made after December 31, 1979, and before January 1, 1986,
for an onsite well drilled for any geothermal
[[Page 36]]
deposit (as defined in paragraph (h)), or for labor costs properly
allocable to onsite preparation, assembly, or original installation of
such well, but only if the requirements of paragraphs (b) (1) and (2) of
this section are met and the taxpayer has not elected under section
263(c) to deduct any portion of such expenditures or allocable labor
costs.
Eligibility as a renewable energy source expenditure does not depend on
the date of construction of the dwelling unit. Thus, such an expenditure
may be made in connection with either a new or an existing dwelling
unit. Renewable energy source expenditures need only be made in
connection with a dwelling, rather than in or on a dwelling unit. For
example, a solar collector that otherwise constitutes renewable energy
source property is not ineligible merely because it is installed
separately from the dwelling unit. The term ``renewable energy source
expenditure'' does not include any expenditure allocable to a swimming
pool even when used as an energy storage medium or to any other energy
storage medium whose primary function is other than the storage of
energy. It also does not include the cost of maintenance of an installed
system or the cost of leasing renewable energy source property.
(c) Insulation. The term ``insulation'' means any item that
satisfies all of the following conditions:
(1) The item is specifically and primarily designed to reduce, when
installed in or on a dwelling or on a water heater, the heat loss or
gain of such dwelling or water heater. To qualify as insulation the item
must be installed between a conditioned area and a nonconditioned area
(except when installed on a water heater, water pipe, or heating/cooling
duct). Thus for example, awnings do not qualify as insulation. For
purposes of this section the term ``conditioned area'' means an area
that has been heated or cooled by conventional or renewable energy
source means. Insulation includes materials made of fiberglass, rock
wool, cellulose, urea based foam, urethane, vermiculite, perlite,
polystyrene, and extruded polystyrene foam.
(2) The original use of the item begins with the taxpayer.
(3) The item can reasonably be expected to remain in operation at
least 3 years.
(4) The item meets the applicable performance and quality standards
prescribed in Sec. 1.23-4 (if any) that are in effect at the time the
taxpayer acquires the item. The term ``insulation'' shall not include
items whose primary purpose is not insulation (e.g., whose function is
primarily structural, decorative, or safety-related). For example,
carpeting, drapes (including linings), shades, wood paneling, fireplace
screens (including those made of glass), new or replacement walls
(except for qualifying insulation therein) and exterior siding do not
qualify although they may have been designed in part to have an
insulating effect.
(d) Other energy-conserving components. The term ``other energy-
conserving component'' means any item (other than insulation) that
satisfies all of the following conditions:
(1) The original use of the item begins with the taxpayer.
(2) The item can reasonably be expected to remain in operation for
at least 3 years.
(3) The item meets the applicable performance and quality standards
prescribed in Sec. 1.23-4 (if any) that are in effect at the time of the
taxpayer's acquisition of the item.
(4) The item is one of the following items:
(i) A furnace replacement burner. The term ``furnace replacement
burner'' means a device (for oil and gas-fired furnaces or boilers) that
is designed to achieve a reduction in the amount of fuel consumed as a
result of increased combustion efficiency. The burner must replace an
existing burner. It does not qualify if it is acquired as a component
of, or for use in, a new furnace or boiler.
(ii) A device for modifying flue openings. The term ``device for
modifying flue openings'' means an automatically operated damper that--
(A) Is designed for installation in the flue, between the barometric
damper or draft hood and the chimney, of a furnace; and
(B) Conserves energy by substantially reducing the flow of
conditioned
[[Page 37]]
air through the chimney when the furnace is not in operation.
Conditioned air is air that has been heated or cooled by conventional or
renewable energy source means.
(iii) A furnace ignition system. The term ``furnace ignition
system'' means an electrical or mechanical device, designed for
installation in a gas-fired furnace or boiler that automatically ignites
the gas burner. In order to qualify, the device must replace a gas pilot
light. Furthermore, it does not qualify if it is acquired as a component
of, or for use in, a new furnace or boiler.
(iv) A storm or thermal window or door. The terms ``storm or thermal
window'' and ``storm or thermal door'' mean the following:
(A)(1) A window placed outside or inside an ordinary or prime
window, creating an insulating air space.
(2) A window with enhanced resistance to heat flow through the
glazed area by multi-glazing.
(3) A window that consists of glass or other glazing materials that
have exceptional heat-absorbing or heat-reflecting properties. For
purposes of this subdivision (iv), the term ``glazing material'' does
not include films and coatings applied on the surface of a window.
(B)(1) A second door, installed outside or inside a prime exterior
door, creating an insulating air space.
(2) A door with enhanced resistance to heat flow through the glazed
area by multi-glazing.
(3) A prime exterior door that has an R-value (a measurement of the
ability of insulation to resist the flow of heat) of at least 2
throughout.
For purposes of this subdivision, ``multi-glazing'' is an arrangement in
which two or more sheets of glazing material are affixed in a window or
door frame to create one or more insulating air spaces. Multi-glazing
can be achieved by installing a preassembled, sealed insulating glass
unit or by affixing one or more additional sheets of glazing onto an
existing window (or sash) or door. For purposes of this subdivision, a
storm or thermal window or door does not include any film applied on or
over the surface of a window or door.
(v) Automatic energy-saving setback thermostat. The term ``automatic
energy-saving setback thermostat'' means a device that is designed to
reduce energy consumption by regulating the demand on the heating or
cooling system in which it is installed, and uses--
(A) A temperature control device for interior spaces incorporating
more than one temperature control level, and
(B) A clock or other automatic mechanism for switching from one
control level to another.
(vi) Caulking and weatherstripping. The term ``caulking'' means
pliable materials used to fill small gaps at fixed joints on buildings
to reduce the passage of air and moisture. Caulking includes, but is not
limited to, materials commonly known as ``sealants'', ``putty'', and
``glazing compounds''. The term ``weatherstripping'' means narrow strips
of material placed over or in movable joints of windows and doors to
reduce the passage of air and moisture.
(vii) Energy usage display meter. The term ``energy usage display
meter'' means a device the sole purpose of which is to display the cost
(in money) of energy usage in the dwelling. It may show cost information
for electricity usage, gas usage, oil usage, or any combination thereof.
The device may measure energy usage of the whole dwelling, or individual
appliances or systems on an instantaneous or cumulative basis.
(viii) Components specified by the Secretary. The Secretary (or his
delegate) may, in his discretion, after consultation with the Secretary
of Energy and the Secretary of Housing and Urban Development (or their
delegates), and any other appropriate Federal officers, specify by
regulation other energy-conserving components for addition to the list
of qualified items. See Sec. 1.23-6 for the procedures and criteria to
be used in determining whether an item will be considered for addition
to the list of qualified items by the Secretary.
The term ``other energy-conserving component'' is limited to items in a
category specifically listed in section 44(c)(4)(A) (i) through (vii) or
added by the Secretary.
[[Page 38]]
(e) Renewable energy source property--(1) In general. The term
``renewable energy source property'' includes any solar energy property,
wind energy property, geothermal energy property, or property referred
to in subparagraph (2), which meets the following conditions:
(i) The original use of the property begins with the taxpayer.
(ii) The property can reasonably be expected to remain in operation
for at least 5 years.
(iii) The property meets the applicable performance and quality
standards prescribed in Sec. 1.23-4 (if any) that are in effect at the
time of the taxpayer's acquisition of the property.
Renewable energy source property does not include heating or cooling
systems, nor systems to provide hot water or electricity, which serve to
supplement renewable energy source equipment in heating, cooling, or
providing hot water or electricity to a dwelling unit, and which employ
a form of energy (such as oil or gas) other than solar, wind, or
geothermal energy (or other forms of renewable energy provided in
paragraph (e)(2) of this section. Thus, heat pumps or oil or gas
furnaces, used in connection with renewable energy source property, are
not eligible for the credit. In order to be eligible for the credit for
renewable energy source property, the property (as well as labor costs
properly allocable to onsite preparation, assembly or installation of
equipment) must be clearly identifiable. See Sec. 1.23-3(l) for
recordkeeping rules.
(2) Renewable energy source specified by the Secretary. In addition
to solar, wind, and geothermal energy property, renewable energy source
property includes property that transmits or uses another renewable
energy source that the Secretary (or his delegate) specifies by
regulations, after consultation with the Secretary of Energy and the
Secretary of Housing and Urban Development (or their delegates), and any
other appropriate Federal officers, to be of a kind that is appropriate
for the purpose of heating or cooling the dwelling or providing hot
water or (in the case of expenditures made after December 31, 1979)
electricity for use within the dwelling. For purposes of this section,
references to the transmission or use of energy include its collection
and storage. See Sec. 1.23-6 for the procedures and criteria to be used
in determining when another energy source will be considered for
addition to the list of qualified renewable energy sources.
(f) Solar energy property--(1) In general. The term ``solar energy
property'' means equipment and materials of a solar energy system as
defined in this paragraph (and parts solely related to the functioning
of such equipment) which, when installed in connection with a dwelling,
transmits or uses solar energy to heat or cool the dwelling or to
provide hot water or (in the case of expenditures made after December
31, 1979) electricity for use within the dwelling. For this purpose,
solar energy is energy derived directly from sunlight (solar radiation).
Property which uses, as an energy source, fuel or energy which is
indirectly derived from sunlight (solar radiation), such as fossil fuel
or wood or heat in underground water, is not considered solar energy
property. Materials and components of ``passive solar systems'' as well
as ``active solar systems'', or a combination of both types of systems
may qualify as solar energy property.
(2) Active solar system. An active solar system is based on the use
of mechanically forced energy transfer, such as the use of fans or pumps
to circulate solar generated energy, or thermal energy transfer, such as
systems utilizing thermal siphon principles. Generally, this is
accomplished through the use of equipment such as collectors (to absorb
sunlight and create hot liquids or air), storage tanks (to store hot
liquids), rockbeds (to store hot air), thermostats (to activate pumps or
fans which circulate the hot liquids or air), and heat exchangers (to
utilize hot liquids or air to heat air or water).
(3) Passive solar system. A passive solar system is based on the use
of conductive, convective, or radiant energy transfer. In order to
qualify as a passive solar system, a solar system used for heating
purposes must contain all of the following: a solar collection area, an
absorber, a storage mass, a heat distribution method, and heat
regulation devices. The term ``solar collection area'' means an expanse
of
[[Page 39]]
transparent or translucent material, such as glass which is positioned
in such a manner that the rays of the sun directly strike an absorber.
The term ``absorber'' means a surface, such as a floor, that is exposed
to the rays of the sun admitted through the solar collection area, which
converts solar radiation into heat, and then transfers the heat to a
storage mass. The term ``storage mass'' means material, such as masonry,
that receives and holds heat from the absorber and later releases the
heat to the interior of the dwelling. The storage mass must be of
sufficient volume, depth, and thermal energy capacity to store and
deliver adequate amounts of solar heat for the relative size of the
dwelling. In addition, the storage mass must be located so that it is
capable of distributing the stored heat directly to the habitable areas
of the dwelling through a heat distribution method. The term ``heat
distribution method'' means the release of radiant heating from the
storage mass within the habitable areas of the dwelling, or convective
heating from the storage mass through airflow paths provided by openings
or by ducts in the storage mass, to habitable areas of the dwelling. The
term ``heat regulations devices'' means shading or venting mechanisms
(such as awnings or insulated drapes) to control the amount of solar
heat admitted through the solar collection areas and nighttime
insulation or its equivalent to control the amount of heat permitted to
escape from the interior of the dwelling.
(4) Components with dual function. To the extent that a passive or
active solar system utilizes portions of the structure of a residence,
only the materials and components whose sole purpose is to transmit or
use solar radiation (and labor costs associated with installing such
materials and components) are included within the term ``solar energy
property''. Accordingly, materials and components that serve a dual
purpose, e.g., they have a significant structural function or are
structural components of the dwelling (and labor costs associated with
installing such materials and components) are not included within the
term ``solar energy property''. For example, roof ponds that form part
of a roof (including additional structural components to support the
roof), windows (including clerestories and skylights), and greenhouses
do not qualify as solar energy property. However, with respect to
expenditures made after December 31, 1979, a solar collector panel
installed as a roof or portion thereof (including additional structural
components to support the roof attributable to the collector) does not
fail to qualify as solar energy property solely because it constitutes a
structural component of the dwelling on which it is installed. For this
purpose, the term ``solar collector panel'' does not include a skylight
or other type of window. In the case of a trombe wall (a south facing
wall composed of a mass wall and exterior glazing), the mass wall (and
labor costs associated with installing the mass wall) will not qualify.
However, the exterior (non-window) glazing will qualify. Any shading,
venting and heat distribution mechanisms or storage systems that do not
have a dual function will also qualify.
(g) Wind energy property. The term ``wind energy property'' means
equipment (and parts solely related to the functioning of such
equipment) which, when installed in connection with a dwelling,
transmits or uses wind energy to produce energy in a useful form for
personal residential purposes. Examples of equipment using wind energy
to produce energy in a useful form are windmills, wind-driven
generators, power conditioning and storage devices that use wind to
generate electricity or mechanical forms of energy. Devices that use
wind merely to ventilate do not qualify as wind energy property.
(h) Geothermal energy property. The term ``geothermal energy
property'' means equipment (and parts solely related to the functioning
of such equipment) necessary to transmit or use energy from a geothermal
deposit to heat or cool a dwelling or provide hot water for use within
the dwelling. With respect to expenditures made after December 31, 1979,
the term ``geothermal energy property'' also means equipment (and parts
solely related to the functioning of such equipment) necessary to
transmit or use energy from a geothermal deposit to produce electricity
for use within the dwelling.
[[Page 40]]
Equipment such as a pipe that serves both a geothermal function (by
transmitting hot geothermal water within a dwelling) and a non-
geothermal function (by transmitting hot water from a water heater
within a dwelling) does not qualify as geothermal property. A geothermal
deposit is a geothermal reservoir consisting of natural heat which is
from an underground source and is stored in rocks or in an aqueous
liquid or vapor (whether or not under pressure), having a temperature
exceeding 50 degrees Celsius as measured at the wellhead or, in the case
of a natural hot spring (where no well is drilled), at the intake to the
distribution system.
(i) Subsidized energy financing--(1) In general. The term
``subsidized energy financing'' means financing (e.g., a loan) made
directly or indirectly (such as in association with, or through the
facilities of, a bank or other lender) during a taxable year beginning
after December 31, 1980, under a Federal, State, or local program, a
principal purpose of which is to provide subsidized financing for
projects designed to conserve or produce energy. For purposes of this
paragraph (i), financing is made when funds that constitute subsidized
energy financing are disbursed. Subsidized energy financing includes
financing under a Federal, State, or local program having two or more
principal purposes (provided that at least one of the principal purposes
is to provide subsidized financing for projects designed to conserve or
produce energy), but only to the extent that the financing--
(i) Is to be used for energy production or conservation purposes, or
(ii) Is provided out of funds designated specifically for energy
production or conservation.
Loan proceeds meet the use test of paragraph (i)(l)(i) of this section
only to the extent that the loan application, the loan instrument, or
any other loan-related documents indicate that the funds are intended
for such use. However, loan proceeds designated for the purchase either
of property that contains ``insulation'' or any ``other energy-
conserving component'' or of ``renewable energy source property'' as
defined in paragraphs (c), (d), and (e), respectively, of this section
meet the test of paragraph (i)(l)(i) of this section. Financing is
subsidized if the interest rate or other terms of the financing
(including any special tax treatment) provided to the taxpayer in
connection with the program or used to raise funds for the program are
more favorable than the terms generally available commercially. In
addition, financing is subsidized if the principal obligation of the
financing provided to the taxpayer is reduced by funds provided under
the program. The source from which the funds for the program are derived
is not a factor to be taken into account in determining whether the
financing is subsidized. If a public utility disburses funds for the
financing of energy conservation or renewable energy source property
under a program that obtains the funds through sales to the utility's
ratepayers, the program is not considered to be a Federal, State or
local program even though the utility is a governmental agency, and,
thus, the funds are not subsidized energy financing. Subsidized energy
financing does not include a grant includible in gross income under
section 61, nontaxable grants, a credit against State or local taxes
made directly to the taxpayer claiming the credit provided for in
section 23, or a loan guarantee made directly to the taxpayer claiming
the credit provided for in section 23.
(2) Examples. The provisions of this paragraph (i) may be
illustrated by the following examples:
Example 1. State A has a farm and home loan program. The program is
used to provide low interest mortgage loans. In 1984 State A's
legislature enacted statutory amendments to its farm and home loan
program in an effort to encourage energy conservation-type measures. Low
interest loans for such improvements were made available to qualified
purchasers and owners under the farm and home loan program. The energy
conservation measures subsidized by the program include energy
conserving components and renewable energy source devices. State A's tax
exempt bonds are the source of funds for loans under the program.
Although the 1984 legislation authorizing loans for energy conserving
components and renewable energy source improvements did not diminish the
original purpose of the farm and home loan program, the 1984 legislation
added another principal purpose to the program. Therefore, State A's
program which has two
[[Page 41]]
principal purposes, one of which is the conservation or production of
energy, is considered as providing subsidized energy financing for
purposes of section 23 (c)(10) of the Code, to the extent that financing
is provided by State A out of funds designated specifically for energy
production or conservation. State A's program will also be considered as
providing subsidized energy financing to the extent that the loan
proceeds are to be used for energy production or conservation purposes.
Loan proceeds meet the use test of the preceding sentence only to the
extent that loan application, the loan instruments, or any other loan-
related documents indicate that the funds are intended for such use.
Example 2. The United States Department of Energy disburses funds to
State B that the Department received from settlements from alleged
petroleum pricing and allocation violations. State B establishes a
program under which B will use the funds to make loans at below market
interest rates directly to qualified applicants for the purchase of
renewable energy source property. B's loans are subsidized energy
financing.
Example 3. State C establishes a program under which C will make
loans at below market interest rates directly to qualified applicants
for the purchases of renewable energy source property. The program is
funded with money that State C was able to borrow after it obtained a
loan guarantee from a Federal agency. C's loans provided under the
program are subsidized energy financing.
Example 4. Company D is an electric utility that is a Federal
agency. D purchases its electricity from another federal agency,
transmits the electricity over its own distribution system, and sells
the electricity to numerous local public utilities that in turn sell the
electricity to their customers. D wishes to start a program under which
D will make loans at below market interest rates directly to customers
of the local utilities for the purchase of renewable energy source
property from D. The local public utility will act as the collection
agent for repayment of the loans. The loans will be repayable over a
period of time not in excess of 15 years. Under law, D must cover its
full costs through its own revenues derived from the sale of power and
other services. While D may borrow by sale of bonds to the United States
Treasury, D must borrow at rates comparable to the rates prevailing in
the market for similar bonds. Thus, the subsidized loans made under D's
program will be financed by the profits from the sale of electricity to
consumers and not by the federal government. D's program, which is
substantially the same as that carried out by private (investor-owned)
utilities, is not considered to be a Federal, State or local
governmental program. Therefore, D's loans are not subsidized energy
financing.
Example 5. The Solar Energy and Energy Conservation Bank (Bank)
disburses funds to State E. E disburses a portion of the funds to
Financial Institution F. Both the Bank and State E make these
disbursements under a program the principal purpose of which is to
provide subsidized financing for projects designed to conserve or
produce energy. F uses the funds to reduce a portion of the principal
obligation on loans it issues to finance energy conservation or solar
energy expenditures. Taxpayer G borrows $3,000 from F in order to
purchase a solar water heating system. F uses $500 of the funds it
received from the Bank to reduce the principal obligation of the loan to
G to $2,500. The amount of subsidized energy financing to G is $3,000.
Example 6. State H allows a tax credit to Financial Institution J
under a program the principal purpose of which is to provide loans at
below market interest rates directly to qualified applicants for the
purchase of renewable energy source property. J receives a credit each
year in the amount of the excess of the interest that would have been
paid at private market rates over the actual interest paid on such
loans. The State H tax credit arrangement is an interest subsidy. Thus,
any low-interest loans made pursuant to this credit arrangement are
subsidized energy financing.
[T.D. 7717, 45 FR 57716, Aug. 29, 1980. Redesignated and amended by T.D.
8146, 52 FR 26670, July 16, 1987]
Sec. 1.23-3 Special rules.
(a) When expenditures are treated as made--(1) Timeliness of an
expenditure for the energy credit. In general, for the purpose of
determining whether an expenditure qualifies as being timely for the
residential energy credit under section 23 or former section 44C (i.e.,
is made after April 19, 1977, and before January 1, 1986), the
expenditure is treated as made when original installation of the item is
completed. Thus, solely for that purpose, the time of payment or accrual
is irrelevant.
(2) Special rule for renewable energy source expenditures in the
case of construction or reconstruction of a dwelling. In the case of
renewable energy source expenditures in connection with the construction
or reconstruction of a dwelling that becomes the taxpayer's new
principal residence, the expenditures are to be treated as made (for the
purpose of determining the timeliness of an expenditure for the
residential
[[Page 42]]
energy credit) when the taxpayer commences use of the dwelling as his or
her principal residence following its construction or reconstruction.
The term ``reconstruction'' means the replacement of most of a
dwelling's major structural components such as floors, walls, and
ceiling. When a taxpayer reoccupies a reconstructed dwelling that was
the taxpayer's principal residence prior to reconstruction, a renewable
energy source expenditure is considered made when the original
installation of the renewable energy source property is completed.
(3) Taxable year in which credit is allowable. For the purpose of
determining the taxable year in which the credit for an expenditure is
allowable (once it has qualified as timely under subparagraph (1) or
(2)), an expenditure is treated as made on the later of (i) the date on
which it qualifies as timely; or (ii) the date on which it is paid or
incurred by the taxpayer.
(b) Expenditures in 1977. No credit under section 23 or former
section 44C shall be allowed for any taxable year beginning before 1978.
However, the amount of any credit under section 23 or former section 44C
for the taxpayer's first taxable year beginning after December 31, 1977,
shall take into account qualified energy conservation expenditures and
qualified renewable energy source expenditures made during the period
beginning April 20, 1977, and ending on the last day of such first
taxable year.
(c) Cross reference. For rules relating to expenditures financed
with Federal, State, or local government grants or subsidized financing
see paragraph (d)(3) of Sec. 1.23-1 and paragraph (i) of Sec. 1.23-2.
(d) Expenditures qualifying both as energy conservation expenditures
and renewable source expenditures. In the case of an expenditure which
meets both the definition of an energy conservation expenditure (as
defined in Sec. 1.23-2(a)) and a renewable energy source expenditure (as
defined in Sec. 1.23-2(b)), the taxpayer may claim either a credit under
Sec. 1.23-1(b) (relating to qualified energy conservation expenditures)
or Sec. 1.23-1(c) (relating to qualified renewable energy source
expenditures) but may not claim both credits with respect to the same
expenditure.
(e) Principal residence. For purposes of section 23 or former
section 44C the determination of whether a dwelling unit is the
taxpayer's principal residence shall be made under principles similar to
those applicable to section 1034 and the regulations thereunder
(relating to sale or exchange of a principal residence) except that
ownership of the dwelling unit is not required. In making this
determination, the period for which a dwelling is treated as a
taxpayer's principal residence includes the 30-day period ending on the
first day on which the dwelling unit would (but for this sentence) be
treated as being used as the taxpayer's principal residence under
principles similar to those applicable to section 1034. Thus,
installation that are completed within that 30-day period may be
eligible for the credit although, in the absence of the 30-day rule, the
date of habitation of the dwelling unit by the taxpayer would mark the
beginning of the taxpayer's use of the unit as a principal residence.
(f) Construction substantially completed. Construction of a dwelling
unit is substantially completed when construction has progressed to the
point where the unit could be put to use as a personal residence, even
though comparatively minor items remain to be finished or performed in
order to conform to the plans or specifications of the completed
building. For this purpose, construction includes reconstruction as
defined in paragraph (a)(2). This rule may be illustrated by the
following example:
Example. On January 1, 1979, A purchases a dwelling that is to
become A's principal residence. The dwelling unit was originally
constructed in 1950. A spends $50,000 to reconstruct the dwelling by
replacing most of the dwelling's major structural components such as
floors, walls, and ceilings. Included in the cost is $3,000 attributable
to energy-conserving components. Reconstruction is substantially
completed on April 1, 1979, and A moves into the reconstructed residence
on May 1, 1979. Since construction includes reconstruction, A's
reconstructed residence is not considered substantially completed before
April 20, 1977. Thus, amounts spent with respect to A's reconstructed
residence for energy-conserving components do not qualify as energy
conservation expenditures.
[[Page 43]]
(g) Residential use of property. To be eligible for the residential
energy credit, expenditures must be made for personal residential
purposes. If at least 80 percent of the use of a component or item of
property is for personal residential purposes, the entire amount of the
energy conservation expenditure or the renewable energy source
expenditure is taken into account in computing the credit under this
section. If less than 80 percent of the use of a component or item of
property is for personal residential purposes, the amount of an
expenditure taken into account is the amount that bears the same ratio
to the amount of the expenditure as the amount of personal residential
use of the component or item bears to its total use. For purposes of
this paragraph, use of a component or an item of property with respect
to a swimming pool is not a use for a personal residential purpose. The
rules with respect to residential use of property are illustrated by the
following examples:
Example 1. In 1978 A makes an expenditure of $3,000 for the
installation of storm windows of which 50 percent is on the portion of
A's dwelling used as the principal family residence and 50 percent is on
the portion of the dwelling used as an office. A has made no other
energy conservation expenditures for the residence. The allowable energy
conservation expenditure is $1,500 (50 percent of $3,000), the portion
attributable to residential use. Therefore, the residential energy
credit is $225 (the qualified conservation expenditure of 15 percent of
$1.500).
Example 2. During 1979, B makes $10,000 of renewable energy source
expenditures on solar energy property for B's principal residence.
Approximately 60 percent of the use of the solar energy property will be
for heating B's swimming pool; the other 40 percent will be for heating
the dwelling unit. B had not previously made renewable energy source
expenditures with respect to the residence. Since use for a swimming
pool is not considered a residential use, less than 80 percent of the
use of B's solar energy property is considered used for personal
residential purposes. Therefore, only $4,000 (40 percent of $10,000),
the proportionate part of B's expenditures representing personal
residential use, is treated as a renewable energy source expenditure. B
is allowed a $1,000 residential energy credit (30 percent of $2,000 plus
20 percent of $2,000) for 1979.
(h) Joint occupancy--(1) In general. If two or more individuals
jointly occupied and used a dwelling unit as their principal residence
during any portion of a calendar year--
(i) The amount of the credit allowable under section 23 or former
section 44C by reason of energy conservation expenditures or by reason
of renewable energy source expenditures shall be determined by treating
all of the joint occupants as one taxpayer whose taxable year is such
calendar year; and
(ii) The credit under section 23 or former section 44C allowable to
each joint occupant for the taxable year with which or in which such
calendar year ends shall be an amount which bears the same ratio to the
amount determined under paragraph (h)(1)(i) of this section as the
amount of energy conservation expenditures or renewable energy source
expenditures made by that occupant bears to the total amount of each
type of such expenditures made by all joint occupants during such
calendar year.
The provisions of this subparagraph may be illustrated by the following
example:
Example. A, a calendar year taxpayer, and B, a June 1 fiscal year
taxpayer, make energy conservation exenditures of $2,000 (A making
expenditures of $500 and B making expenditures of $1,500) on their
principal and jointly occupied residence in 1978. A and B have not
previously make energy conservation expenditures with respect to this
residence. Of the $300 credit (15 percent of $2,000), $75 will be
allocated to A ($500/$2,000 x $300) and $225 to B ($1,500/$2,000
x 300). A will claim the allocable share of the credit on A's 1978 tax
return and B will claim the allocable share of the credit on B's tax
return for the fiscal year ending May 31, 1979.
(2) Minimum credit. The fact that one joint occupant may be unable
to claim all or part of the credit under section 23 of former section
44C because of insufficient tax liability or because that occupant's
allowable credit does not exceed the $10 minimum credit (as set forth in
paragraph (d)(1) of Sec. 1.23-1) shall have no effect upon the
computation of the amount of the allowable credits for the other joint
occupants.
(3) Prior expenditures. Because joint occupants are treated as one
taxpayer for purposes of determining the residential energy credit, the
maximum
[[Page 44]]
amount of energy conservation expenditures or renewable energy source
expenditures must be reduced by the total amount of such expenditures
made in connection with the dwelling unit during prior calendar years in
which any one of the residents of the unit during the current calendar
year was a resident (whether made by the current resident or by an
individual previously occupying the dwelling with the current resident).
However, the preceding sentence shall not apply to prior expenditures no
part of which was taken into account in computing the credits under
section 23 of former section 44C for such years. Prior years'
expenditures are not to be allocated among joint occupants to take into
account the specific expenditures of each of the occupants in prior
years.
(4) The rules of this paragraph may be illustrated by the following
examples:
Example 1. Assume A and B have together made prior years' energy
conservation expenditures of $1,600 (A having made $1,200 of
expenditures and B having made $400) on their principal and jointly
occupied residence. In the current year, each makes energy conservation
expenditures of $300 with respect to the same residence. The maximum
qualified expenditure with respect to the residence is reduced by the
$1,600 of prior expenditures made by A and B. Therefore, only $400 of
the $600 current expenditures are eligible as energy conservation
expenditures. The resulting residential energy credit is $60 (15 percent
of $400) of which $30 apiece will be allocated to A and B ($300/$600 x
$60). The fact that A had previously computed the credit in prior years
with respect to $1,200 of the total $1,600 of expenditures is irrelevant
to the apportionment of the credit in the current year.
Example 2. In 1978, spouses C and D make $10,000 of renewable energy
source expenditures with respect to their principal residence, half of
which is paid by each spouse. No prior renewable energy source
expenditures have been taken into account with respect to that residence
by either C or D. C and D file separate returns for the calendar year.
Under the joint occupancy rule, the maximum allowable renewable energy
source credit with respect to C and D's principal residence is $2,200
(30 percent of the first $2,000, and 20 percent of the next $8,000 of
expenditures). Half of this amount or $1,100, will be allowed to each
spouse. If either spouse makes renewable energy source expenditures with
respect to the same principal residence in future years, none of those
expenditures would be qualified renewable energy source expenditures for
which a credit can be claimed. That is, not more than $2,200 may be
taken in the aggregate by C and D as a renewable energy source credit
with respect to their principal residence.
Example 3. In 1978, E and F make energy conservation expenditures of
$1,500 on their principal and jointly occupied residence. In 1979, E
moves away and G becomes the other joint occupant of the residence. F
and G make energy conservation expenditures of $1,000 in 1979. In 1980 F
moves away and H moves in with G. G and H make energy conservation
expenditures of $500. The maximum qualified expenditure made by F and G
with respect to the residence is reduced by the $1,500 of prior
expenditures made in 1978 by E and F. The maximum qualified expenditures
made by G and H with respect to the residence is reduced only by the
expenditures in prior years in connection with the residence during
which either G or H was a joint occupant. Accordingly, the maximum
qualified expenditures made by G and H with respect to the residence is
reduced only by the $1,000 of prior expenditures made in 1979 by F and
G.
(i) Condominiums and cooperative housing corporations. An individual
who is a tenant stockholder in a cooperative housing corporation (as
defined in section 216) or who is a member of a condominium management
association with respect to a condominium which he or she owns shall be
treated as having made a proportionate share of the energy conservation
expenditures or renewable energy source expenditures of such corporation
or association. The cooperative stockholder's allocable share of the
expenditures is to be the same as his or her proportionate share of the
cooperative's total outstanding stock (including any stock held by the
corporation). However, in the case where only certain cooperative
stockholders are assessed for the expenditures made by the cooperative
housing corporation, only those cooperative stockholders that are
assessed shall be treated as having made a share of the expenditures of
such corporation. In such case, the cooperative stockholder's share of
the expenditures is the amount that the stockholder is assessed. The
allocable share of a condominium management association member's energy
conservation of renewable energy source expenditures is the amount that
the member is assessed
[[Page 45]]
(or would be assessed in the case where expenditures are from general
funds) by the association as a result of such expenditures. The
residential energy credit for a qualified expenditure is allowable for
the year in which the association or corporation has completed original
installation of the item (or has paid or incurred the expenditure, if
later). For purposes of this paragraph, the term ``condominium
management association'' means an organization meeting the requirements
of section 528(c)(1) of the Code (other than subparagraph (E) of that
section), with respect to a condominium project substantially all the
units of which are used as residences.
(j) Joint ownership of energy conservation property or renewable
energy source property--(1) In general. Energy conservation property
renewable energy source property include property which is jointly owned
by the taxpayer and another person (or persons) and installed in
connection with two or more dwelling units. For example, the fact that a
windmill, solar collector, or geothermal well and distribution system is
owned by two or more individuals does not preclude its qualification as
renewable energy source property. The amount of the credit allowable
under section 23 shall be computed separately with respect to the amount
of the expenditures made by each individual, subject to the limitations
of $2,000 imposed by section 23(b)(1) and $10,000 imposed by section
23(b)(2), per dwelling units of jointly owned property. For example, in
1982, A, B, and C purchased as joint owners renewable energy source
property that serviced two houses. One of the houses is jointly owned
and occupied by A and B and the other is owned and occupied by C alone.
The renewable energy source property cost $30,000 of which A paid
$9,000, B paid $6,000, and C paid $15,000. A and B must share the $4,000
credit (40% of $10,000 maximum) with respect to the expenditures for the
jointly owned house. Therefore, A is allowed a $2,400 credit ($4,000
times $9,000 divided by $9,000 plus $6,000) and B is allowed a $1,600
credit ($4,000 times $6,000 divided by $9,000 plus $6,000) with respect
to the expenditures attributable to the jointly owned house. C is
entitled to a credit of $4,000 with respect to the expenditures
attributable to the other house.
(2) Example. The application of this subparagraph may be illustrated
by the following example:
Example. A, B, and C each has a separate principal residence. They
agree to finance jointly the construction of a solar collector, each
providing one-third of the costs and taking one-third of the output of
the collector. Each will separately pay for the costs of connecting the
solar collector with his or her principal residence. Provided the solar
collector and connection equipment otherwise qualify as renewable energy
source property, A, B, and C will each be considered to have made
renewable energy source expenditures equal to one-third of the cost of
the collector plus his or her separate connection costs. Such
expenditures will be subject to the limitations and other rules
separately applicable to A, B, and C with respect to each principal
residence, such as those with respect to the $10 minimum (Sec. 1.23-
1(d)(1)), prior expenditures (Sec. 1.23-1(d)(2)), residential use
(paragraph (g) of this section), and joint occupancy (paragraph (h) of
this section).
(k) Basic adjustments. If a credit is allowed under section 23 or
former section 44C for any expenditure with respect to any property, the
increase in the basis of that property which would (but for this
paragraph) result from such expenditure shall be reduced by the amount
of the credit allowed.
(l) Recordkeeping--(1) In general. No residential energy credit is
allowable unless the taxpayer maintains the records described in
paragraph (l)(2) of this section. The records shall be retained so long
as the contents thereof may become material in the administration of any
internal revenue law.
(2) Records. The taxpayer must maintain records that clearly
identify the energy-conserving components and renewable energy source
property with respect to which a residential energy credit is claimed,
and substantiate their cost to the taxpayer, any labor costs properly
allocable to them paid for by the taxpayer, and the method used for
allocating such labor costs.
[T.D. 7717, 45 FR 57719, Aug. 29, 1980. Redesignated and amended by T.D.
8146, 52 FR 26672, July 16, 1987]
[[Page 46]]
Sec. 1.23-4 Performance and quality standards. [Reserved]
[T.D. 7717, 45 FR 57721, Aug. 29, 1980. Redesignated by T.D. 8146, 52 FR
26672, July 16, 1987]
Sec. 1.23-5 Certification procedures.
(a) Certification that an item meets the definition of an energy-
conserving component or renewable energy source property. Upon the
request of a manufacturer of an item pursuant to paragraph (b) of this
section which is supported by proof that the item is entitled to be
certified, the Assistant Commissioner (Technical) shall certify (or
shall notify the manufacturer that the request is denied) that:
(1) The item meets the definition of insulation (see Sec. 1.23-
2(c)(1)).
(2) The item meets the definition of an other energy-conserving
component specified in section 23(c)(4) or former section 44C(c)(4) see
(Sec. 1.23-2(d)(4)).
(3) The item meets the definition of solar energy property (see
Sec. 1.23-2(f)), wind energy property (see Sec. 1.23-2(g)), or
geothermal energy property (see Sec. 1.23-2(h)).
(4) The item meets the definition of a category of energy-conserving
component that has been added to the list of approved items pursuant to
paragraph (d)(4)(viii) of Sec. 1.23-2.
(5) The item meets the definition of renewable energy source
property that transmits or uses a renewable energy source that has been
added to the list of approved renewable energy sources pursuant to
paragraph (e)(2) of Sec. 1.23-2.
(b) Procedure--(1) In general. A manufacturer of an item desiring to
apply under paragraph (a) shall submit the application to the
Commissioner of Internal Revenue, Attention: Associate Chief Counsel
(Technical), CC:C:E, 1111 Constitution Avenue NW., Washington, DC 20224.
Upon being advised by the National Office, orally or in writing, that an
adverse decision is contemplated a manufacturer may request a
conference. The conference must be held within 21 calendar days from the
date of that advice. Procedures for requesting an extension of the 21-
day period and notifying the manufacturer of the Service's decision on
that request are the same as those applicable to conferences on ruling
requests by taxpayers (see section 9.05 of Rev. Proc. 80-20).
(2) Contents of application. The application shall include a
description of the item (including appropriate design drawings and
specifications) and an explanation of the purpose and function of the
item. There shall accompany the application a declaration in the
following form: ``Under penalties of perjury, I declare that I have
examined this application, including accompanying documents and, to the
best of my knowledge and belief, the facts presented in support of the
application are true, correct, and complete.'' The statement must be
signed by the person or persons making the application.
(c) Effect of certification under paragraph (a). Certifications
granted under paragraph (a)(1), (2), or (3) will be applied
retroactively to April 20, 1977. However, certifications granted under
paragraph (a) (4) or (5) will be applied retroactively only to the date
the applicable energy-conserving component or renewable energy source
was added by Treasury decision to the list of qualifying components or
sources. Certification of an item under this section means that the
applicable definitional requirement of Sec. 1.23-2 is considered
satisfied in the case of any person claiming a residential energy credit
with respect to such item. However, it does not relieve manufacturers of
the need to establish that their items conform to performance and
quality standards (if any) provided under Sec. 1.23-4 and that their
items can reasonably be expected to remain in operation at least 3
years, in the case of insulation and other energy-conserving components,
or at least 5 years, in the case of renewable energy source property.
[T.D. 7717, 45 FR 57721, Aug. 29, 1980. Redesignated and amended by T.D.
8146, 52 FR 26672, July 16, 1987]
Sec. 1.23-6 Procedure and criteria for additions to the approved list of energy-conserving components or renewable energy sources.
(a) Procedures for additions to the list of energy-conserving
components or renewable energy sources--(1) In general. A manufacturer
of an item (or a group of manufacturers) desiring to apply for addition
to the approved list of energy-
[[Page 47]]
conserving components or renewable energy sources pursuant to paragraph
(d)(4)(viii) or (e)(2) of Sec. 1.23-2 shall submit an application to the
Internal Revenue Service, Attention: Associate Chief Counsel
(Technical), CC:C:E, 1111 Constitution Avenue, NW., Washington, DC
20224. The term ``manufacturer'' includes a person who assembles an item
or a system from components manufactured by other persons. The
application shall provide the information required under paragraph (b)
of this section. An application may request that more than one item be
added to the approved list. It will be the responsibility of the Office
of the Associate Chief Counsel (Technical) upon receipt of the
application to determine whether all the information required under
paragraph (b) of this section has been furnished with the application.
If an application lacks essential information, the applicant will be
advised of the additional information required. If the information (or a
reasonable explanation of the reason why the information cannot be made
available) is not forthcoming within 30 days of the date of that advice,
the application will be closed and the applicant will be so informed.
Any resubmission of information beyond the 30-day period will be treated
as a new application. If the Office of the Associate Chief Counsel
(Technical) already is considering an application with respect to the
same or a similar item, it may consolidate applications. The Office of
the Associate Chief Counsel will make a report and recommendation to the
ad hoc advisory board as to whether each item that is the subject to an
application should be added in accordance with the manufacturer's
request to the approved list of energy-conserving components or
renewable energy sources in light of the applicable criteria provided in
paragraph (c) and the standards for Secretarial determination provided
in paragraph (d) of this section. In making this recommendation, the
Office of the Associate Chief Counsel shall consult with the Secretary
of Energy and the Secretary of Housing and Urban Development (or their
delegates) and any other appropriate Federal officers to obtain their
views concerning the item in question. In addition, the Office of the
Associate Chief Counsel may request from the manufacturer clarification
of information submitted with the application. The Office of the
Associate Chief Counsel shall report its recommendation and forward the
application to the ad hoc advisory board for further consideration.
(2) Ad hoc advisory board. The Commissioner of Internal Revenue and
the Assistant Secretary (Tax Policy) shall establish an ad hoc advisory
board to consider applications and recommendations forwarded by the
Office of the Associate Chief Counsel (Technical). If a finding in favor
of addition of any item is made, the board shall report its
recommendation and forward the application to the Commissioner for
further consideration. If the item is approved by the Commissioner, the
application will be forwarded to the Secretary (or his delegate) for
further consideration. The application will be closed with respect to an
item if the board, the Commissioner, or the Secretary (or his delegate)
determines that, under the applicable criteria or the standards for
Secretarial determination, the item should not be added to the list of
energy-conserving components or renewable energy sources.
(3) Action on application. (i) A final decision to grant or deny any
application filed under paragraph (a)(1) shall be made within 1 year
after the application and all information required to be filed with such
request under paragraph (b) have been received by the Office of the
Associate Chief Counsel (Technical). The applicant manufacturer shall be
notified in writing of the final decision. In the event of a favorable
determination, a regulation will be issued in accordance with the
procedures contained in Sec. 601.601 to include the item as an energy-
conserving component or as a renewable energy source. A final decision
to grant approval of an application is made when a Treasury decision
adding the item (that is subject of the application) as an energy-
conserving component or as a renewable energy source is published in the
Federal Register.
(ii) The applicant manufacturer shall be entitled to a conference
and be so notified anytime an adverse action is
[[Page 48]]
contemplated by the Office of the Associate Chief Counsel, the ad hoc
advisory board, the Commissioner of Internal Revenue, or the Secretary
(or his delegate) and no conference was previously conducted. Upon being
advised in writing that an adverse recommendation or decision as to any
item that is the subject of an application is contemplated, a
manufacturer may request a conference. The conference must be held
within 21 calendar days from the mailing of that advice. Procedures for
requesting an extension of the 21-day period and notifying the
manufacturer of the recommendation or decision with respect to that
request are the same as those applicable to conferences on ruling
requests by taxpayers. The applicant is entitled to only one conference.
There is no right to another conference when a favorable recommendation
or decision is reversed at a higher level.
(iii) A report of any application which has been denied during the
preceding month and the reasons for the denial shall be published each
month.
(b) Contents of application. The application by the manufacturer
shall include the following information:
(1) A description of the item and the generic class to which it
belongs, including any features relating to safe installation and use of
the item. This description shall include appropriate design drawings and
technical specifications (or representative drawings and specifications
when application by a group of manufacturers).
(2) An explanation of the purpose, function, and each recommended
use of the item.
(3) An estimate (and explanation of the estimation methods employed
and the assumptions made) of the total number of units that would be
sold for each recommended use during the first 4 years following the
addition of the item to the approved list and of the total number that
would be sold for each recommended use during that period in the absence
of addition. If the item is sold in more than one size, the estimate
shall indicate the projected sales for each size. This estimate shall
reflect total industry sales of the item. Past industry sales
information for each recommended use for the previous two years shall
also be provided.
(4) Whether sufficient capacity is available to increase production
to meet any increase in demand for the item, or for associated fuels and
materials, caused by such addition. This determination shall be based on
industry-wide data and not just the manufacturing capability of the
applicant. If the applicant has the exclusive right to manufacture the
item, this information shall also be provided in the application.
(5) An estimate (including estimation methods and assumptions) of
the energy in Btu's of oil and natural gas used directly or indirectly
per unit by the applicant in the manufacture of the item and other items
necessary for its use, the type of energy source (e.g., oil, natural
gas, coal, electricity), and the extent of its use in the manufacturing
process of the item. The applicant must also provide a list of the major
components of the item and their composition and weight.
(6) Test data and experience data (where experience data is
available) to substantiate for each recommended use the energy savings
in Btu's that are claimed will be achieved by one unit during a period
of one year. The data shall be obtained by controlled tests in which, if
possible, the addition of the item is the only variable. If the item may
be sold in various configurations, data shall be provided with respect
to energy savings from each configuration with significantly different
energy use characteristics. Test methods are to conform to recognized
industry or government standards. This determination shall take into
account the seasonal use of the item. If the energy savings of the item
varies with climatic conditions, data shall be provided with respect to
each climate zone. The applicant may use the Department of Energy's
climatic zones for heating and cooling (see Sec. 450.35 of 10 CFR part
450 (1980)).
(7) The impact of increased demand on the price of the item and the
energy source used by the item.
(8) The energy source which will be replaced or conserved by the
item, and, in the case of a request for addition to the approved list of
renewable energy
[[Page 49]]
sources, data establishing that the energy source is inexhaustible.
(9) Data to show the total estimated savings of energy in Btu's
attributable to reduced consumption of oil or natural gas whether
directly or indirectly from use of the item, including assumptions
underlying this estimate. If the consumption of both oil and natural gas
will be reduced, data to show the energy savings in Btu's attributable
to each shall be provided. The estimate is to be based on energy savings
in Btu's per unit determined under paragraph (b)(6) of this section for
the first four years of the useful life of the item and is to take into
account only the additional units of the item estimated to be placed in
service as a result of the addition using data obtained under paragraph
(b)(3) of this section. If the item will result in reduction of oil or
natural gas consumption by replacing an item which uses such an energy
source, the application shall indicate the item replaced and the extent
to which this reduction will occur.
(10) Geographical information if required under paragraph (b)(6) of
this section to show the climatic zones of the country where the item is
expected to be used, including an estimate of the total number of
additional units to be placed in service during the first 4 years
following the addition of the item in the area as a result of the
addition of the item to the list of qualifying items.
(11) The retail cost of the item (or items if the item is sold in
more than one size) including all installation costs necessary for safe
and effective use.
(12) Whether the item is designed for residential use.
(13) The estimated useful life of the item and associated equipment
necessary for its use.
(14) The type and amount of waste and emissions in weight per unit
of energy saved resulting from use of the item.
(15) If the item might reasonably be suspected of presenting any
health or safety hazard, test data to show that the item does not
present such hazard.
With respect to applications for addition to the approved list of
renewable energy sources, the term ``item'' as used in this paragraph
refers to the property which uses the energy source and not the energy
source itself. The application should clearly indicate whether the
request is for addition to the approved list of energy-conserving
components or renewable energy sources, identify the provisions for
which data is being submitted, and present the data in the order
requested. The tests required under this paragraph may be conducted by
independent laboratories but the underlying data must be submitted along
with the test results. There shall accompany the request a declaration
in the following form: ``Under penalties of perjury, I declare that I
have examined this application, including accompanying documents, and,
to the best of my knowledge and belief, the facts presented in support
of the application are true, correct and complete.'' The statement must
be signed by the person or persons making the application. The
declaration shall not be made by the taxpayer's representative.
(c) Criteria for additions--(1) Additions to the approved list of
energy-conserving components. For an item to be considered for addition
to the approved list of energy-conserving components, the manufacturer
must show that the item increases the energy efficiency of a dwelling.
For an item to be considered as increasing the energy efficiency of a
dwelling, all of the following criteria must be met:
(i) The use of the item must improve the energy efficiency of the
dwelling structure, structural components of the dwelling, hot water
heating, or heating or cooling systems.
(ii) The use of the item must result, directly or indirectly, in a
significant reduction in the consumption of oil or natural gas.
(iii) The increase in energy efficiency must be established by test
data and in accordance with accepted testing standards.
(iv) The item must not present a safety, fire, environmental, or
health hazard when properly installed.
(2) Additions to the approved list of renewable energy sources. For
an energy source to be considered for addition to the approved list of
renewable energy
[[Page 50]]
sources, the manufacturer must show that the following criteria are met:
(i) As in the case of solar, wind, and geothermal energy, the energy
source must be an inexhaustible energy supply. Accordingly, wood and
agricultural products and by-products are not considered renewable
energy sources. Similarly, no exhaustible or depletable energy source
(such as sources that are depletable under 611) will be considered.
(ii) The energy source must be capable of being used for heating or
cooling a residential dwelling or providing hot water or electricity for
use in such a dwelling.
(iii) A practical working device, machine, or mechanism, etc., must
exist and be commercially available to use such renewable energy source.
(iv) The use of the renewable energy source must not present a
significant safety, fire, environmental, or health hazard.
(d) Standards for Secretarial determination--(1) In general. The
Secretary will not make any addition to the approved list of energy-
conserving components or renewable energy sources unless the Secretary
determines that--
(i) There will be a reduction in the total consumption of oil or
natural gas as a result of the addition, and that reduction is
sufficient to justify any resulting decrease in Federal revenues.
(ii) The addition will not result in an increased use of any item
which is known to be, or reasonably suspected to be, environmentally
hazardous or a threat to public health or safety, and
(iii) Available Federal subsidies do not make the addition
unnecessary or inappropriate (in the light of the most advantageous
allocation of economic resources).
(2) Factors taken into account. In making any determination under
paragraph (d)(1)(i) of this section, the Secretary will--
(i) Make an estimate of the amount by which the addition will reduce
oil and natural gas consumption, and
(ii) Determine whether the addition compares favorably, on the basis
of the reduction in oil and natural gas consumption per dollar of cost
to the Federal Government (including revenue loss), with other Federal
programs in existence or being proposed.
(3) Factors taken into account in making estimates. In making any
estimate under subparagraph (2)(i), the Secretary will take into account
(among other factors)--
(i) The extent to which the use of any item will be increased as a
result of the addition,
(ii) Whether sufficient capacity is available to increase production
to meet any increase in demand for the item or associated fuels and
materials caused by the addition,
(iii) The amount of oil and natural gas used directly or indirectly
in the manufacture of the item and other items necessary for its use,
(iv) The estimated useful life of the item, and
(v) The extent additional use of the item leads, directly or
indirectly, to the reduced use of oil or natural gas. Indirect uses of
oil or natural gas include use of electricity derived from oil or
natural gas.
(e) Effective date of addition to approved lists. In the case of
additions to the approved list of energy-conserving components or
renewable energy sources, the credit allowable by Sec. 1.23-1 shall
apply with respect to expenditures which are made on or after the date a
Treasury decision amending the regulations pursuant to the application
is published in the Federal Register. However, the Secretary may
prescribe by regulations that expenditures for additions made on or
after the date referred to in the preceding sentence and before the
close of the taxable year in which such date occurs shall be taken into
account in the following taxable year. Additions to the list will be
subject to the performance and quality standards (if any) provided under
Sec. 1.23-4 which are in effect at the time of the addition.
Furthermore, any addition made to the approved list will be subject to
reevaluation by the Secretary for the purpose of determining whether the
item still meets the requisite criteria and standards for addition to
the list. If it is determined by the Secretary that an item no longer
meets the requisite criteria, the Secretary will amend the regulations
to delete
[[Page 51]]
the item from the approved list. Removal of an item from the list will
be prospective from the date a Treasury decision amending the
regulations is published in the Federal Register.
(Secs. 44C and 7805 of the Internal Revenue Code of 1954 (92 Stat. 3175,
26 U.S.C. 44C; 68A Stat. 917, 26 U.S.C. 7805). The amendments to the
Statement of Procedural Rules are issued under the authority contained
in 5 U.S.C. 301 and 552)
[T.D. 7861, 47 FR 56331, Dec. 16, 1982. Redesignated and amended by T.D.
8146, 52 FR 26673, July 16, 1987]
Sec. 1.25-1T Credit for interest paid on certain home mortgages (Temporary).
(a) In general. Section 25 permits States and political subdivisions
to elect to issue mortgage credit certificates in lieu of qualified
mortgage bonds. An individual who holds a qualified mortgage credit
certificate (as defined in Sec. 1.25-3T) is entitled to a credit against
his Federal income taxes. The amount of the credit depends upon (1) the
amount of mortgage interest paid or accrued during the year and (2) the
applicable certificate credit rate. See Sec. 1.25-2T. The amount of the
deduction under section 163 for interest paid or accrued during any
taxable year is reduced by the amount of the credit allowable under
section 25 for such year. See Sec. 1.163-6T. The holder of a qualified
mortgage credit certificate may be entitled to additional withholding
allowances. See section 3402 (m) and the regulations thereunder.
(b) Definitions. For purposes of Secs. 1.25-2T through 1.25-8T and
this section, the following definitions apply:
(1) Mortgage. The term ``mortgage'' includes deeds of trust,
conditional sales contracts, pledges, agreements to hold title in
escrow, and any other form of owner financing.
(2) State. (i) The term ``State'' includes a possession of the
United States and the District of Columbia.
(ii) Mortgage credit certificates issued by or on behalf of any
State or political subdivision (``governmental unit'') by constituted
authorities empowered to issue such certificates are the certificates of
such governmental unit.
(3) Qualified home improvement loan. The term ``qualified home
improvement loan'' has the meaning given that term under section 103A
(1)(6) and the regulations thereunder.
(4) Qualified rehabilitation loan. The term ``qualified
rehabilitation loan'' has the meaning given that term under section 103A
(1)(7)(A) and the regulations thereunder.
(5) Single-family and owner-occupied residences. The terms ``single-
family'' and ``owner-occupied'' have the meaning given those terms under
section 103A (1)(9) and the regulations thereunder.
(6) Constitutional home rule city. The term ``constitutional home
rule city'' means, with respect to any calendar year, any political
subdivision of a State which, under a State constitution which was
adopted in 1970 and effective on July 1, 1971, had home rule powers on
the 1st day of the calendar year.
(7) Targeted area residence. The term ``targeted area residence''
has the meaning given that term under section 103A (k) and the
regulations thereunder.
(8) Acquisition cost. The term ``acquisition cost'' has the meaning
given that term under section 103A (1)(5) and the regulations
thereunder.
(9) Average area purchase price. The term ``average area purchase
price'' has the meaning given that term under subparagraphs (2), (3),
and (4) of section 103A (f) and the regulations thereunder. For purposes
of this paragraph (b)(9), all determinations of average area purchase
price shall be made with respect to residences as that term is defined
in section 103A and the regulations thereunder.
(10) Total proceeds. The ``total proceeds'' of an issue is the sum
of the products determined by multiplying--
(i) The certified indebtedness amount of each mortgage credit
certificate issued pursuant to such issue, by
(ii) The certificate credit rate specified in such certificate.
Each qualified mortgage credit certificate program shall be treated as a
separate issue of mortgage credit certificates.
[[Page 52]]
(11) Residence. The term ``residence'' includes stock held by a
tenant-stockholder in a cooperative housing corporation (as those terms
are defined in section 216(b) (1) and (2)). It does not include property
such as an appliance, a piece of furniture, a radio, etc., which, under
applicable local law, is not a fixture. The term also includes any
manufactured home which has a minimum of 400 square feet of living space
and a minimum width in excess of 102 inches and which is of a kind
customarily used at a fixed location. The preceding sentence shall not
apply for purposes of determining the average area purchase price for
single-family residences, nor shall it apply for purposes of determining
the State ceiling amount. The term ``residence'' does not, however,
include recreational vehicles, campers, and other similar vehicles.
(12) Related person. The term ``related person'' has the meaning
given that term under section 103(b)(6)(C)(i) and Sec. 1.103-10(e)(1).
(13) Date of issue. A mortgage credit certificate is considered
issued on the date on which a closing agreement is signed with respect
to the certified indebtedness amount.
(c) Affidavits. For purposes of Secs. 1.25-1T through 1.25-8T, an
affidavit filed in connection with the requirements of Secs. 1.25-1T
through 1.25-8T shall be made under penalties of perjury. Applicants for
mortgage credit certificates who are required by a lender or the issuer
to sign affidavits must be informed that any fraudulent statement will
result in (1) the revocation of the individual's mortgage credit
certificate, and (2) a $10,000 penalty under section 6709. Other persons
required by a lender or an issuer to provide affidavits must receive
similar notice. A person may not rely on an affidavit where that person
knows or has reason to know that the information contained in the
affidavit is false.
[T.D. 8023, 50 FR 19346, May 8, 1985]
Sec. 1.25-2T Amount of credit (Temporary).
(a) In general. Except as otherwise provided, the amount of the
credit allowable for any taxable year to an individual who holds a
qualified mortgage credit certificate is equal to the product of the
certificate credit rate (as defined in paragraph (b)) and the amount of
the interest paid or accrued by the taxpayer during the taxable year on
the certified indebtedness amount (as defined in paragraph (c)).
(b) Certificate credit rate--(1) In general. For purposes of
Secs. 1.25-1T through 1.25-8T, the term ``certificate credit rate''
means the rate specified by the issuer on the mortgage credit
certificate. The certificate credit rate shall not be less than 10
percent nor more than 50 percent.
(2) Limitation in certain States. (i) In the case of a State which--
(A) Has a State ceiling for the calendar year in which an election
is made that exceeds 20 percent of the average annual aggregate
principal amount of mortgages executed during the immediately preceding
3 calendar years for single-family owner-occupied residences located
within the jurisdiction of such State, or
(B) Issued qualified mortgage bonds in an aggregate amount less than
$150 million for calendar year 1983.
the certificate credit rate for any mortgage credit certificate issued
under such program shall not exceed 20 percent unless the issuing
authority submits a plan to the Commissioner to ensure that the weighted
average of the certificate credit rates in such mortgage credit
certificate program does not exceed 20 percent and the Commissioner
approves such plan. For purposes of determining the average annual
aggregate principal amount of mortgages executed during the immediately
preceding 3 calendar years for single-family owner-occupied residences
located within the jurisdiction of such State, an issuer may rely upon
the amount published by the Treasury Department for such calendar years.
An issuer may rely on a different amount from that safe-harbor
limitation where the issuer has made a more accurate and comprehensive
determination of that amount. The weighted average of the certificate
credit rates in a mortgage credit certificate program is determined by
dividing the sum of the products obtained by multiplying the certificate
credit rate of
[[Page 53]]
each certificate by the certified indebtedness amount with respect to
that certificate by the sum of the certified indebtedness amounts of the
certificates issued. See section 103A(g) and the regulations thereunder
for the definition of the term ``State ceiling''.
(ii) The following example illustrates the application of this
paragraph (b)(2):
Example. City Z issues four qualified mortgage credit certificates
pursuant to its qualified mortgage credit certificate program. H
receives a certificate with a certificate credit rate of 30 percent and
a certified indebtedness amount of $50,000. I receives a certificate
with a certificate credit rate of 25 percent and a certified
indebtedness amount of $100,000. J and K each receive certificates with
certificate credit rates of 10 percent; their certified indebtedness
amounts are $50,000 and $100,000, respectively. The weighted average of
the certificate credit rates is determined by dividing the sum of the
products obtained by multiplying the certificate credit rate of each
certificate by the certified indebtedness amount with respect to that
certificate ((.3 x $50,000) + (.25 x $100,000) + (.1 x $50,000) +
(.1 x $100,000)) by the sum of the certified indebtedness amounts of the
certificates issued ($50,000+$100,000+$50,000+$100,000). Thus, the
weighted average of the certificate credit rates is 18.33 percent
($55,000/$300,000).
(c) Certified indebtedness amount--(1) In general. The term
``certified indebtedness amount'' means the amount of indebtedness which
is--
(i) Incurred by the taxpayer--
(A) To acquire his principal residence, Sec. 1.25-2T(c)(1)(i),
(B) As a qualified home improvement loan, or
(C) As a qualified rehabilitation loan, and
(ii) Specified in the mortgage credit certificate.
(2) Example. The following example illustrates the application of
this paragraph:
Example. On March 1, 1986, State X, pursuant to its qualified
mortgage credit certificate program, provides a mortgage credit
certificate to B. State X specifies that the maximum amount of the
mortgage loan for which B may claim a credit is $65,000. On March 15, B
purchases for $67,000 a single-family dwelling for use as his principal
residence. B obtains from Bank M a mortgage loan for $60,000. State X,
or Bank M acting on behalf of State X, indicates on B's mortgage credit
certificate that the certified indebtedness amount of B's loan is
$60,000. B may claim a credit under section 25 (e) based on this amount.
(d) Limitation on credit--(1) Limitation where certificate credit
rate exceeds 20 percent. (i) If the certificate credit rate of any
mortgage credit certificate exceeds 20 percent, the amount of the credit
allowed to the taxpayer by section 25(a)(1) for any year shall not
exceed $2,000. Any amount denied under this paragraph (d)(1) may not be
carried forward under section 25(e)(1) and paragraph (d)(2) of this
section.
(ii) If two or more persons hold interests in any residence, the
limitation of paragraph (d)(1)(i) shall be allocated among such persons
in proporation to their respective interests in the residence.
(2) Carryforward of unused credit. (i) If the credit allowable under
section 25 (a) and Sec. 1.25-2T for any taxable year exceeds the
applicable tax limit for that year, the excess (the ``unused credit'')
will be a carryover to each of the 3 succeeding taxable years and,
subject to the limitations of paragraph (d)(2)(ii), will be added to the
credit allowable by section 25 (a) and Sec. 1.25-2T for that succeeding
year.
(ii) The amount of the unused credit for any taxable year (the
``unused credit year'') which may be taken into account under this
paragraph (d)(2) for any subsequent taxable year may not exceed the
amount by which the applicable tax limit for that subsequent taxable
year exceeds the sum of (A) the amount of the credit allowable under
section 25 (a) and Sec. 1.25-1T for the current taxable year, and (B)
the sum of the unused credits which, by reason of this paragraph (d)(2),
are carried to that subsequent taxable year and are attributable to
taxable years before the unused credit year. Thus, if by reason of this
paragraph (d)(2), unused credits from 2 prior taxable years are carried
forward to a subsequent taxable year, the unused credit from the earlier
of those 2 prior years must be taken into account before the unused
credit from the later of those 2 years is taken into account.
(iii) For purposes of this paragraph (d)(2) the term ``applicable
tax limit'' means the limitation imposed by section 26 (a) for the
taxable year reduced by the sum of the credits allowable for
[[Page 54]]
that year under section 21, relating to expenses for household and
dependent care services necessary for gainful employment, section 22,
relating to the credit for the elderly and the permanently disabled,
section 23, relating to the residential energy credit, and section 24,
relating to contributions to candidates for public office. The
limitation imposed by section 26 (a) for any taxable year is equal to
the taxpayer's tax liability (as defined in section 26 (b)) for that
year.
(iv) The following examples illustrate the application of this
paragraph (d)(2):
Example 1. (i) B, a calendar year taxpayer, holds a qualified
mortgage credit certificate. For 1986 B's applicable tax limit (i.e.,
tax liability) is $1,100. The amount of the credit under section 25 (a)
and Sec. 1.25-2T for 1986 is $1,700. For 1986 B is not entitled to any
of the credits described in sections 21 through 24. Under Sec. 1.25-2T
(d)(2), B's unused credit for 1986 is $600, and B is entitled to carry
forward that amount to the 3 succeeding years.
(ii) For 1987 B's applicable tax limit is $1,500, the amount of the
credit under section 25 (a) and Sec. 1.25-2T is $1,700, and the unused
credit is $200. For 1988 B's applicable tax limit is $2,000, the amount
of the credit under section 25 (a) and Sec. 1.25-2T is $1,300, and there
is no unused credit. For 1987 and 1988 B is not entitled to any of the
credits described in sections 21 through 24. No portion of the unused
credit for 1986 my be used in 1987. For 1988 B is entitled to claim a
credit of $2,000 under section 25 (a) and Sec. 1.25-2T, consisting of a
$1,300 credit for 1988, the $600 unused credit for 1986, and $100 of the
$200 unused credit for 1987. In addition, B may carry forward the
remaining unused credit for 1987 ($100) to 1989 and 1990.
Example 2. The facts are the same as in Example (1) except that for
1988 B is entitled to a credit of $400 under section 23. B's applicable
tax limit for 1988 is $1,600 ($2,000 less $400). For 1988 B is entitled
to claim a credit of $1,600 under section 25 (a) and Sec. 1.25-2T,
consisting of a $1,300 credit for 1988 and $300 of the unused credit for
1986. In addition, B may carry forward the remaining unused credits of
$300 for 1986 to 1989 and of $200 for 1987 to 1989 and 1990.
[T.D. 8023, 50 FR 19346, May 8, 1985]
Sec. 1.25-3 Qualified mortgage credit certificate.
(a) through (g)(1)(ii) [Reserved] For further guidance, see
Sec. 1.25-3T(a) through (g)(1)(ii).
(g)(1)(iii) Reissued certificate exception. See paragraph (p) of
this section for rules regarding the exception in the case of
refinancing existing mortgages.
(g)(2) through (o) [Reserved] For further guidance, see Sec. 1.25-
3T(g)(2) through (o).
(p) Reissued certificates for certain refinancings--(1) In general.
If the issuer of a qualified mortgage credit certificate reissues a
certificate in place of an existing mortgage credit certificate to the
holder of that existing certificate, the reissued certificate is treated
as satisfying the requirements of this section. The period for which the
reissued certificate is in effect begins with the date of the
refinancing (that is, the date on which interest begins accruing on the
refinancing loan).
(2) Meaning of existing certificate. For purposes of this paragraph
(p), a mortgage credit certificate is an existing certificate only if it
satisfies the requirements of this section. An existing certificate may
be the original certificate, a certificate issued to a transferee under
Sec. 1.25-3T(h)(2)(ii), or a certificate previously reissued under this
paragraph (p).
(3) Limitations on reissued certificate. An issuer may reissue a
mortgage credit certificate only if all of the following requirements
are satisfied:
(i) The reissued certificate is issued to the holder of an existing
certificate with respect to the same property to which the existing
certificate relates.
(ii) The reissued certificate entirely replaces the existing
certificate (that is, the holder cannot retain the existing certificate
with respect to any portion of the outstanding balance of the certified
mortgage indebtedness specified on the existing certificate).
(iii) The certified mortgage indebtedness specified on the reissued
certificate does not exceed the remaining outstanding balance of the
certified mortgage indebtedness specified on the existing certificate.
(iv) The reissued certificate does not increase the certificate
credit rate specified in the existing certificate.
(v) The reissued certificate does not result in an increase in the
tax credit that would otherwise have been allowable to the holder under
the existing certificate for any taxable year. The holder of a reissued
certificate determines the amount of tax credit that
[[Page 55]]
would otherwise have been allowable by multiplying the interest that was
scheduled to have been paid on the refinanced loan by the certificate
rate of the existing certificate. In the case of a series of
refinancings, the tax credit that would otherwise have been allowable is
determined from the amount of interest that was scheduled to have been
paid on the original loan and the certificate rate of the original
certificate.
(A) In the case of a refinanced loan that is a fixed interest rate
loan, the interest that was scheduled to be paid on the refinanced loan
is determined using the scheduled interest method described in paragraph
(p)(3)(v)(C) of this section.
(B) In the case of a refinanced loan that is not a fixed interest
rate loan, the interest that was scheduled to be paid on the refinanced
loan is determined using either the scheduled interest method described
in paragraph (p)(3)(v)(C) of this section or the hypothetical interest
method described in paragraph (p)(3)(v)(D) of this section.
(C) The scheduled interest method determines the amount of interest
for each taxable year that was scheduled to have been paid in the
taxable year based on the terms of the refinanced loan including any
changes in the interest rate that would have been required by the terms
of the refinanced loan and any payments of principal that would have
been required by the terms of the refinanced loan (other than repayments
required as a result of any refinancing of the loan).
(D) The hypothetical interest method (which is available only for
refinanced loans that are not fixed interest rate loans) determines the
amount of interest treated as having been scheduled to be paid for a
taxable year by constructing an amortization schedule for a hypothetical
self-amortizing loan with level payments. The hypothetical loan must
have a principal amount equal to the remaining outstanding balance of
the certified mortgage indebtedness specified on the existing
certificate, a maturity equal to that of the refinanced loan, and
interest equal to the annual percentage rate (APR) of the refinancing
loan that is required to be calculated for the Federal Truth in Lending
Act.
(E) A holder must consistently apply the scheduled interest method
or the hypothetical interest method for all taxable years beginning with
the first taxable year the tax credit is claimed by the holder based
upon the reissued certificate.
(4) Examples. The following examples illustrate the application of
paragraph (p)(3)(v) of this section:
Example 1. A holder of an existing certificate that meets the
requirements of this section seeks to refinance the mortgage on the
property to which the existing certificate relates. The final payment on
the holder's existing mortgage is due on December 31, 2000; the final
payment on the new mortgage would not be due until January 31, 2004. The
holder requests that the issuer provide to the holder a reissued
mortgage credit certificate in place of the existing certificate. The
requested certificate would have the same certificate credit rate as the
existing certificate. For each calendar year through the year 2000, the
credit that would be allowable to the holder with respect to the new
mortgage under the requested certificate would not exceed the credit
allowable for that year under the existing certificate. The requested
certificate, however, would allow the holder credits for the years 2001
through 2004, years for which, due to the earlier scheduled retirement
of the existing mortgage, no credit would be allowable under the
existing certificate. Under paragraph (p)(3)(v) of this section, the
issuer may not reissue the certificate as requested because, under the
existing certificate, no credit would be allowable for the years 2001
through 2004. The issuer may, however, provide a reissued certificate
that limits the amount of the credit allowable in each year to the
amount allowable under the existing certificate. Because the existing
certificate would allow no credit after December 31, 2000, the reissued
certificate could expire on December 31, 2000.
Example 2. (a) The facts are the same as Example 1 except that the
existing mortgage loan has a variable rate of interest and the
refinancing loan will have a fixed rate of interest. To determine
whether the limit under paragraph (p)(3)(v) of this section is met for
any taxable year, the holder must calculate the amount of credit that
otherwise would have been allowable absent the refinancing. This
requires a determination of the amount of interest that would have been
payable on the refinanced loan for the taxable year. The holder may
determine this amount by--
(1) Applying the terms of the refinanced loan, including the
variable interest rate or
[[Page 56]]
rates, for the taxable year as though the refinanced loan continued to
exist; or
(2) Obtaining the amount of interest, and calculating the amount of
credit that would have been available, from the schedule of equal
payments that fully amortize a hypothetical loan with the principal
amount equal to the remaining outstanding balance of the certified
mortgage indebtedness specified on the existing certificate, the
interest equal to the annual percentage rate (APR) of the refinancing
loan, and the maturity equal to that of the refinanced loan.
(b) The holder must apply the same method for each taxable year the
tax credit is claimed based upon the reissued mortgage credit
certificate.
(5) Coordination with Section 143(m)(3). A refinancing loan
underlying a reissued mortgage credit certificate that replaces a
mortgage credit certificate issued on or before December 31, 1990, is
not a federally subsidized indebtedness for the purposes of section
143(m)(3) of the Internal Revenue Code.
[T.D. 8692, 61 FR 66214, Dec. 17, 1996]
Sec. 1.25-3T Qualified mortgage credit certificate (Temporary).
(a) Definition of qualified mortgage credit certificate. For
purposes of Secs. 1.25-1T through 1.25-8T, the term ``qualified mortgage
credit certificate'' means a certificate that meets all of the
requirements of this section.
(b) Qualified mortgage credit certificate program. A certificate
meets the requirements of this paragraph if it is issued under a
qualified mortgage credit certificate program (as defined in Sec. 1.25-
4T).
(c) Required form and information. A certificate meets the
requirements of this paragraph if it is in the form specified in
Sec. 1.25-6T and if all the information required by the form is
specified on the form.
(d) Residence requirement--(1) In general. A certificate meets the
requirements of this paragraph only if it is provided in connection with
the acquisition, qualified rehabilitation, or qualified home improvement
of a residence, that is--
(i) A single-family residence (as defined in Sec. 1.25-1T(b)(5))
which, at the time the financing on the residence is executed or
assumed, can reasonably be expected by the issuer to become (or, in the
case of a qualified home improvement loan, to continue to be) the
principal residence (as defined in section 1034 and the regulations
thereunder) of the holder of the certificate within a reasonable time
after the financing is executed or assumed, and
(ii) Located within the jurisdiction of the governmental unit
issuing the certificate.
See section 103a(d) and the regulations thereunder for further
definitions and requirements.
(2) Certification procedure. The requirements of this paragraph will
be met if the issuer or its agent obtains from the holder of the
certificate an affidavit stating his intent to use (or, in the case of a
qualified home improvement loan, that he is currently using and intends
to continue to use) the residence as his principal residence within a
reasonable time (e.g., 60 days) after the mortgage credit certificate is
issued and stating that the holder will notify the issuer of the
mortgage credit certificate if the residence ceases to be his principal
residence. The affidavit must also state facts that are sufficient for
the issuer or his agent to determine whether the residence is located
within the jurisdiction of the issuer that issued the mortgage credit
certificate.
(e) 3-year requirement--(1) In general. A certificate meets the
requirements of this paragraph only if the holder of the certificate had
no present ownership interest in a principal residence at any time
during the 3-year period prior to the date on which the mortgage on the
residence in connection with which the certificate is provided is
executed. For purposes of the preceding sentence, the holder's interest
in the residence with respect to which the certificate is being provided
shall not be taken into account. See section 103A(e) and the regulations
thereunder for further definitions and requirements.
(2) Exceptions. Paragraph (e)(1) shall not apply with respect to--
(i) Any certificate provided with respect to a targeted area
residence (as defined in Sec. 1.25-1T(b)(7)),
(ii) Any qualified home improvement loan (as defined in Sec. 1.25-
1T(b)(3)), and
(iii) Any qualified rehabilitation loan (as defined in Sec. 1.25-
1T(b)(4)).
[[Page 57]]
(3) Certification procedure. The requirements of paragraph (e)(1)
will be met if the issuer or its agent obtains from the holder of the
certificate an affidavit stating that he had no present ownership
interest in a principal residence at any time during the 3-year period
prior to the date of which the certificate is issued and the issuer or
its agent obtains from the applicant copies of the applicant's Federal
tax returns for the preceding 3 years and examines each statement to
determine whether the applicant has claimed a deduction for taxes on
property which was the applicant's principal residence pursuant to
section 164(a)(1) or a deduction pursuant to section 163 for interest
paid on a mortgage secured by property which was the applicant's
principal residence. Where the mortgage is executed during the period
between January 1 and February 15 and the applicant has not yet filed
has Federal income tax return with the Internal Revenue Service, the
issuer may, with respect to such year, rely on an affidavit of the
applicant that the applicant is not entitled to claim deductions for
taxes or interest on indebtedness with respect to property constituting
his principal residence for the preceding calendar year. In the
alternative, when applicable, the holder may provide an affidavit
stating that one of the exceptions provided in paragraph (e)(2) applies.
(4) Special rule. An issuer may submit a plan to the Commissioner
for distributing certificates, in an amount not to exceed 10 percent of
the proceeds of the issue, to individuals who do not meet the
requirements of this paragraph. Such plan must describe a procedure for
ensuring that no more than 10 percent of the proceeds of a such issue
will be used to provide certificates to such individuals. If the
Commissioner approves the issuer's plan, certificates issued in
accordance with the terms of the plan to holders who do not meet the 3-
year requirement do not fail to satisfy the requirements of this
paragraph.
(f) Purchase price requirement--(1) In general. A certificate meets
the requirements of this paragraph only if the acquisition cost (as
defined in Sec. 1.25-1T(b)(8)) of the residence, other than a targeted
area residence, in connection with which the certificate is provided
does not exceed 110 percent of the average area purchase price (as
defined in Sec. 1.25-1T(b)(9)) applicable to that residence. In the case
of a targeted area residence (as defined in Sec. 1.251T(b)(7)) the
acquisition cost may not exceed 120 percent of the average area purchase
price applicable to such residence. See section 1093A(f) and the
regulations thereunder for further definitions and requirements.
(2) Certification procedure. The requirements of paragraph (f)(1)
will be met if the issuer or its agent obtains affidavits executed by
the seller and the buyer that state these requirements have been met.
Such affidavits must include an itemized list of--
(i) Any payments made by the buyer (or a related person) or for the
benefit of the buyer,
(ii) If the residence is incomplete, an estimate of the reasonable
cost of completing the residence, and
(iii) If the residence is purchased subject to a ground rent, the
capitalized value of the ground rent.
The issuer or his agent must examine such affidavits and determine
whether, on the basis of information contained therein, the purchase
price requirement is met.
(g) New mortgage requirement--(1) In general. (i) A certificate
meets the requirements of this paragraph only if the certificate is not
issued in connection with the acquisition or replacement of an existing
mortgage. Except in the case of a qualified home improvement loan, the
certificate must be issued to an individual who did not have a mortgage
(whether or not paid off) on the residence with respect to which the
certificate is issued at any time prior to the execution of the
mortgage.
(ii) Exceptions. For purposes of this paragraph, a certificate used
in connection with the replacement of--
(A) Construction period loans,
(B) Bridge loans or similar temporary initial financing, and
(C) In the case of a qualified rehabilitation loan, an existing
mortgage,
shall not be treated as being used to acquire or replace an existing
mortgage. Generally, temporary initial financing is any financing which
has a
[[Page 58]]
term of 24 months or less. See section 103A(j)(1) and the regulations
thereunder for examples illustrating the application of these
requirements.
(2) Certification procedure. The requirements of paragraph (g)(1)
will be met if the issuer or its agent obtains from the holder of the
certificate an affidavit stating that the mortage being acquired in
connection with the certificate will not be used to acquire or replace
an existing mortgage (other than one that falls within the exceptions
described in paragraph (g)(1)(ii)).
(h) Transfer of mortgage credit certificates--(1) In general. A
certificate meets the requirements of this paragraph only if it is (i)
not transferable or (ii) transferable only with the approval of the
issuer.
(2) Transfer procedure. A certificate that is transferred with the
approval of the issuer is a qualified mortgage credit certificate in the
hands of the transferee only if each of the following requirements is
met:
(i) The transferee assumed liability for the remaining balance of
the certified indebtedness amount in connection with the acquisition of
the residence from the transferor,
(ii) The issuer issues a new certificate to the transferee, and
(iii) The new certificate meets each of the requirements of
paragraphs (d), (e), (f), and (i) of this section based on the facts as
they exist at the time of the transfer as if the mortgage credit
certificate were being issued for the first time. For example, the
purchase price requirement is to be determined by reference to the
average area purchase price at the time of the assumption and not when
the mortgage credit certificate was originally issued.
(3) Statement on certificate. The requirements of paragraph (h)(1)
will be met if the mortgage credit certificate states that the
certificate may not be transferred or states that the certificate may
not be transferred unless the issuer issues a new certificate in place
of the original certificate.
(i) Prohibited mortgages--(1) In general. A certificate meets the
requirements of this paragraph only if it is issued in connection with
the acquisition of a residence none of the financing of which is
provided from the proceeds of--
(i) A qualified mortgage bond (as defined under section 103A(c)(1)
and the regulations thereunder), or
(ii) A qualified veterans' mortgage bond (as defined under section
103A(c)(3) and the regulations thereunder).
Thus, for example, if a mortgagor has a mortgage on his principal
residence that was obtained from the proceeds of a qualified mortgage
bond, a mortgage credit certificate issued to such mortgagor in
connection with a qualified home improvement loan with respect to such
residence is not a qualified mortgage credit certificate. If, however,
the financing provided from the proceeds of the qualified mortgage bond
had been paid off in full, the certificate would be a qualified mortgage
credit certificate (assuming all the requirements of this paragraph are
met).
(2) Certification procedure. The requirements of paragraph (i)(1)
will be met if the issuer or its agent obtains from the holder of the
certificate an affidavit stating that no portion of the financing of the
residence in connection with which the certificate is issued is provided
from the proceeds of a qualified mortgage bond or a qualified veterans'
mortgage bond.
(j) Particular lenders--(1) In general. Except as otherwise provided
in paragraph (j)(2), a certificate meets the requirements of this
paragraph only if the certificate is not limited to indebtedness
incurred from particular lenders. A certificate is limited to
indebtedness from particular lenders if the issuer, directly or
indirectly, prohibits the holder of a certificate from obtaining
financing from one or more lenders or requires the holder of a
certificate to obtain financing from one or more lenders. For purposes
of this paragraph, a lender is any person, including an issuer of
mortgage credit certificates, that provides financing for the
acquisition, qualified rehabilitation, or qualified home improvement of
a residence.
(2) Exception. A mortgage credit certificate that is limited to
indebtedness incurred from particular lenders will not cease to meet the
requirements of
[[Page 59]]
this paragraph if the Commissioner approves the basis for such
limitation. The Commissioner may approve the basis for such limitation
if the issuer establishes to the satisfaction of the Commissioner that
it will result in a significant economic benefit to the holders of
mortgage credit certificates (e.g., substantially lower financing costs)
compared to the result without such limitation.
(3) Taxable bonds. The requirements of this paragraph do not prevent
an issuer of mortgage credit certificates from issuing mortgage subsidy
bonds (other than obligations described in section 103 (a)) the proceeds
of which are to be used to provide mortgages to holders of mortgage
credit certificates provided that the holders of such certificates are
not required to obtain financing from the proceeds of the bond issue.
See Sec. 1.25-4T (h) with respect to permissible fees.
(4) Lists of participating lenders. The requirements of this
paragraph do not prohibit an issuer from maintaining a list of lenders
that have stated that they will make loans to qualified holders of
mortgage credit certificates, provided that (i) the issuer solicits such
statements in a public notice similar to the notice described in
Sec. 1.25-7T, (ii) lenders are provided a reasonable period of time in
which to express their interest in being included in such a list, and
(iii) holders of mortgage credit certificates are not required to obtain
financing from the lenders on the list. If an issuer maintains such a
list, it must update the list at least annually.
(5) Certification procedure. The requirements of this paragraph will
be met if (i) the issuer or its agent obtains from the holder of the
certificate an affidavit stating that the certificate was not limited to
indebtedness incurred from particular lenders or (ii) the issuer obtains
a ruling from the Commissioner under paragraph (j)(2).
(6) Examples. The following examples illustrate the application of
this paragraph:
Example 1. Under its mortgage credit certificate program, County Z
distributes all the certificates to be issued to a group of 60
participating lenders. Residents of County Z may obtain mortgage credit
certificates only from the participating lenders and only in connection
with the acquisition of mortgage financing from that lender or one of
the other participating lenders. Certificates issued under this program
do not meet the requirements of this paragraph since the certificates
are limited to indebtedness incurred from particular lenders. The
certificates, therefore, are not qualified mortgage credit certificates.
Example 2. In connection with its mortgage credit certificate
program, County Y arranges with Bank P for a line of credit to be used
to provide mortgage financing to holders of mortgage credit
certificates. County Y, pursuant to paragraph (j)(4), maintains a list
of lenders participating in the mortgage credit certificate program.
County Y distributes the certificates directly to applicants. Holders of
the certificates are not required to obtain mortgage financing through
the line of credit or through a lender on the list of participating
lenders. Certificates issued pursuant to County Y's program satisfy the
requirements of this paragraph.
(k) Developer certification--(1) In general. A mortgage credit
certificate that is allocated by the issuer to any particular
development meets the requirements of this paragraph only if the
developer provides a certification to the purchaser of the residence and
the issuer stating that the purchase price of that residence is not
higher than the price would be if the issuer had not allocated mortgage
credit certificates to the development. The certification must be made
by the developer if a natural person or, if not, by a duly authorized
official of the developer.
(2) Certification procedure. The requirements of this paragraph will
be met if the issuer or its agent obtains from the holder of the
certificate an affidavit stating that he has received from the developer
the certification described in this paragraph.
(l) Expiration--(1) In general. A certificate meets the requirements
of this paragraph if the certified indebtedness amount is incurred prior
to the close of the second calender year following the calendar year for
which the issuer elected not to issue qualified mortgage bonds under
Sec. 1.25-4T with respect to that issue of mortgage credit certificates.
Thus, for example, if on October 1, 1984, an issuing authority elects
under Sec. 1.25-4T not to issue qualified mortgage bonds, a mortgage
credit certificate provided under that program
[[Page 60]]
does not meet the requirements of this paragraph unless the indebtedness
is incurred on or before December 31, 1986.
(2) Issuer-imposed expiration dates. An issuer of mortgage credit
certificates may provide that a certificate shall expire if the holder
of the certificate does not incure certified indebtedness by a date that
is prior to the expiration date provided in paragraph (l)(1). A
certificate that expires prior to the date provided in paragraph (l)(1)
may be reissued provided that the requirements of this paragraph are
met.
(m) Revocation. A certificate meets the requirements of this
paragraph only if it has not been revoked. Thus, the credit provided by
section 25 and Sec. 1.25-1T does not apply to interest paid or accrued
following the revocation of a certificate. A certificate is treated as
revoked when the residence to which the certificate relates ceases to be
the holder's principal residence. An issuer may revoke a mortgage credit
certificate if the certificate does not meet all the requirements of
Sec. 1.25-3T (d), (e), (f), (g), (h), (i), (j), (k), and (n). The
certificate is revoked by the issure's notifying the holder of the
certificate and the Internal Revenue Service that the certificate is
revoked. The notice to the Internal Revenue Service shall be made as
part of the report requred by Sec. 1.25-8T (b)(2).
(n) Interest paid to related person--(1) In general. A certificate
does not meet the requirements of this paragraph if interest on the
certified indebtedness amount is paid to a person who is a related
person to the holder of the certificate.
(2) Certification procedure. The requirements of this paragraph will
be met if the issuer or its agent obtains from the holder of the
certificate an affidavit stating that a related person does not have,
and is not expected to have, an interest as a creditor in the certified
indebtedness amount.
(o) Fraud. Notwithstanding any other provision of this section, a
mortgage credit certificate does not meet the requirements of this
section and, therefore, the certificate is not a qualified mortgage
credit certificate for any calendar year, if the holder of the
certificate provides a certification or any other information to the
lender providing the mortgage or to the issuer of the certificate
containing a material misstatement and such misstatement is due to
fraud. In determining whether any misstatement is due to fraud, the
rules generally applicable to underpayments of tax due to fraud
(including rules relating to the statute of limitations) shall apply.
See Sec. 1.6709-1T with respect to the penalty for filing negligent or
fraudulent statements.
[T.D. 8023, 50 FR 19348, May 8, 1985, as amended at T.D. 8502, 58 FR
67689, Dec. 22, 1993; T.D. 8692, 61 FR 66215, Dec. 17, 1996]
Sec. 1.25-4T Qualified mortgage credit certificate program (Temporary).
(a) In general--(1) Definition of qualified mortgage credit
certificate program. For purposes of Secs. 1.25-1T through 1.25-8T, the
term ``qualified mortgage credit certificate program'' means a program
to issue qualified mortgage credit certificates which meets all of the
requirements of paragraphs (b) through (i) of this section.
(2) Requirements are a minimum. Except as otherwise provided in this
section, the requirements of this section are minimum requirements.
Issuers may establish more stringent criteria for participation in a
qualified mortgage credit certificate program. Thus, for example, an
issuer may target 30 percent of the proceeds of an issue of mortgage
credit certificates to targeted areas. Further, issuers may establish
additional eligibility criteria for participation in a qualified
mortgage credit certificate program. Thus, for example, issuers may
impose an income limitation designed to ensure that only those
individuals who could not otherwise purchase a residence will benefit
from the credit.
(3) Except as otherwise provided in this section and Sec. 1.25-3T,
issuers may use mortgage credit certificates in connection with other
Federal, State, and local programs provided that such use complies with
the requirements of Sec. 1.25-3T(j). Thus, for example, a mortgage
credit certificate may be issued in connection with the qualified
rehabilitation of a residence part of the cost of which will be paid
from the proceeds of a State grant.
(b) Establishment of program. A program meets the requirements of
this
[[Page 61]]
paragraph only if it is established by a State or political subdivision
thereof for any calendar year for which it has the authority to issue
qualified mortgage bonds.
(c) Election not to issue qualified mortgage bonds--(1) In general.
A program meets the requirements of this paragraph only if the issuer
elects, in the time and manner specified in this paragraph, not to issue
an amount of qualified mortgage bonds that it may otherwise issue during
the calendar year under section 103A and the regulations thereunder.
(2) Manner of making election. On or before the earlier of the date
of distribution of mortgage credit certificates under a program or
December 31, 1987, the issuer must file an election not to issue an
amount of qualified mortgage bonds. The election (and the certification
(or affidavit) described in paragraph (d)) shall be filed with the
Internal Revenue Service Center, Philadelphia, Pennsylvania 19255. The
election should be titled ``Mortgage Credit Certificate Election'' and
must include--
(i) The name, address, and TIN of the issuer,
(ii) The issuer's applicable limit, as defined in section 103A (g)
and the regulations thereunder,
(iii) The aggregate amount of qualified mortgage bonds issued by the
issuing authority during the calendar year,
(iv) The amount of the issuer's applicable limit that it has
surrendered to other issuers during the calendar year,
(v) The date and amount of any previous elections under this
paragraph for the calendar year, and
(vi) The amount of qualfied mortgage bonds that the issuer elects
not to issue.
(3) Revocation of election. Any election made under this paragraph
may be revoked, in whole or in part, at any time during the calendar
year in which the election was made. The revocation, however, may not be
made with respect to any part of the nonissued bond amount that has been
used to issue mortgage credit certificates pursuant to the election. The
revocation shall be filed with the Internal Revenue Service Center,
Philadelphia, Pennsylvania 19255. The revocation should be titled
``Revocation of Mortgage Credit Certificate Election'' and must
include--
(i) The name, address, and TIN of the issuer,
(ii) The nonissued bond amount as originally elected, and
(iii) The portion of the nonissued bond amount with respect to which
the election is being revoked.
(4) Special rule. If at the time that an issuer makes an election
under this paragraph it does not know its applicable limit, the issuer
may elect not to use all of its remaining authority to issue qualified
mortgage bonds; this form of election will be treated as meeting the
requirements of paragraph (c)(2) if, prior to the later of the end of
the calendar year and December 31, 1985, the issuer amends its election
so as to indicate the exact amount of qualified mortgage bond authority
that it elected not to issue.
(5) Limitation on nonissued bond amount. The amount of qualified
mortgage bonds which an issuer elects not to issue may not exceed the
issuer's applicable limit (as determined under section 103A (g) and the
regulations thereunder). For example, a governmental unit that, pursuant
to section 103A (g)(3), may issue $10 million of qualified mortgage
bonds that elects to trade in $11 million in qualified mortgage bond
authority has not met the requirements of this paragraph, and mortgage
credit certificates issued pursuant to such election are not qualified
mortgage credit certificates.
(d) State certification requirement--(1) In general. A program meets
the requirements of this paragraph only if the State official designated
by law (or, where there is no State official, the Governor) certifies,
based on facts and circumstances as of the date on which the
certification is requested, following a request for such certification,
that the issue meets the requirements of section 103A(g) (relating to
volume limitation) and the regulations thereunder. A copy of the State
certification must be attached to the issuer's election not to issue
qualified mortgage bonds, except that, in the case of elections made
during calendar year 1984, the certification may be filed with the
Service prior to July 8, 1985 provided
[[Page 62]]
that mortgage credit certificates may not be distributed until the
certification is filed. In the case of any constitutional home rule
city, the certification shall be made by the chief executive officer of
the city.
(2) Certification procedure. The official making the certification
described in this paragraph (d) need not perform an independent
investigation to determine whether the issuer has met the requirements
of section 103A(g). In determining the aggregate amount of qualified
mortgage bonds previously issued by that issuer during the calendar year
the official may rely on copies of prior elections under paragraph (c)
of this section made by the issuer for that year, together with an
affidavit executed by an official of the issuer who is responsible for
issuing bonds stating that the issuer has not, to date, issued any other
issues of qualified mortgage bonds during the calendar year and stating
the amount, if any, of the issuer's applicable limit that it has
surrendered to other issuers during the calendar year; for any calendar
year prior to 1985, the official may rely on an affidavit executed by a
duly authorized official of the issuer who states the aggregate amount
of qualified mortgage bonds issued by the issuer during the year. In
determining the aggregate amount of qualified mortgage bonds that the
issuer has previously elected not to issue during that calendar year,
the official may rely on copies of any elections not to issue qualified
mortgage bonds filed by the issuer for that calendar year, together with
an affidavit executed by an official of the issuer responsible for
issuing mortgage credit certificates stating that the issuer has not, to
date, made any other elections not to issue qualified mortgage bonds.
If, based on such information, the certifying official determines that
the issuer has not, as of the date on which the certification is
provided, exceeded its applicable limit for the year, the official may
certify that the issue meets the requirements of section 103A(g). The
fact that the certification described in this paragraph (d) is provided
does not ensure that the issuer has met the requirements of section
103A(g) and the regulations thereunder, nor does it preclude the
application of the penalty for over-issuance of mortgage credit
certificates if such over-issuance actually occurs. See Sec. 1.25-5T.
(3) Special rule. If within 30 days after the issuer files a proper
request for the certification described in this paragraph (d) the issuer
has not received from the State official designated by law (or, if there
is no State official, the Governor) certification that the issue meets
the requirements of section 103A(g) or, in the alternative, a statement
that the issue does not meet such requirements, the issuer may submit,
in lieu of the certification required by this paragraph (d), an
affidavit executed by an officer of the issuer responsible for issuing
mortgage credit certificates stating that--
(i) The issue meets the requirements of section 103A(g) and the
regulations thereunder,
(ii) At least 30 days before the execution of the affidavit the
issuer filed a proper request for the certification described in this
paragraph (d), and
(iii) The State official designated by law (or, if there is no State
official, the Governor) has not provided the certification described in
this paragraph (d) or a statement that the issue does not meet such
requirements.
For purposes of this paragraph, a request for certification is proper if
the request includes the reports and affidavits described in paragraph
(d)(2).
(e) Information reporting requirement--(1) Reports. With respect to
mortgage credit certificates issued after September 30, 1985, a program
meets the requirements of this paragraph only if the issuer submits a
report containing the information concerning the holders of certificates
issued during the preceding reporting period required by this paragraph.
The report must be filed for each reporting period in which certificates
(other than transferred certificates) are issued under the program. The
issuer is not responsible for false information provided by a holder if
the issuer did not know or have reason to know that the information was
false. The report must be filed on the form prescribed by the Internal
Revenue Service. If no form is prescribed, or if the form prescribed is
not readily available, the issuer may use its own
[[Page 63]]
form provided that such form is in the format set forth in this
paragraph and contains the information required by this paragraph. The
report must be titled ``Mortgage Credit Certificate Information Report''
and must include the name, address, and TIN of the issuer, the reporting
period for which the information is provided, and the following tables
containing information concerning the holders of certificates issued
during the reporting period for which the report is filed:
(i) A table titled ``Number of Mortgage Credit Certificates by
Income and Acquisition Cost'' showing the number of mortgage credit
certificates issued (other than those issued in connection with
qualified home improvement and rehabilitation loans) according to the
annualized gross income of the holders (categorized in the following
intervals of income:
$0-$9,999;
$10,000-$19,999;
$20,000-$29,999;
$30,000-$39,999;
$40,000-$49,999;
$50,000-$74,999; and
$75,000 or more)
and according to the acquisition cost of the residences acquired in
connection with the mortgage credit certificates (categorized in the
following intervals of acquisition cost:
$0-$19,999;
$20,000-$39,999;
$40,000-$59,999;
$60,000-$79,999;
$80,000-$99,999;
$100,000-$119,999;
$120,000-$149,999;
$150,000-$199,999; and
$200,000 or more).
For each interval of income and acquisition cost the table must also be
categorized according to--
(A) The aggregate amount of fees charged to holders to cover any
administrative costs incurred by the issuer in issuing mortgage credit
certificates, and
(B) The number of holders that--
(1) Did not have a present ownership interest in a principal
residence at any time during the 3-year period ending on the date the
mortgage credit certificate is executed (i.e., satisfied the 3-year
requirement) and purchased residences in targeted areas,
(2) Satisfied the 3-year requirement and purchased residences not
located in targeted areas,
(3) Did have a present ownership interest in a principal residence
at any time during the 3-year period ending on the date the mortgage
credit certificate is executed (i.e., did not satisfy the 3-year
requirement) and purchased residences in targeted areas, and
(4) Did not satisfy the 3-year requirement and purchased residences
not located in targeted areas.
(ii) A table titled ``Volume of Mortgage Credit Certificates by
Income and Acquisition Cost'' containing data on--
(A) The total of the certified indebtedness amounts of the
certificates issued (other than those issued in connection with
qualified home improvement and rehabilitation loans);
(B) The sum of the products of the certified indebtedness amount and
the certificate credit rate for each certificate (other than those
issued in connection with qualified home improvement and rehabilitation
loans) according to annualized gross income (categorized in the same
intervals of income as the preceding table) and according to the
acquisition cost of the residences acquired in connection with mortgage
credit certificates (categorized in the same intervals of acquisition
cost as the preceding table); and
(C) For each interval of income and acquisition cost, the
information described in paragraph (e)(1)(ii) (A) and (B) categorized
according to the holders that--
(1) Satisfied the 3-year requirement and purchased residences in
targeted areas,
(2) Satisfied the 3-year requirement and purchased residences not
located in targeted areas,
(3) Did not satisfy the 3-year requirement and purchased residences
in targeted areas, and
(4) Did not satisfy the 3-year requirement and purchased residences
not located in targeted areas.
(iii) A table titled ``Mortgage Credit Certificates for Qualified
Home Improvement and Rehabilitation Loans'' showing the number of
mortgage credit certificates issued in connection with
[[Page 64]]
qualified home improvement loans and qualified rehabilitation loans, the
total of the certified indebtedness amount with respect to such
certificates, and the sum of the products of the certified indebtedness
amount and the certificate credit rate for each certificate; the
information contained in the table must also be categorized according to
whether the residences with respect to which the certificates were
provided are located in targeted areas.
(2) Format. If no form is prescribed by the Internal Revenue
Service, or if the prescribed form is not readily available, the issuer
must submit the report in the format specified in this paragraph (e)(2).
The specified format of the report is the following:
Mortgage Credit Certificate Information Report
Name of issuer:
Address of issuer:
TIN of issuer:
Reporting period:
Number of Mortgage Credit Certificates by Income and Acquisition Cost
----------------------------------------------------------------------------------------------------------------
Satisfied Not satisfied
3-year requirement: Annualized gross monthly income of ---------------------------------------------- Totals
borrowers Nontargeted Targeted Nontargeted Targeted fees
area area area area
----------------------------------------------------------------------------------------------------------------
$0 to $9,999.............................................
$10,000 to $19,999.......................................
$20,000 to $29,999.......................................
$30,000 to $39,999.......................................
$40,000 to $49,999.......................................
$50,000 to $74,999.......................................
$75,000 or more..........................................
------------------------------------------------------
Total................................................
Acquisition Cost
0 to $19,999.............................................
$20,000 to $39,999.......................................
$40,000 to $59,999.......................................
$60,000 to $79,999.......................................
$80,000 to $99,999.......................................
$100,000 to $119,999.....................................
$120,000 to $149,999.....................................
$150,000 to $199,999.....................................
$200,000 or more.........................................
------------------------------------------------------
Total................................................
----------------------------------------------------------------------------------------------------------------
[[Page 65]]
Volume of Mortgage Credit Certificates by Income and Acouisition Cost
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Holders satisfying the 3-year requirement 3-year requirement not satisfied Totals
-------------------------------------------------------------------------------------------------------------------------------------------
Nontargeted area Targeted area Nontargeted area Targeted area
---------------------------------------------------------------------------------------------------------------- Total sum of
Sum of Sum of Sum of Sum of Total of the products of
Annualized gross monthly income of holders Total of the products of Total of the products of Total of the products of Total of the products of certified certified
certified certified certified certified certified certified certified certified indebtedness indebtedness
indebtedness indebtedness indebtedness indebtedness indebtedness indebtedness indebtedness indebtedness amounts amounts and
amounts amounts and amounts amounts and amounts amounts and amounts amounts and credit rates
credit rates credit rates credit rates credit rates
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
$0 to $9,999........................................
$10,000 to $19,999..................................
$20,000 to $29,999..................................
$30,000 to $39,999..................................
$40,000 to $49,999..................................
$50,000 to $74,999..................................
$75,000 to more.....................................
-------------------------------------------------------------------------------------------------------------------------------------------
Total...........................................
Acquisition Cost
$0 to $19,999.......................................
$20,000 to $39,999..................................
$40,000 to $59,999..................................
$60,000 to $79,999..................................
$80,000 to $99,999..................................
$100,000 to $119,999................................
$120,000 to $149,999................................
$150,000 to $199,999................................
$200,000 or more....................................
-------------------------------------------------------------------------------------------------------------------------------------------
Total...........................................
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 66]]
Mortgage Credit Certificates for Qualified Home Improvement and
Rehabilitation Loans
------------------------------------------------------------------------
Nontargeted Targeted
area area Totals
------------------------------------------------------------------------
Home Improvement Loans
Number of mortgage credit certificates..
Total of the certified indebtedness
amounts................................
Product of certified indebtedness
amounts and credit rates...............
Rehabilitation Loans
Number of mortgage credit certificates..
Total of the certified indebtedness
amounts................................
Product of certified indebtedness
amounts and credit rates...............
------------------------------------------------------------------------
(3) Definitions and special rules. (i) For purposes of this
paragraph the term ``annualized gross income'' means the borrower's
gross monthly income multiplied by 12. Gross monthly income is the sum
of monthly gross pay, any additional income from investments, pensions,
Veterans Administration (VA) compensation, part-time employment,
bonuses, dividends, interest, current overtime pay, net rental income,
etc., and other income (such as alimony and child support, if the
borrower chooses to disclose such income). Information with respect to
gross monthly income may be obtained from available loan documents,
e.g., the sum of lines 23D and 23E on the Application for VA or FmHA
Home Loan Guaranty or for HUD/FHA Insured Mortgage (VA Form 26-1802a,
HUD 92900, Jan. 1982), or the total line from the Gross Monthly Income
section of FHLMC Residential Loan Application form (FHLMC 65 Rev. 8/78).
(ii) For purposes of this paragraph, the term ``reporting period''
means each one year period beginning July 1 and ending June 30, except
that issuers need not provide data with respect to the period prior to
October 1, 1985.
(iii) For purposes of this paragraph, verification of information
concerning a holder's gross monthly income by utilizing other available
information concerning the holder's income (e.g., Federal income tax
returns) is not required. In determining whether the holder of a
mortgage credit certificate acquiring a residence in a targeted area
satisfies the 3-year requirement, the issuer may rely on a statement
signed by the holder.
(4) Time for filing. The report required by this paragraph shall be
filed not later than the 15th day of the second calendar month after the
close of the reporting period. The Commissioner may grant an extension
of time for the filing of a report required by this paragraph if there
is reasonable cause for the failure to file such report in a timely
fashion. The report may be filed at any time before such date but must
be complete based on facts and reasonable expectations as of the date
the report is filed. The report need not be amended to reflect
information learned subsequent to the date of filing, or to reflect
changed circumstances with respect to any holder.
(5) Place for filing. The report required by this paragraph is to be
filed at the Internal Revenue Service Center, Philadelphia, Pennsylvania
19255.
(f) Policy statement. A program established pursuant to an election
under paragraph (c) made after 1984 meets the requirements of this
paragraph only if the applicable elected representative of the
governmental unit--
(1) Which is the issuer, or
(2) On whose behalf the certificates were issued,
has published (after a public hearing following reasonable public
notice) a policy statement described in Sec. 1.103A-2(1) by the last day
of the year preceding the year in which the election under paragraph (c)
is made, and a copy of such report has been submitted to the
Commissioner on or before such last day. See Sec. 1.103A-2(1) for
further definitions and requirements.
(g) Targeted areas requirement--(1) In general. A program meets the
requirements of this paragraph only if--
(i) The portion of the total proceeds of the issue specified in
paragraph (g)(2) is made available to provide mortgage credit
certificates in connection with owner financing of targeted area
residents for at least 1 year after the date on which mortgage credit
certificates are first made available with respect to targeted area
residences, and
(ii) The issuer attempts with reasonable diligence to place such
proceeds with qualified persons.
Mortgage credit certificates are considered first made available with
respect to targeted area residences on the date on which the issuer
first begins to accept applications for mortgage credit certificates
provided under that issue.
(2) Specified portion. (i) The specified portion of the total
proceeds of an issue is the lesser of--
(A) 20 percent of the total proceeds, or
(B) 8 percent of the average annual aggregate principal amount of
mortgages executed during the immediately preceding 3 calendar years for
single-family, owner-occupied residences in targeted areas within the
jurisdiction of the issuing authority.
For purposes of computing the required portion of the total proceeds
specified in paragraph (g)(2)(i)(B) where such provision is applicable,
an issuer may rely upon the safe-
[[Page 67]]
harbor formula provided in the regulations under section 103A(h).
(ii) See Sec. 1.25-1T(b)(10)(ii) for the definition of ``total
proceeds''.
(h) Fees--(1) In general. A program meets the requirements of this
paragraph only if each applicant is required to pay, directly or
indirectly, no fee other than those fees permitted under this paragraph.
(2) Permissible fees. Applicants may be required to pay the
following fees provided that they are reasonable:
(i) Points, origination fees, servicing fees, and other fees in
amounts that are customarily charged with respect to mortgages not
provided in connection with mortgage credit certificates,
(ii) Application fees, survey fees, credit report fees, insurance
fees, or similar settlement or financing costs to the extent such
amounts do not exceed the amounts charged in the area in cases where
mortgages are not provided in connection with mortgage credit
certificates. For example, amounts charged for FHA, VA, or similar
private mortgage insurance on an individual's mortgage are permissible
so long as such amounts do not exceed the amounts charged in the area
with respect to a similar mortgage that is not provided in connection
with a mortgage credit certificate, and
(iii) Other fees that, taking into account all the facts and
circumstances, are reasonably necessary to cover any administrative
costs incurred by the issuer or its agent in issuing mortgage credit
certificates.
(i) Qualified mortgage credit certificate. A program meets the
requirements of this paragraph only if each mortgage credit certificate
issued under the program meets each of the requirements of paragraphs
(c) through (o) of Sec. 1.25-3T.
(j) Good faith compliance efforts--(1) Eligibility requirements. (i)
A program under which each of the mortgage credit certificates issued
does not meet each of the requirements of paragraphs (c) through (o) of
Sec. 1.25-3T shall be treated as meeting the requirements of paragraph
(i) of this section if each of the requirements of this paragraph (j)(1)
is satisfied. A mortgage credit certificate program meets the
requirements of this paragraph (j)(1) only if each of the following
provisions is met:
(A) The issuer in good faith attempted to issue mortgage credit
certificates only to individuals meeting each of the requirements of
paragraphs (c) through (o) of Sec. 1.25-3T. Good faith requires that
agreements with lenders and agents and other relevant instruments
contain restrictions that permit the approval of mortgage credit
certificates only in accordance with the requirements of paragraphs (c)
through (o) of Sec. 1.25-3T. In addition, the issuer must establish
reasonable procedures to ensure compliance with those requirements.
Reasonable procedures include reasonable investigations by the issuer to
determine whether individuals satisfy the requirements of paragraphs (c)
through (o) of Sec. 1.25-3T.
(B) 95 percent or more of the total proceeds of the issue were
devoted to individuals with respect to whom, at the time that the
certificate was issued, all the requirements of paragraphs (c) through
(o) of Sec. 1.25-3T were met. If a holder of a mortgage credit
certificate fails to meet more than one of these requirements, the
amount of the certificate (i.e., the certificate credit rate multiplied
by the certified indebtedness amount) issued to that individual will be
taken into account only once in determining whether the 95-percent
requirement is met. However, all of the defects in that individual's
certificate must be corrected pursuant to paragraph (j)(1)(i)(C).
(C) Any failure to meet the requirements of paragraphs (c) through
(o) of Sec. 1.25-3T is corrected within a reasonable period after that
failure is discovered. For example, if an individual fails to meet one
or more of such requirements those failures can be corrected by revoking
that individual's certificate.
(ii) Examples. The following examples illustrate the application of
this paragraph (j)(1):
Example 1. County X only distributes mortgage credit certificates to
individuals who have contracted to purchase a principal residence.
County X requires that applicants for mortgage credit certificates
present the following information:
(i) An affidavit stating that the applicant intends to use the
residence in connection with which the mortgage credit certificate is
issued as his principal residence within a reasonable time after the
certificate is issued by County X, that the applicant will notify the
County if the residence ceases to be his principal residence, and facts
that are sufficient for County X to determine whether the residence is
located within the jurisdiction of County X,
(ii) An affidavit stating that the applicant had no present
ownership interest in a principal residence at any time during the 3-
year period prior to the date on which the certificate is issued,
(iii) Copies of the applicant's Federal tax returns for the
preceding 3 years,
(iv) Affidavits from the seller of the residence with respect to
which the certificate is issued and the applicant stating the purchase
price of the residence, including an itemized list of (A) payments made
by or for the benefit of the applicant, (B) if the residence is
incomplete, an estimate of the reasonable cost of completing the
residence, and (C) if the residence is subject to a ground rent, the
capitalized value of the ground rent,
(v) An affidavit executed by the applicant stating that the mortgage
being acquired in connection with the certificate will not be
[[Page 68]]
used to acquire or replace an existing mortgage,
(vi) An affidavit executed by the applicant stating that no portion
of the financing for the residence in connection with which the
certificate is issued is provided from the proceeds of a qualified
mortgage bond or qualified veterans' mortgage bond and that no portion
of the mortgage for the residence is provided by a person related to the
applicant (as defined in Sec. 1.25-3T(n)),
(vii) An affidavit executed by the applicant stating that the
certificate was not limited to indebtedness incurred from particular
lenders, and
(viii) In the case of a mortgate credit certificate allocated for
use in connection with a particular development, and affidavit executed
by the applicant stating that the applicant received from the developer
a certification stating that the price of the residence with respect to
which the certificate was issued is no higher than it would be without
the use of a mortgage credit certificate.
County X examines the information submitted by the applicant to
determine whether the requirements of paragraphs (c), (d), (e), (f),
(g), (i), (j), (k), and (n) of Sec. 1.25-3T are met. County X determines
that the certificate has not expired. The mortgage credit certificates
issued by County X are in the form prescribed by Sec. 1.25-6T and County
X provides all the required information and statements. After
determining that the applicant meets all these requirements County X
issues a mortgage credit certificate to the applicant. This procedure
for issuing mortgage credit certificates is sufficient evidence of the
good faith of County X to meet the requirements of Sec. 1.25-
4T(j)(1)(i)(A).RE
Example 2. County W distributes preliminary mortgage credit
certificates to individuals who have not entered into contracts to
purchase a principal residence. County W issues preliminary certificates
in the form prescribed by Sec. 1.25-6T to those applicants that have
submitted statements that they (i) intend to purchase a single-family
residence located within the jurisdiction of County W which they will
occupy as a principal residence, (ii) have had no present ownership
interest in a principal residence within the preceding 3-year period,
and (iii) will not use the certificate in connection with the
acquisition or replacement of an existing mortgage. The certificates
contain a maximum purchase price, the certificate credit rate, and a
statement that the certificate will expire if the applicant does not
enter into a closing agreement with respect to a loan within 6 months
from the date of preliminary issuance. Holders of these certificates may
apply for a mortgage loan from any lender. When the holder of the
certificate applies for a loan the lender requires that he submit the
following:
(i) An affidavit stating that the applicant intends to use the
residence in connection with which the mortgage credit certificate is
issued as his principal residence within a reasonable time after the
certificate is issued by County W, that the applicant will notify the
County if the residence ceases to be his principal residence, and facts
that are sufficient for County W to determine whether the residence is
located within the jurisdication of County W,
(ii) An affidavit stating that the applicant had no present
ownership interest in a principal residence at any time during the 3-
year period prior to the date on which the certificate is issued,
(iii) Copies of the applicant's Federal tax returns for the
preceding 3 years,
(iv) Affidavits from the seller of the residence with respect to
which the certificate is issued and the applicant stating the purchase
price of the residence, including an itemized list of (A) payments made
by or for the benefit of the applicant, (B) if the residence is
incomplete, an estimate of the reasonable cost of completing the
residence, and (C) if the residence is subject to a ground rent, the
capitalized value of the ground rent,
(v) An affidavit executed by the applicant stating that the mortgage
being acquired in connection with the certificate will not be used to
acquire or replace an existing mortgage,
(vi) An affidavit executed by the applicant stating that no portion
of the financing for the residence in connection with which the
certificate is issued in provided from the proceeds of a qualified
mortgage bond or qualified veterans' mortgage bond and that no portion
of the mortgage for the residence is provided by a person related to the
applicant (as defined in Sec. 1.25-3T(n)),
(vii) An affidavit executed by the applicant stating that the
certificate was not limited to indebtedness incurred from particular
lenders, and
(viii) In the case of a mortgage credit certificate allocated for
use in connection with a particular development, an affidavit executed
by the applicant stating that the applicant received from the developer
a certification stating that the price of the residence with respect to
which the certificate was issued is no higher than it would be without
the use of a mortgage credit certificate.
The lender then submits those affidavits, together with its statement as
to the amount of the indebtedness incurred, to County W. After
determining that the requirements of paragraphs (c), (d), (e), (f), (g),
(i), (j), (k) and (n) of Sec. 1.25-3T are met and determining that the
certificate has not expired, County W completes the mortgage credit
certificate. This procedure for issuing mortgage credit certificates is
sufficient evidence of the good
[[Page 69]]
faith of County W to meet the requirements of Sec. 1.25-
4T(j)(1)(i)(A).RE
(2) Program requirements. (i) A mortgage credit certificate program
which fails to meet one or more of the requirements of paragraphs (b)
through (h) of this section shall be treated as meeting such
requirements if the requirements of this paragraph (j)(2) are satisfied.
A mortgage credit certificate program meets the requirements of this
paragraph (j)(2) only if each of the following provisions is met:
(A) The issuer in good faith attempted to meet all of the
requirements of paragraphs (b) through (h) of this section. This good
faith requirement will be met if all reasonable steps are taken by the
issuer to ensure that the program complies with these requirements.
(B) Any failure to meet such requirements is due to inadvertent
error, e.g., mathematical error, after taking reasonable steps to comply
with such requirements.
(ii) The following example illustrate the application of this
paragraph (j)(2):
Example. City X issues an issue of mortgage credit certificates.
However, despite taking all reasonable steps to determine accurately the
size of the applicable limit, as provided in section 103A (g)(3) and the
regulations thereunder, the limit is exceeded because the amount of the
mortgages, originated in the area during the past 3 years is incorrectly
computed as a result of mathematical error. Such facts are sufficient
evidence of the good faith of the issuer to meet the requirements of
paragraph (j)(2).
[T.D. 8023, 50 FR 19350, May 8, 1985, as amended by T.D. 8048, 50 FR
35538, Sept. 3, 1985]
Sec. 1.25-5T Limitation on aggregate amount of mortgage credit certificates (Temporary).
(a) In general. If the aggregate amount of qualified mortgage credit
certificates (as defined in paragraph (b)) issued by an issuer under a
qualified mortgage credit certificate program exceeds 20 percent of the
nonissued bond amount (as defined in paragraph (c)), the provisions of
paragraph (d) shall apply.
(b) Aggregate amount of mortgage credit certificates--(1) In
general. The aggregate amount of qualified mortgage credit certificates
issued under a qualified mortgage credit certificate program is the sum
of the products determined by multiplying--
(i) The certified indebtedness amount of each qualified mortgage
credit certificate issued under that program, by
(ii) The certificate credit rate with respect to such certificate.
(2) Examples. The following examples illustrate the application of
this paragraph (b):
Example 1. For 1986 City Q has a nonissued bond amount of $100
million. After making a proper election, Q issues 2,000 qualified
mortgage credit certificates each with a certificate credit rate of 20
percent and a certified indebtedness amount of $50,000. The aggregate
amount of qualified mortgage credit certificates is $20 million (2,000 x
(.2 x $50,000)). Since this amount does not exceed 20 percent of the
nonissued bond amount (.2 x $100 million = $20 million), Q has complied
with the limitation on the aggregate amount of mortgage credit
certificates, provided that it does not issue any additional
certificates.
Example 2. The facts are the same as in example (1) except that
instead of issuing all its certificates at the 20 percent rate, Q issues
(i) qualified mortgage credit certificates with a certificate credit
rate of 10 percent and an aggregate principal amount of $25 million,
(ii) qualified mortgage credit certificates with a certificate credit
rate of 40 percent and an aggregate principal amount of $25 million, and
(iii) qualified mortgage credit certificates with a certificate credit
rate of 30 percent and an aggregate principal amount of $25 million. The
aggregate amount of qualified mortgage credit certificates is $20
million ((10 percent of $25 million) plus (40 percent of $25 million)
plus (30 percent of $25 million)). Q has complied with the limitation on
the aggregate amount of qualified mortgage credit certificates, provided
that it does not issue any additional certificates pursuant to the same
program.
(c) Nonissued bond amount. The term ``nonissued bond amount'' means,
with respect to any qualified mortgage credit certificate program, the
amount of qualified mortgage bonds (as defined in section 103A(c)(1) and
the regulations thereunder) which the issuer is otherwise authorized to
issue and elects not to issue under section 25(c)(2) and Sec. 1.25-
4T(b). The amount of qualified mortgage bonds which an issuing authority
is authorized to issue is determined under section 103A(g) and the
regulations thereunder; such determination shall take into account any
prior elections by the issuer not to
[[Page 70]]
issue qualified mortgage bonds, the amount of any reduction in the State
ceiling under paragraph (d) of this section, and the aggregate amount of
qualified mortgage bonds issued by the issuer prior to its election not
to issue qualified mortgage bonds.
(d) Noncompliance with limitation on aggregate amount of mortgage
credit certificates--(1) In general. If the provisions of this paragraph
apply, the State ceiling under section 103A(g)(4) and the regulations
thereunder for the calendar year following the calendar year in which
the Commissioner determines the correction amount for the State in which
the issuer which exceeded the limitation on the aggregate amount of
mortgage credit certificates is located shall be reduced by 1.25 times
the correction amount with respect to such failure.
(2) Correction amount. (i) The term ``correction amount'' means an
amount equal to the excess credit amount divided by .20.
(ii) The term ``excess credit amount'' means the excess of--
(A) The credit amount for any mortgage credit certificate program,
over
(B) The amount which would have been the credit amount for such
program had such program met the requirements of section 25(d)(2) and
paragraph (a) of this section.
(iii) The term ``credit amount'' means the sum of the products
determined by multiplying--
(A) The certified indebtedness amount of each qualified mortgage
credit certificate issued under the program, by
(B) The certificate credit rate with respect to such certificate.
(3) Example. The following example illustrates the application of
this paragraph:
Example. For 1987 City R has a nonissued bond amount of $100
million. City R issues all of its mortgage credit certificates with a
certificate credit rate of 20 percent. City R issues certificates with
an aggregate certified indebtedness amount of $120 million. The
aggregate amount of mortgage credit certificates issued by City R is $24
million, which exceeds 20 percent of the nonissued bond amount. The
State ceiling for the calendar year following the calendar year in which
the Commissioner determines the correction amount is reduced by $25
million (the correction amount multiplied by 1.25). The correction
amount is determined as follows: The credit amount is $24 million
(.2 x $120 million); the amount which would have been the credit amount
for the program had it met the requirements of section 25(d)(2) is $20
million (.2 x $100 million); the excess credit amount is $4 million ($24
million--$20 million); therefore, the correction amount is $20 million
($4 million/.2).
(4) Cross-references. See section 103A(g)(4) and the regulations
thereunder with respect to the reduction of the applicable State
ceiling.
[T.D. 8023, 50 FR 19353, May 8, 1985]
Sec. 1.25-6T Form of qualified mortgage credit certificate (Temporary).
(a) In general. Qualified mortgage credit certificates are to be
issued on the form prescribed by the Internal Revenue Service. If no
form is prescribed by the Internal Revenue Service, or if the form
prescribed by the Internal Revenue Service is not readily available, the
issuer may use its own form provided that such form contains the
information required by this section. Each mortgage credit certificate
must be issued in a form such that there are at least three copies of
the form. One copy of the certificate shall be retained by the issuer;
one copy shall be retained by the lender; and one copy shall be
forwarded to the State official who issued the certification required by
Sec. 1.25-4T(d), unless that State official has stated in writing that
he does not want to receive such copies.
(b) Required information. Each qualified mortgage credit certificate
must include the following information:
(1) The name, address, and TIN of the issuer,
(2) The date of the issuer's election not to issue qualified
mortgage bonds pursuant to which the certificate is being issued,
(3) The number assigned to the certificate,
(4) The name, address, and TIN of the holder of the certificate,
(5) The certificate credit rate,
(6) The certified indebtness amount,
(7) The acquisition cost of the residence being acquired in
connection with the certificate,
(8) The average area purchase price applicable to the residence,
[[Page 71]]
(9) Whether the certificate meets the requirements of Sec. 1.25-
3T(d), relating to residence requirement,
(10) Whether the certificate meets the requirements of Sec. 1.25-
3T(e), relating to 3-year requirement,
(11) Whether the certificate meets the requirements of Sec. 1.25-
3T(g), relating to new mortgage requirement,
(12) Whether the certificate meets the requirements of Sec. 1.25-
3T(i), relating to prohibited mortgages,
(13) Whether the certificate meets the requirements of Sec. 1.25-
3T(j), relating to particular lenders,
(14) Whether the certificate meets the requirements of Sec. 1.25-
3T(k), relating to allocations to particular developments,
(15) Whether the certificate meets the requirements of Sec. 1.25-
3T(n), relating to interest paid to related persons,
(16) Whether the residence in connection with which the certificate
is issued is a targeted area residence,
(17) The date on which a closing agreement is signed with respect to
the certified indebtness amount,
(18) The expiration date of the certificate,
(19) A statement that the certificate is not transferable or a
statement that the certificate may be transferred only if the issuer
issues a new certificate, and
(20) A statement, signed under penalties of perjury by an authorized
official of the issuer or its agent, that such person has made the
determinations specified in paragraph (b) (9) through (16).
[T.D. 8023, 50 FR 19354, May 8, 1985]
Sec. 1.25-7T Public notice (Temporary).
(a) In general. At least 90 days prior to the issuance of any
mortgage credit certificate under a qualified mortgage credit
certificate program, the issuer shall provide reasonable public notice
of--
(1) The eligibility requirements for such certificate,
(2) The methods by which such certificates are to be issued, and
(3) The other information required by this section.
(b) Reasonable public notice--(1) In general. Reasonable public
notice means published notice which is reasonably designed to inform
individuals who would be eligible to receive mortgage credit
certificates of the proposed issuance. Reasonable public notice may be
provided through newspapers of general circulation.
(2) Contents of notice. The public notice required by paragraph (a)
must include a brief description of the principal residence requirement,
3-year requirement, purchase price requirement, and new mortgage
requirement. The notice must also provide a brief description of the
methods by which the certificates are to be issued and the address and
telephone number for obtaining further information.
[T.D. 8023, 50 FR 19354, May 8, 1985]
Sec. 1.25-8T Reporting requirements (Temporary).
(a) Lender--(1) In general. Each person who makes a loan that is a
certified indebtedness amount with respect to any mortgage credit
certificate must file the report described in paragraph (a)(2) and must
retain on its books and records the information described in paragraph
(a)(3). The report described in paragraph (a)(2) is an annual report and
must be filed on or before January 31 of the year following the calendar
year to which the report relates. See section 6709(c) and the
regulations thereunder for the applicable penalties with respect to
failure to file reports.
(2) Information required. The report shall be submitted on Form 8329
and shall contain the information required therein. A separate Form 8329
shall be filed for each issue of mortgage credit certificates with
respect to which the lender made mortgage loans during the preceding
calendar year. Thus, for example, if during 1986 Bank M makes three
mortgage loans which are certified indebtedness amounts with respect to
State Z's January 15, 1986, issue of mortgage credit certificates, and
two mortgage loans which are certified indebtedness amounts with respect
to State Z's April 15, 1986, issue of mortgage credit certificates, and
fifty mortgage loans which are certified indebtedness amounts with
respect to County X's December 31, 1985, issue of mortgage credit
certificates, Bank M
[[Page 72]]
must file three separate reports for calendar year 1986. The lender must
submit the Form 8329 with the information required therein, including--
(i) The name, address, and TIN of the issuer of the mortgage credit
certificates,
(ii) The date on which the election not to issue qualified mortgage
bonds with respect to that mortgage credit certificate was made,
(iii) The name, address, and TIN of the lender, and
(iv) The sum of the products determined by multiplying--
(A) The certified indebtedness amount of each mortgage credit
certificate issued under such program, by
(B) The certificate credit rate with respect to such certificate.
(3) Recordkeeping requirements. Each person who makes a loan that is
a certified indebtedness amount with respect to any mortgage credit
certificate must retain the information specified in this paragraph
(a)(3) on its books and records for 6 years following the year in which
the loan was made. With respect to each loan the lender must retain the
following information:
(i) The name, address, and TIN of each holder of a qualified
mortgage credit certificate with respect to which a loan is made,
(ii) The name, address, and TIN of the issuer of such certificate,
and
(iii) The date the loan for the certified indebtedness amount is
closed, the certified indebtedness amount, and the certificate credit
rate of such certificate.
(b) Issuers--(1) In general. Each issuer of mortgage credit
certificates shall file the report described in paragraph (b)(2) of this
section.
(2) Quarterly reports. (i) Each issuer which elects to issue
mortgage credit certificates shall file reports on Form 8330. These
reports shall be filed on a quarterly basis, beginning with the quarter
in which the election is made, and are due on the following dates: April
30 (for the quarter ending March 31), July 31 (for the quarter ending
June 30), October 31 (for the quarter ending September 30), and January
31 (for the quarter ending December 31). For elections made prior to May
8, 1985, the first report need not be filed until July 31, 1985. An
issuer shall file a separate report for each issue of mortgage credit
certificates. In the quarter in which the last qualified mortgage credit
certificate that may be issued under a program is issued, the issuer
must state that fact on the report to be filed for that quarter; the
issuer is not required to file any subsequent reports with respect to
that program. See section 6709(c) for the penalties with respect to
failure to file a report.
(ii) The report shall be submitted on Form 8330 and shall contain
the information required therein, including--
(A) The name, address, and TIN of the issuer of the mortgage credit
certificates,
(B) The date of the issuer's election not to issue qualified
mortgage bonds with respect to the mortgage credit certificate program
and the nonissued bond amount of the program,
(C) The sum of the products determined by multiplying--
(1) The certified indebtedness amount of each qualified mortgage
credit certificate issued under that program during the calendar
quarter, by
(2) The certificate credit rate with respect to such certificate,
and
(D) A listing of the name, address, and TIN of each holder of a
qualified mortgage credit certificate which has been revoked during the
calendar quarter.
(c) Extensions of time for filing reports. The Commissioner may
grant an extension of time for the filing of a report required by this
section if there is reasonable cause for the failure to file such report
in a timely fashion.
(d) Place for filing. The reports required by this section are to be
filed at the Internal Revenue Service Center, Philadelphia, Pennsylvania
19225.
(e) Cross reference. See section 6709 and the regulations thereunder
with respect to the penalty for failure to file a report required by
this section.
[T.D. 8023, 50 FR 19354, May 8, 1985]
[[Page 73]]
Sec. 1.28-0 Credit for clinical testing expenses for certain drugs for rare diseases or conditions; table of contents.
In order to facilitate use of Sec. 1.28-1, this section lists the
paragraphs, subparagraphs, and subdivisions contained in Sec. 1.28-1.
(a) General rule.
(b) Qualified clinical testing expenses.
(1) In general.
(2) Modification of section 41(b).
(3) Exclusion for amounts funded by another person.
(i) In general.
(ii) Clinical testing in which taxpayer retains no rights.
(iii) Clinical testing in which taxpayer retains substantial rights.
(A) In general.
(B) Drug by drug determination.
(iv) Funding for qualified clinical testing expenses determinable
only in subsequent taxable years.
(4) Special rule governing the application of section 41(b) beyond
its expiration date.
(c) Clinical testing.
(1) In general.
(2) Definition of ``human clinical testing''.
(3) Definition of ``carried out under'' section 505(i).
(d) Definition and special rules.
(1) Definition of ``rare disease or condition''.
(i) In general.
(ii) Cost of developing and making available the designated drug.
(A) In general.
(B) Exclusion of costs funded by another person.
(C) Computation of cost.
(D) Allocation of common costs. Costs for developing and making
available the designated drug for both the disease or condition for
which it is designated and one or more other diseases or conditions.
(iii) Recovery from sales.
(iv) Recordkeeping requirements.
(2) Tax liability limitation.
(i) Taxable years beginning after December 31, 1986.
(ii) Taxable years beginning before January 1, 1987, and after
December 31, 1983.
(iii) Taxable years beginning before January 1, 1984.
(3) Special limitations on foreign testing.
(i) Clinical testing conducted outside the United States--In
general.
(ii) Insufficient testing population in the United States.
(A) In general.
(B) ``Insufficient testing population''.
(C) ``Unrelated to the taxpayer''.
(4) Special limitations for certain corporations.
(i) Corporations to which section 936 applies.
(ii) Corporations to which section 934(b) applies.
(5) Aggregation of expenditures.
(i) Controlled group of corporations: organizations under common
control.
(A) In general.
(B) Definition of controlled group of corporations.
(C) Definition of organization.
(D) Determination of common control.
(ii) Tax accounting periods used.
(A) In general.
(B) Special rule where the timing of clinical testing is
manipulated.
(iii) Membership during taxable year in more than one group.
(iv) Intra-group transactions.
(A) In general.
(B) In-house research expenses.
(C) Contract research expenses.
(D) Lease payments.
(E) Payments for supplies.
(6) Allocations.
(i) Pass-through in the case of an S corporation
(ii) Pass-through in the case of an estate or a trust.
(iii) Pass-through in the case of a partnership.
(A) In general.
(B) Certain partnership non-business expenditures.
(C) Apportionment.
(iv) Year in which taken into account.
(v) Credit allowed subject to limitation.
(7) Manner of making an election.
[T.D. 8232, 53 FR 38710, Oct. 3, 1988; 53 FR 40879, Oct. 19, 1988]
Sec. 1.28-1 Credit for clinical testing expenses for certain drugs for rare diseases or conditions.
(a) General rule. Section 28 provides a credit against the tax
imposed by chapter 1 of the Internal Revenue Code. The amount of the
credit is equal to 50 percent of the qualified clinical testing expenses
(as defined in paragraph (b) of this section) for the taxable year. The
credit applies to qualified clinical testing expenses paid or incurred
by the taxpayer after December 31, 1982, and before January 1, 1991. The
credit may not exceed the taxpayer's tax liability for the taxable year
(as determined under paragraph (d)(2) of this section).
(b) Qualified clinical testing expenses--(1) In general. Except as
otherwise provided in paragraph (b)(3) of this section, the term
``qualified clinical testing expenses'' means the amounts which are paid
or incurred during the
[[Page 74]]
taxable year which would constitute ``qualified research expenses''
within the meaning of section 41(b) (relating to the credit for
increasing research activities) as modified by section 28(b)(1)(B) and
paragraph (b)(2) of this section. For example, amounts paid or incurred
for the acquisition of depreciable property used in the conduct of
clinical testing (as defined in paragraph (c) of this section) are not
qualified clinical testing expenses.
(2) Modification of section 41(b). For purposes of paragraph (b)(1)
of this section, section 41(b) is modified by substituting ``clinical
testing'' for ``qualified research'' each place it appears in paragraph
(2) of section 41(b) (relating to in-house research expenses) and
paragraph (3) of section 41(b) (relating to contract research expenses).
In addition, ``100 percent'' is substituted for ``65 percent'' in
paragraph (3)(A) of section 41(b).
(3) Exclusion for amounts funded by another person--(i) In general.
The term ``qualified clinical testing expenses'' shall not include any
amount which would otherwise constitute qualified clinical testing
expenses, to the extent such amount is funded by a grant, contract, or
otherwise by another person (or any governmental entity). The
determination of the extent to which an amount is funded shall be made
in light of all the facts and circumstances. For a special rule
regarding funding between commonly controlled businesses, see paragraph
(d)(5)(iv) of Sec. 1.28-1.
(ii) Clinical testing in which taxpayer retains no rights. If a
taxpayer conducting clinical testing with respect to the designated drug
for another person retains no substantial rights in the clinical testing
under the agreement providing for the clinical testing the taxpayer's
clinical testing expenses are treated as fully funded for purposes of
section 28(b)(1)(C). Thus, for example, if the taxpayer incurs clinical
testing expenses under an agreement that confers on another person the
exclusive right to exploit the results of the clinical testing, those
expenses do not constitute qualified clinical testing expenses because
they are fully funded under this paragraph (b)(3)(ii). Incidental
benefits to the taxpayer from the conduct of the clinical testing (for
example, increased experience in the field of human clinical testing) do
not constitute substantial rights in the clinical testing.
(iii) Clinical testing in which taxpayer retains substantial
rights--(A) In general. If a taxpayer conducting clinical testing with
respect to the designated drug for another person retains substantial
rights in the clinical testing under the agreement providing for the
clinical testing, the clinical testing expenses are funded to the extent
of the payments (and fair market value of any property at the time of
transfer) to which the taxpayer becomes entitled by conducting the
clinical testing. The taxpayer shall reduce the amount paid or incurred
by the taxpayer for the clinical testing expenses that would, but for
section 28(b)(1)(C) constitute qualified clinical testing expenses of
the taxpayer by the amount of the funding determined under the preceding
sentence. Rights retained in the clinical testing are not treated as
property for purposes of this paragraph (b)(3)(iii)(A). If the property
that is transferred to the taxpayer is to be consumed in the clinical
testing (for example, supplies), the taxpayer should exclude the value
of that property from both the payments received and the expenses paid
or incurred for the clinical testing.
(B) Drug by drug determination. The provisions of this paragraph
(b)(3) shall be applied separately to each designated drug tested by the
taxpayer.
(iv) Funding for qualified clinical testing expenses determinable
only in subsequent taxable years. If, at the time the taxpayer files its
return for a taxable year, it is impossible to determine to what extent
some or all of the qualified clinical testing expenses may be funded,
the taxpayer shall treat the clinical testing expenses as fully funded
for purposes of that return. When the amount of funding for qualified
clinical testing expenses is finally determined, the taxpayer should
amend the return and any interim returns to reflect the amount of
funding for qualified clinical testing expenses.
(4) Special rule governing the application of section 41(b) beyond
its expiration date. For purposes of section 28 and this section,
section 41(b), as amended,
[[Page 75]]
and the regulations thereunder shall be deemed to remain in effect after
December 31, 1988.
(c) Clinical testing--(1) In general. The term ``clinical testing''
means any human clinical testing which--
(i) Is carried out under an exemption under section 505(i) of the
Federal Food, Drug, and Cosmetic Act (21 U.S.C. 355(i)) and the
regulations relating thereto (21 CFR part 312) for the purpose of
testing a drug for a rare disease or condition as defined in paragraph
(d)(1) of this section,
(ii) Occurs after the date the drug is designated as a drug for a
rare disease or condition under section 526 of the Federal Food, Drug,
and Cosmetic Act (21 U.S.C. 360bb),
(iii) Occurs before the date on which an application for the
designated drug is approved under section 505(b) of the Federal Food,
Drug, and Cosmetic Act (21 U.S.C. 355(b)) or, if the drug is a
biological product (other than a radioactive biological product intended
for human use), before the date on which a license for such drug is
issued under section 351 of the Public Health Services Act (42 U.S.C.
262), and
(iv) Is conducted by or on behalf of the taxpayer to whom the
designation under section 526 of the Federal Food, Drug, and Cosmetic
Act applies.
Human clinical testing shall be taken into account under this paragraph
(c)(1) only to the extent that the testing relates to the use of a drug
for the rare disease or condition for which the drug was designated
under section 526 of the Federal Food, Drug, and Cosmetic Act. For
purposes of paragraph (c)(1)(i) of this section the testing under
section 505(i) exemption procedures (21 CFR part 312) of a biological
product (other than a radioactive biological product intended for human
use) pursuant to 21 CFR Sec. 601.21 is deemed to be carried out under an
exemption under section 505(i) of the Federal Food, Drug, and Cosmetic
Act.
(2) Definition of ``human clinical testing.'' Testing is considered
to be human clinical testing only to the extent that it uses human
subjects to determine the effect of the designated drug on humans and is
necessary for the designated drug either to be approved under section
505(b) of the Federal Food, Drug, and Cosmetic Act and the regulations
thereunder (21 CFR part 314), or if the designated drug is a biological
product (other than a radioactive biological product intended for human
use), to be licensed under section 351 of the Public Health Services Act
and the regulations thereunder (21 CFR part 601). For purposes of this
paragraph (c)(2), a human subject is an individual who is a participant
in research, either as a recipient of the drug or as a control. A
subject may be either a healthy individual or a patient.
(3) Definition of ``carried out under'' section 505(i). Human
clinical testing is not carried out under section 505(i) of the Federal
Food, Drug, and Cosmetic Act and the regulations thereunder (21 CFR part
312) unless the primary purpose of the human clinical testing is to
ascertain the data necessary to qualify the designated drug for sale in
the United States, and not to ascertain data unrelated or only
incidentally related to that needed to qualify the designated drug.
Whether or not this primary purpose test is met shall be determined in
light of all of the facts and circumstances.
(d) Definition and special rules--(1) Definition of ``rare disease
or condition''--(i) In general. The term ``rare disease or condition''
means any disease or condition which--
(A) Afflicts 200,000 or fewer persons in the United States, or
(B) Afflicts more than 200,000 persons in the United States but for
which there is no reasonable expectation that the cost of developing and
making available in the United States (as defined in section 7701(a)(9))
a drug for such disease or condition will be recovered from sales in the
United States (as so defined) of such drug.
Determinations under paragraph (d)(1)(i)(B) of this section with respect
to any drug shall be made on the basis of the facts and circumstances as
of the date such drug is designated under section 526 of the Federal
Food, Drug, and Cosmetic Act. Examples of diseases or conditions which
in 1987 afflicted 200,000 or fewer persons in the United States are
Duchenne dystrophy, one of the muscular dystrophies; Huntington's
disease, a hereditary chorea; myoclonus; Tourette's syndrome; and
[[Page 76]]
amyotrophic lateral sclerosis (ALS or Lou Gehrig's disease).
(ii) Cost of developing and making available the designated drug--
(A) In general. Except as otherwise provided in this paragraph
(d)(1)(ii), the taxpayer's computation of the cost of developing and
making available in the United States the designated drug shall include
only the costs that the taxpayer (or any person whose right to make
sales of the drug is directly or indirectly derived from the taxpayer,
e.g., a licensee or transferee) has incurred or reasonably expects to
incur in developing and making available in the United States the
designated drug for the disease or condition for which it is designated.
For example, if, prior to designation under section 526, the taxpayer
incurred costs of $125,000 to test the drug for the rare disease or
condition for which it is subsequently designated and incurred $500,000
to test the same drug for other diseases, and if, on the date of
designation, the taxpayer expects to incur costs of $1.2 million to test
the drug for the rare disease or condition for which it is designated,
the taxpayer shall include in its cost computation both the $125,000
incurred prior to designation and the $1.2 million expected to be
incurred after designation to test the drug for the rare disease or
condition for which it is designated. The taxpayer shall not include the
$500,000 incurred to test the drug for other diseases.
(B) Exclusion of costs funded by another person. In computing the
cost of developing and making available in the United States the
designated drug, the taxpayer shall not include any cost incurred or
expected to be incurred by the taxpayer to the extent that the cost is
funded or is reasonably expected to be funded (determined under the
principles of paragraph (b)(3)) by a grant, contract, or otherwise by
another person (or any governmental entity).
(C) Computation of cost. The cost computation shall use only
reasonable costs incurred after the first indication of an orphan
application for the designated drug. Such costs shall include the costs
of obtaining data needed, and of meetings to be held, in connection with
a request for FDA assistance under section 525 of the Federal, Food,
Drug, and Cosmetic Act (21 U.S.C. 360aa) or a request for orphan
designation under section 526 of that Act; costs of determining
patentability of the drug; costs of screening, animal and clinical
studies; costs associated with preparation of a Notice of Claimed
Investigational Exemption for a New Drug (IND) and a New Drug
Application (NDA); costs of possible distribution of drug under a
``treatment'' protocol; costs of development of a dosage form;
manufacturing costs; distribution costs; promotion costs; costs to
maintain required records and reports; and costs of the taxpayer in
acquiring the right to market a drug from the owner of that right prior
to designation. The taxpayer shall also include general overhead,
depreciation costs and premiums for insurance against liability losses
to the extent that the taxpayer can demonstrate that these costs are
properly allocable to the designated drug under the established
standards of financial accounting and reporting of research and
development costs.
(D) Allocation of common costs. Costs for developing and making
available the designated drug for both the disease or condition for
which it is designated and one or more other diseases or conditions. In
the case where the costs incurred or expected to be incurred in
developing and making available the designated drug for the disease or
condition for which it is designated are also incurred or expected to be
incurred in developing and making available in the United States the
same drug for one or more other diseases or conditions (whether or not
they are also designated or expected to be designated), the costs shall
be allocated between the cost of developing and making available the
designated drug for the disease or condition for which the drug is
designated and the cost of developing and making available the
designated drug for the other diseases or conditions. The amount of the
common costs to be allocated to the cost of developing and making
available the designated drug for the disease or condition for which it
is designated is determined by multiplying the common costs by a
fraction the numerator of
[[Page 77]]
which is the sum of the expected amount of sales in the United States of
the designated drug for the disease or condition for which the drug is
designated and the denominator of which is the total expected amount of
sales in the United States of the designated drug. For example, if prior
to designation, the taxpayer incurs (among other costs) costs of
$100,000 in testing the designated drug for its toxic effect on animals
(without reference to any disease or condition), and if the taxpayer
expects to recover $500,000 from sales in the United States of the
designated drug for disease X, the disease for which the drug is
designated, and further expects to recover another $1.5 million from the
sales in the United States of the designated drug for disease Y, the
taxpayer must allocate a proportionate amount of the common costs of
$100,000 to the cost of developing and making available the designated
drug for both disease X and disease Y. Since the ratio of the expected
amount of sales in the United States of the designated drug for disease
X to the total of both the expected amount of sales in the United States
of the designated drug for disease X and the expected amount of sales in
the United States of the designated drug for disease Y is $500,000/
$2,000,000, 25% of the common costs of $100,000 (i.e., $25,000) is
allocated to the cost of developing and making available the designated
drug for disease X.
(iii) Recovery from sales. In determining whether the taxpayer's
cost described in paragraph (d)(1)(ii) of this section will be recovered
from sales in the United States of the designated drug for the disease
or condition for which the drug is designated, the taxpayer shall
include anticipated sales by the taxpayer or any person whose right to
make such sales is directly or indirectly derived from the taxpayer
(such as a licensee or transferee). The anticipated sales shall be based
upon the size of the anticipated patient population for which the
designated drug would be useful, including the following factors: the
degree of effectiveness and safety of the designated drug, if known: the
projected fraction of the anticipated patient population expected to be
given the designated drug and to continue to take it; other available
agents and other types of therapy; the likelihood that superior agents
will become available within a few years; and the number of years during
which the designated drug would be exclusively available, e.g., under a
patent.
(iv) Recordkeeping requirements. The taxpayer shall keep records
sufficient to substantiate the cost and sales estimates made pursuant to
this paragraph (d)(1). The records required by this paragraph (d)(1)(iv)
shall be retained so long as the contents thereof may become material in
the administration of section 28.
(2) Tax liability limitation--(i) Taxable years beginning after
December 31, 1986. The credit allowed by section 28 shall not exceed the
excess (if any) of--
(A) The taxpayer's regular tax liability for the taxable year (as
defined in section 26(b)), reduced by the sum of the credits allowable
under--
(1) Section 21 (relating to expenses for household and dependent
care services necessary for gainful employment),
(2) Section 22 (relating to the elderly and permanently and totally
disabled),
(3) Section 23 (relating to residential energy),
(4) Section 25 (relating to interest on certain home mortgages), and
(5) Section 27 (relating to taxes on foreign countries and
possessions of the United States), over
(B) The tentative minimum tax for the taxable year (as determined
under section 55(b)(1)).
(ii) Taxable years beginning before January 1, 1987, and after
December 31, 1983. The credit allowed by section 28 shall not exceed the
taxpayer's tax liability for the taxable year (as defined in section 26
(b) prior to its amendment by the Tax Reform Act of 1986 (Pub. L. 99-
514)), reduced by the sum of the credits allowable under--
(A) Section 21 (relating to expenses for household dependent care
services necessary for gainful employment),
(B) Section 22 (relating to the elderly and permanently and totally
disabled),
(C) Section 23 (relating to residential energy),
(D) Section 24 (relating to contributions to candidates for public
office),
[[Page 78]]
(E) Section 25 (relating to interest on certain home mortgages), and
(F) Section 27 (relating to the taxes on foreign countries and
possessions of the United States).
(iii) Taxable years beginning before January 1, 1984. The credit
allowed by section 28 shall not exceed the amount of the tax imposed by
chapter 1 of the Internal Revenue Code for the taxable year, reduced by
the sum of the credits allowable under the following sections as
designated prior to the enactment of the Tax Reform Act of 1984 (Pub.
Law 98-369):
(A) Section 32 (relating to tax withheld at source on nonresident
aliens and foreign corporations and on tax-free convenant bonds),
(B) Sections 33 (relating to taxes of foreign countries and
possessions of the United States),
(C) Section 37 (relating to the retirement income),
(D) Section 38 (relating to investment in certain depreciable
property),
(E) Section 40 (relating to expenses of work incentive programs).
(F) Section 41 (relating to contributions to candidates for public
office).
(G) Section 44 (relating to purchase of new principal residence).
(H) Section 44A (relating to expenses for household and dependent
care services necessary for gainful employment).
(I) Section 44B (relating to employment of certain new employees).
(J) Section 44C (relating to residential energy).
(K) Section 44D (relating to producing fuel from a nonconventional
source).
(L) Section 44E (relating to alcohol used as fuel).
(M) Section 44F (relating to increasing research activities), and
(N) Section 44G (relating to employee stock ownership).
The term ``tax imposed by chapter 1'' as used in this paragraph
(d)(2)(iii) does not include any tax treated as not imposed by chapter 1
of the Internal Revenue Code under the last sentence of section 53(a).
(3) Special limitations on foreign testing--(i) Clinical testing
conducted outside of the United States--In general. Except as otherwise
provided in this paragraph (d)(3), expenses paid or incurred with
respect to clinical testing conducted outside the United States (as
defined in section 7701(a)(9)) are not eligible for credit under this
section. Thus, for example, wages paid an employee clinical investigator
for clinical testing conducted in medical facilities in the United
States and Mexico generally must be apportioned between the clinical
testing conducted within the United States and the clinical testing
conducted outside the United States, and only the wages apportioned to
the clinical testing conducted within the United States are qualified
clinical testing expenses.
(ii) Insufficient testing population in the United States--(A) In
general. If clinical testing is conducted outside of the United States
because there is an insufficient testing population in the United
States, and if the clinical testing is conducted by a United States
person (as defined in section 7701(a)(30)) or is conducted by any other
person unrelated to the taxpayer to whom the designation under section
526 of the Federal Food, Drug, and Cosmetic Act applies, then the
expenses paid or incurred for clinical testing conducted outside of the
United States are eligible for the credit provided by section 28.
(B) ``Insufficient testing population.'' The testing population in
the United States is insufficient if there are not within the United
States the number of available and appropriate human subjects needed to
produce reliable data from the clinical investigation.
(C) ``Unrelated to the taxpayer.'' For the purpose of determining
whether a person is unrelated to the taxpayer to whom the designation
under section 526 of the Federal Food, Drug, and Cosmetic Act and the
regulations thereunder applies, the rules of section 613A(d)(3) shall
apply except that the number ``5'' in section 613A(d)(3) (A), (B), and
(C) shall be deleted and the number ``10'' inserted in lieu thereof.
(4) Special limitations for certain corporations--(i) Corporations
to which section 936 applies. Expenses paid or incurred for clinical
testing conducted either inside or outside the United States by a
corporation to which section 936 (relating to Puerto Rico and
[[Page 79]]
possessions tax credit) applies are not eligible for the credit under
section 28.
(ii) Corporations to which section 934(b) applies. For taxable years
beginning before January 1, 1987, expenses paid or incurred for clinical
testing conducted either inside or outside the United States by a
corporation to which section 934(b) (relating to the limitation on
reduction in income tax liability incurred to the Virgin Islands), as in
effect prior to its amendment by the Tax Reform Act of 1986, applies are
not eligible for the credit under section 28. For taxable years
beginning after December 31, 1986, see section 1277(c)(1) of the Tax
Reform Act of 1986 (100 Stat. 2600) which makes the rule set forth in
the preceding sentence inapplicable with respect to corporations created
or organized in the Virgin Islands only if (and so long as) an
implementing agreement described in that section is in effect between
the United States and the Virgin Islands.
(5) Aggregation of expenditures--(i) Controlled group of
corporations; organizations under common control--(A) In general. In
determining the amount of the credit allowable with respect to an
organization that at the end of its taxable year is a member of a
controlled group of corporations or a member of a group of organizations
under common control, all members of the group are treated as a single
taxpayer and the credit (if any) allowable to the member is determined
on the basis of its proportionate share of the qualified clinical
testing expenses of the aggregated group.
(B) Definition of controlled group of corporations. For purposes of
this section, the term ``controlled group of corporations'' shall have
the meaning given to the term by section 41(f)(5).
(C) Definition of organization. For purposes of this section, an
organization is a sole proprietorship, a partnership, a trust, an
estate, or a corporation, that is carrying on a trade or business
(within the meaning of section 162). For purposes of this section, any
corporation that is a member of a commonly controlled group shall be
deemed to be carrying on a trade or business if any other member of that
group is carrying on any trade or business.
(D) Determination of common control. Whether organizations are under
common control shall be determined under the principles set forth in
paragraphs (b) through (g) of 26 CFR 1.52-1.
(ii) Tax accounting periods used--(A) In general. The credit
allowable to a member of a controlled group of corporations or a group
of organizations under common control is that member's share of the
aggregate credit computed as of the end of such member's taxable year.
(B) Special rule where the timing of clinical testing is
manipulated. If the timing of clinical testing by members using
different tax accounting periods is manipulated to generate a credit in
excess of the amount that would be allowable if all members of the group
used the same tax accounting period, the district director may require
all members of the group to calculate the credit in the current taxable
year and all future years by using the ``conformed years'' method. Each
member computing a credit under the ``conformed years'' method shall
compute the credit as if all members of the group had the same taxable
year as the computing member.
(iii) Membership during taxable year in more than one group. An
organization may be a member of only one group for a taxable year. If,
without application of this paragraph (d)(5)(iii), an organization would
be a member of more than one group at the end of its taxable year, the
organization shall be treated as a member of the group in which it was
included for its preceding taxable year. If the organization was not
included for its preceding taxable year in any group in which it could
be included as of the end of its taxable year, the organization shall
designate in its timely filed return the group in which it is being
included. If the return for a taxable year is due before May 1, 1985,
the organization may designate its group membership through an amended
return for that year filed on or before April 30, 1985. If the
organization does not so designate, then the district director with
audit jurisdiction of the return will determine the group in which the
business is to be included.
(iv) Intra-group transactions-- (A) In general. Because all members
of a group
[[Page 80]]
under common control are treated as a single taxpayer for purposes of
determining the credit, transactions between members of the group are
generally disregarded.
(B) In-house research expenses. If one member of a group conducts
clinical testing on behalf of another member, the member conducting the
clinical testing shall include in its qualified clinical testing
expenses any in-house research expenses for that work and shall not
treat any amount received or accrued from the other member as funding
the clinical testing. Conversely, the member for whom the clinical
testing is conducted shall not treat any part of any amount paid or
incurred as a contract research expense. For purposes of determining
whether the in-house research for that work is clinical testing, the
member performing the clinical testing shall be treated as carrying on
any trade or business carried on by the member on whose behalf the
clinical testing is performed.
(C) Contract research expenses. If a member of a group pays or
incurs contract research expenses to a person outside the group in
carrying on the member's trade or business, that member shall include
those expenses as qualified clinical testing expenses. However, if the
expenses are not paid or incurred in carrying on any trade or business
of that member, those expenses may be taken into account as contract
research expenses by another member of the group provided that the other
member--
(1) Reimburses the member paying or incurring the expenses, and
(2) Carries on a trade or business to which the clinical testing
relates.
(D) Lease payments. Amounts paid or incurred to another member of
the group for the lease of personal property owned by a person outside
the group shall be taken into account as in-house research expenses for
purposes of section 28 only to the extent of the lesser of--
(1) The amount paid or incurred to the other member, or
(2) The amount of the lease expense paid to a person outside the
group.
The amount paid or incurred to another member of the group for the
lease of personal property owned by a member of the group is not taken
into account for purposes of section 28.
(E) Payment for supplies. Amounts paid or incurred to another member
of the group for supplies shall be taken into account as in-house
research expenses for purposes of section 28 only to the extent of the
lesser of--
(1) The amount paid or incurred to the other member, or
(2) The amount of the other member's basis in the supplies.
(6) Allocations--(i) Pass-through in the case of an S corporation.
In the case of an S corporation (as defined in section 1361), the amount
of the credit for qualified clinical testing expenses computed for the
corporation for any taxable year shall be allocated among the persons
who are shareholders of the corporation during the taxable year
according to the provisions of section 1366 and section 1377.
(ii) Pass-through in the case of an estate or a trust. In the case
of an estate or a trust, the amount of the credit for qualified clinical
testing expenses computed for the estate or trust for any taxable year
shall be apportioned between the estate or trust and the beneficiaries
on the basis of the income of the estate or trust allocable to each.
(iii) Pass-through in the case of a partnership--(A) In general. In
the case of a partnership, the credit for qualified clinical testing
expenses computed for the partnership for any taxable year shall be
apportioned among the persons who are partners during the taxable year
in accordance with section 704 and the regulations thereunder.
(B) Certain partnership non-business expenditures. A partner's share
of an in-house research expense or contract research expense paid or
incurred by a partnership other than in carrying on a trade or business
of the partnership constitutes a qualified clinical testing expense of
the partner if--
(1) The partner is entitled to make independent use of the result of
the clinical testing, and
(2) The clinical testing expense paid or incurred in carrying on the
clinical testing would have been paid or incurred by the partner in
carrying on a trade or business of the partner if the partner had
carried on the clinical
[[Page 81]]
testing that was in fact carried on by the partnership.
(C) Apportionment. Qualified clinical testing expenses to which
paragraph (d)(6)(iii)(B) of this section applies shall be apportioned
among the persons who are partners during the taxable year in accordance
with section 704 and the regulations thereunder. For purposes of section
28, these expenses shall be treated as paid or incurred directly by the
partners rather than by the partnership. Thus, the partnership shall
disregard these expenses in computing the credit to be apportioned under
paragraph (d)(6)(iii)(A) of this section, and each partner shall
aggregate the portion of these expenses allocated to the partner with
other qualified clinical testing expenses of the partner in making the
computations under section 28.
(iv) Year in which taken into account. An amount apportioned to a
person under paragraph (d)(6) of this section shall be taken into
account by the person in the taxable year of such person in which or
with which the taxable year of the corporation, estate, trust, or
partnership (as the case may be) ends.
(v) Credit allowed subject to limitation. Any person to whom any
amount has been apportioned under paragraph (d)(6)(i), (ii), or (iii) of
this section is allowed, subject to the limitation provided in section
28(d)(2), a credit for that amount.
(7) Manner of making an election. To make an election to have
section 28 apply for its taxable year, the taxpayer shall file Form 6765
(Credit for Increasing Research Activities (or for claiming the orphan
drugs credit)) containing all the information required by that form.
[T.D. 8232, 53 FR 38711, Oct. 3, 1988; 53 FR 40879, Oct. 19, 1988; 53 FR
41013, Oct. 19, 1988]
Credits Against Tax
credits allowable
Sec. 1.30-1 Definition of qualified electric vehicle and recapture of credit for qualified electric vehicle.
(a) Definition of qualified electric vehicle. A qualified electric
vehicle is a motor vehicle that meets the requirements of section 30(c).
Accordingly, a qualified electric vehicle does not include any motor
vehicle that has ever been used (for either personal or business use) as
a non-electric vehicle.
(b) Recapture of credit for qualified electric vehicle--(1) In
general--(i) Addition to tax. If a recapture event occurs with respect
to a taxpayer's qualified electric vehicle, the taxpayer must add the
recapture amount to the amount of tax due in the taxable year in which
the recapture event occurs. The recapture amount is not treated as
income tax imposed on the taxpayer by chapter 1 of the Internal Revenue
Code for purposes of computing the alternative minimum tax or
determining the amount of any other allowable credits for the taxable
year in which the recapture event occurs.
(ii) Reduction of carryover. If a recapture event occurs with
respect to a taxpayer's qualified electric vehicle, and if a portion of
the section 30 credit for the cost of that vehicle was disallowed under
section 30(b)(3)(B) and consequently added to the taxpayer's minimum tax
credit pursuant to section 53(d)(1)(B)(iii), the taxpayer must reduce
its minimum tax credit carryover by an amount equal to the portion of
any minimum tax credit carryover attributable to the disallowed section
30 credit, multiplied by the recapture percentage for the taxable year
of recapture. Similarly, the taxpayer must reduce any other credit
carryover amounts (such as under section 469) by the portion of the
carryover attributable to section 30, multiplied by the recapture
percentage.
(2) Recapture event--(i) In general. A recapture event occurs if,
within 3 full years from the date a qualified electric vehicle is placed
in service, the vehicle ceases to be a qualified electric vehicle. A
vehicle ceases to be a qualified electric vehicle if--
(A) The vehicle is modified so that it is no longer primarily
powered by electricity;
(B) The vehicle is used in a manner described in section 50(b); or
(C) The taxpayer receiving the credit under section 30 sells or
disposes of the vehicle and knows or has reason to know that the vehicle
will be used in a
[[Page 82]]
manner described in paragraph (b)(2)(i)(A) or (B) of this section.
(ii) Exception for disposition. Except as provided in paragraph
(b)(2)(i)(C) of this section, a sale or other disposition (including a
disposition by reason of an accident or other casualty) of a qualified
electric vehicle is not a recapture event.
(3) Recapture amount. The recapture amount is equal to the recapture
percentage times the decrease in the credits allowed under section 30
for all prior taxable years that would have resulted solely from
reducing to zero the cost taken into account under section 30 with
respect to such vehicle, including any credits allowed attributable to
section 30 (such as under sections 53 and 469).
(4) Recapture date. The recapture date is the actual date of the
recapture event unless a recapture event described in paragraph
(b)(2)(i)(B) of this section occurs, in which case the recapture date is
the first day of the recapture year.
(5) Recapture percentage. For purposes of this section, the
recapture percentage is--
(i) 100, if the recapture date is within the first full year after
the date the vehicle is placed in service;
(ii) 66 \2/3\, if the recapture date is within the second full year
after the date the vehicle is placed in service; or
(iii) 33 \1/3\, if the recapture date is within the third full year
after the date the vehicle is placed in service.
(6) Basis adjustment. As of the first day of the taxable year in
which the recapture event occurs, the basis of the qualified electric
vehicle is increased by the recapture amount and the carryover
reductions taken into account under paragraphs (b)(1)(i) and (ii) of
this section, respectively. For a vehicle that is of a character that is
subject to an allowance for depreciation, this increase in basis is
recoverable over the remaining recovery period for the vehicle beginning
as of the first day of the taxable year of recapture.
(7) Application of section 1245 for sales and other dispositions.
For purposes of section 1245, the amount of the credit allowable under
section 30(a) with respect to any qualified electric vehicle that is (or
has been) of a character subject to an allowance for depreciation is
treated as a deduction allowed for depreciation under section 167.
Therefore, upon a sale or other disposition of a depreciable qualified
electric vehicle, section 1245 will apply to any gain recognized to the
extent the basis of the depreciable vehicle was reduced under section
30(d)(1) net of any basis increase described in paragraph (b)(6) of this
section.
(8) Examples. The following examples illustrate the provisions of
this section:
Example 1. A, a calendar-year taxpayer, purchases and places in
service for personal use on January 1, 1995, a qualified electric
vehicle costing $25,000. On A's 1995 federal income tax return, A claims
a credit of $2,500. On January 2, 1996, A sells the vehicle to an
unrelated third party who subsequently converts the vehicle into a non-
electric vehicle on October 15, 1996. There is no recapture upon the
sale of the vehicle by A provided A did not know or have reason to know
that the purchaser intended to convert the vehicle to non-electric use.
Example 2. B, a calendar-year taxpayer, purchases and places in
service for personal use on October 11, 1994, a qualified electric
vehicle costing $20,000. On B's 1994 federal income tax return, B claims
a credit of $2,000, which reduces B's tax by $2,000. The basis of the
vehicle is reduced to $18,000 ($20,000-$2,000). On March 8, 1996, B
sells the vehicle to a tax-exempt entity. Because B knowingly sold the
vehicle to a tax-exempt entity described in section 50(b) in the second
full year from the date the vehicle was placed in service, B must
recapture $1,333 ($2,000 x 66 \2/3\ percent). This recapture amount
increases B's tax by $1,333 on B's 1996 federal income tax return and is
added to the basis of the vehicle as of January 1, 1996, the beginning
of the taxable year in which the recapture event occurred.
Example 3. X, a calendar-year taxpayer, purchases and places in
service for business use on January 1, 1994, a qualified electric
vehicle costing $30,000. On X's 1994 federal income tax return, X claims
a credit of $3,000, which reduces X's tax by $3,000. The basis of the
vehicle is reduced to $27,000 ($30,000-$3,000) prior to any adjustments
for depreciation. On March 8, 1995, X converts the qualified electric
vehicle into a gasoline-propelled vehicle. Because X modified the
vehicle so that it is no longer primarily powered by electricity in the
second full year from the date the vehicle was placed in service, X must
recapture $2,000 ($3,000 x 66\2/3\ percent). This recapture amount
increases X's tax by $2,000 on X's 1995 federal income tax
[[Page 83]]
return. The recapture amount of $2,000 is added to the basis of the
vehicle as of January 1, 1995, the beginning of the taxable year of
recapture, and to the extent the property remains depreciable, the
adjusted basis is recoverable over the remaining recovery period.
Example 4. The facts are the same as in Example 3. In 1996, X sells
the vehicle for $31,000, recognizing a gain from this sale. Under
paragraph (b)(7) of this section, section 1245 will apply to any gain
recognized on the sale of a depreciable vehicle to the extent the basis
of the vehicle was reduced by the section 30 credit net of any basis
increase from recapture of the section 30 credit. Accordingly, the gain
from the sale of the vehicle is subject to section 1245 to the extent of
the depreciation allowance for the vehicle plus the credit allowed under
section 30 ($3,000), less the previous recapture amount ($2,000). Any
remaining amount of gain may be subject to other applicable provisions
of the Internal Revenue Code.
(c) Effective date. This section is effective on October 14, 1994.
If the recapture date is before the effective date of this section, a
taxpayer may use any reasonable method to recapture the benefit of any
credit allowable under section 30(a) consistent with section 30 and its
legislative history. For this purpose, the recapture date is defined in
paragraph (b)(4) of this section.
[60 FR 39649, Aug. 3, 1995]
Sec. 1.31-1 Credit for tax withheld on wages.
(a) The tax deducted and withheld at the source upon wages under
chapter 24 of the Internal Revenue Code of 1954 (or in the case of
amounts withheld in 1954, under subchapter D, chapter 9 of the Internal
Revenue Code of 1939) is allowable as a credit against the tax imposed
by Subtitle A of the Internal Revenue Code of 1954, upon the recipient
of the income. If the tax has actually been withheld at the source,
credit or refund shall be made to the recipient of the income even
though such tax has not been paid over to the Government by the
employer. For the purpose of the credit, the recipient of the income is
the person subject to tax imposed under Subtitle A upon the wages from
which the tax was withheld. For instance, if a husband and wife
domiciled in a State recognized as a community property State for
Federal tax purposes make separate returns, each reporting for income
tax purposes one- half of the wages received by the husband, each spouse
is entitled to one-half of the credit allowable for the tax withheld at
source with respect to such wages.
(b) The tax withheld during any calendar year shall be allowed as a
credit against the tax imposed by Subtitle A for the taxable year of the
recipient of the income which begins in that calendar year. If such
recipient has more than one taxable year beginning in that calendar
year, the credit shall be allowed against the tax for the last taxable
year so beginning.
Sec. 1.31-2 Credit for ``special refunds'' of employee social security tax.
(a) In general. (1) In the case of an employee receiving wages from
more than one employer during the calendar year, amounts may be deducted
and withheld as employee social security tax with respect to more than
$3,600 of wages received during the calendar year 1954, and with respect
to more than $4,200 of wages received during a calendar year after 1954.
For example, employee social security tax may be deducted and withheld
on $5,000 of wages received by an employee during a particular calendar
year if the employee is paid wages in such year in the amount of $3,000
by one employer and in the amount of $2,000 by another employer. Section
6413(c) (as amended by section 202 of the Social Security Amendments of
1954 (68 Stat. 1089)), permits, under certain conditions, a so-called
``special refund'' of the amount of employee social security tax
deducted and withheld with respect to wages paid to an employee in a
calendar year after 1954 in excess of $4,200 ($3,600 for the calendar
year 1954) by reason of the employee receiving wages from more than one
employer during the calendar year. For provisions relating to the
imposition of the employee tax and the limitation on wages, see with
respect to the calendar year 1954, sections 1400 and 1426(a)(1) of the
Internal Revenue Code of 1939 and, with respect to calendar years after
1954, sections 3101 and 3121(a)(1) of the Internal Revenue Code of 1954,
as amended by sections 208(b) and 204(a), respectively, of the Social
Security Amendments of 1954 (68 Stat. 1094, 1091).
[[Page 84]]
(2) An employee who is entitled to a special refund of employee tax
with respect to wages received during a calendar year and who is also
required to file an income tax return for such calendar year (or for his
last taxable year beginning in such calendar year) may obtain the
benefits of such special refund only by claiming credit for such special
refund in the same manner as if such special refund were an amount
deducted and withheld as income tax at the source. For provisions for
claiming special refunds for 1955 and subsequent years in the case of
employees not required to file income tax returns, see section 6413(c)
and the regulations thereunder. For provisions relating to such refunds
for 1954, see 26 CFR (1939) 408.802 (regulations 128).
(3) The amount of the special refund allowed as a credit shall be
considered as an amount deducted and withheld as income tax at the
source under chapter 24 of the Internal Revenue Code of 1954 (or, in the
case of a special refund for 1954, subchapter D, chapter 9 of the
Internal Revenue Code of 1939). If the amount of such special refund
when added to amounts deducted and withheld as income tax exceeds the
taxes imposed by subtitle A of the Internal Revenue Code of 1954, the
amount of the excess constitutes an overpayment of income tax under
Subtitle A, and interest on such overpayment is allowed to the extent
provided under section 6611 upon an overpayment of income tax resulting
from a credit for income tax withheld at source. See section 6401(b).
(b) Federal and State employees and employees of certain foreign
corporations. The provisions of this section shall apply to the amount
of a special refund allowable to an employee of a Federal agency or a
wholly owned instrumentality of the United States, to the amount of a
special refund allowable to an employee of any State or political
subdivision thereof (or any instrumentality of any one or more of the
foregoing), and to the amount of a special refund allowable to employees
of certain foreign corporations. See, with respect to such special
refunds for 1954, section 1401(d)(4) of the Internal Revenue Code of
1939, and with respect to such special refunds for 1955 and subsequent
years, section 6413(c)(2) of the Internal Revenue Code of 1954, as
amended by section 202 of the Social Security amendments of 1954.
Sec. 1.32-2 Earned income credit for taxable years beginning after December 31, 1978.
(a) Allowance of credit. For taxable years beginning after December
31, 1978, subject to the limitations of paragraph (b) of this section,
an eligible individual (as defined in paragraph (c)(1) of this section)
is allowed as a credit against the tax imposed by subtitle A of the Code
for the taxable year, an amount equal to 10 percent of the first $5,000
of earned income (as defined in paragraph (c)(2) of this section) for
the taxable year. For earlier taxable years beginning before January 1,
1979, see Sec. 1.43-1.
(b) Limitations--(1) Amount of credit. The amount of the credit
allowed by section 43 and paragraph (a) of this section for the taxable
year must not exceed the excess, if any, of $500 over 12.5 percent of
that amount of the adjusted gross income (or, if greater, the earned
income) of the taxpayer for the taxable year which exceeds $6,000. For
the meaning of the term ``earned income,'' see paragraph (c)(2) of this
section. Adjusted gross income is determined under section 62 and the
regulations thereunder. If an individual has adjusted gross income or
earned income of $10,000 or more, the individual is not entitled to the
credit.
(2) Married individuals. No credit is allowed by section 43 and
paragraph (a) of this section in the case of an eligible individual who
is married (within the meaning of section 143 and the regulations
thereunder) unless the individual and spouse file a single return
jointly (a joint return) for the taxable year (see section 6013 and the
regulations thereunder relating to joint returns of income tax by
husband and wife). The requirements of the preceding sentence do not
apply to an eligible individual who is not considered as married under
section 143(b) and the regulations thereunder (relating to certain
married individuals living apart).
(3) Length of taxable year. No credit is allowed by section 43 and
paragraph (a) of this section in the case of a taxable
[[Page 85]]
year covering a period of less than 12 months. However, the rule of the
preceding sentence does not apply to a taxable year closed by reason of
the death of the eligible individual.
(c) Definitions--(1) Eligible individual. For purposes of this
section, an eligible individual is an individual who meets the following
requirements of this paragraph (c)(1).
(i) For the taxable year the individual must meet any one of the
following three requirements set forth, respectively, in (A), (B), and
(C) of this subdivision (i).
(A) The individual must be married (within the meaning of section
143 and the regulations thereunder) and be entitled to a deduction under
section 151 for a child (within the meaning of section 151(e)(3) and the
regulations thereunder). The child must have the same principal place of
abode (as defined in Sec. 1.2-2(c)) as the individual and that principal
place of abode must be in the United States for the entire taxable year.
(B) The individual must qualify as a surviving spouse (as determined
under section 2(a) and the regulations thereunder). Thus, the spouse of
the individual must have died within the period of the 2 taxable years
immediately preceding the individual's taxable year. Also, the
individual must have furnished over half the cost of maintaining as the
individual's home a household in the United States for the entire
taxable year which is the principal place of abode of a child of the
individual who qualifies as a dependent for whom the individual is
entitled to a deduction under section 151.
(C) The individual must qualify as a head of household (as
determined under section 2(b) and the regulations thereunder but without
regard to section 2(b)(1)(A)(ii) and (B) and the regulations,
thereunder). Thus, the individual cannot be married as of the close of
the taxable year and also cannot qualify as a surviving spouse under
section 2(a). Also, the individual must have furnished over half the
cost of maintaining as the individual's home a household in the United
States for the entire taxable year which is the principal place of abode
of a child or descendant of the individual who is unmarried or who
qualifies as a dependent for whom the individual is entitled to a
deduction under section 151.
(ii) For the entire taxable year, the individual must not be
entitled to exclude any amount from gross income under section 911
(relating to earned income by individuals in certain camps outside the
United States) or section 931 and the regulations thereunder (relating
to income from sources within the possessions of the United States).
(iii) The rules of this paragraph (c)(1) are illustrated by the
following examples:
Example 1. A, who is married and a member of the United States Armed
Forces, maintains his household outside the United States for part of
the taxable year. A is not an eligible individual. However, if A
maintains his household inside the United States for the entire taxable
year and is only temporarily absent therefrom by reason of military
service and if the household is his principal place of abode and the
principal place of abode of his child who receives over half of his
support from the taxpayer for the calendar year in which the taxable
year of the taxpayer begins and who either has less than $1,000 of gross
income for the calendar year in which the individual's taxable year
begins or who has not attained the age of 19 at the close of the
calendar year in which the individual's taxable year begins or is a
student, then the individual is an eligible individual if he meets the
requirements of subdivision (ii) of this paragraph.
Example 2. B's wife died in 1975 and B has not remarried. For his
entire taxable year beginning January 1, 1979, B maintains his household
inside the United States. The household is, for the entire taxable year,
B's principal place of abode and the principal place of abode of B's
unmarried grandchild whose natural parents are deceased. Thus B
qualifies as a head of household (as determined under section 2(b)
without regard to subparagraphs (A)(ii) and (B) of section 2(b)(1)). In
these circumstances, regardless of whether B provides sufficient support
to claim the grandchild as a dependent, B is an eligible individual if
he meets the requirements of subdivision (ii) of this paragraph.
Example 3. C is married and maintains his household inside the
United States for the entire taxable year. The household is his
principal place of abode and, for the entire year, is also the principal
place of abode of a 12 year old child whose natural parents are deceased
and who is placed with C by a State agency to provide the child with
foster care. C receives compensation from the State
[[Page 86]]
agency to cover all of the cost of maintaining the child in his home.
The child is in C's care and is cared for as C's own child. In these
circumstances, the child is C's foster child, but C is not able to claim
the child as a dependent since C did not provide half the child's
support for the year. C is not eligible for the earned income credit.
Example 4. Assume the same facts as in example (3) except that C
receives no compensation from the State agency, and C provides over half
the child's support and is able to claim the child as a dependent. C is
an eligible individual if he meets the requirements of subdivision (ii)
of this paragraph.
Example 5. D's husband died in 1974 and D has not remarried. For the
entire taxable year beginning January 1, 1979, D maintains her household
inside the United States. The household is D's principal place of abode
and, for the entire taxable year, is also the principal place of abode
of D's unmarried son. D cares for her son in all respects except that
her parents provide over half of the son's support. D qualifies as a
head of household (as determined under section 2(b) without regard to
subparagraph (A)(ii) and (B) of section 2(b)(1)). D is an eligible
individual if D meets the requirements of subdivision (ii) of this
paragraph.
Example 6. Assume the same facts as in example 5 except that D is
married. Since D cannot qualify as a head of household, and D's son
cannot be claimed as D's dependent, D is not an eligible individual.
(2) Earned income. For purposes of this section, earned income
means--
(i) Wages, salaries, tips, other employee compensation, and
(iii) Net earnings from self-employment (within the meaning of
section 1402(a) and the regulations thereunder).
Earned income includes compensation excluded from gross income, such as
disability income excluded under section 105(d), the rental value of a
parsonage excluded under section 107, and the value of meals and lodging
furnished for the convenience of the employer excluded under section
119. Earned income is computed without regard to any community property
laws which may otherwise be applicable. Earned income is reduced by any
net loss in earnings from self-employment. Earned income does not
include amounts received as a pension, an annuity, unemployment
compensation, or workmen's compensation, or an amount to which section
871(a) and the regulations thereunder apply (relating to income of
nonresident alien individuals not connected with United States
business).
(d) Examples. The application of this section is illustrated by the
following examples. For purposes of these examples, assume that the
eligible individual does not receive a pension, an annuity, or an amount
to which section 871(a), 911, or 931 applies.
Example 1 . A and B (married individuals) maintain a household
inside the United States which is their principal place of abode and the
principal place of abode of their two children who are 12 and 14 years
old. A and B are calendar year taxpayers and, for 1979, they file a
joint return. A and B have a total earned income of $7,600 (computed
without regard to any community property laws) and have adjusted gross
income of less than $7,600. The earned income credit of $300 is
determined as follows:
Basic credit (10 percent of $5,000 under ........ ........ $500
paragraph (a) of this section)...........
Initial limitation amount................. ........ $500 ........
Less: Reduction under paragraph (b)(1) of
this section:
Earned income for taxable year............ $7,600 ........ ........
Less...................................... $6,000 ........ ........
----------
Excess over $6,000........................ 1,600 ........ ........
==========
12\1/2\ percent of excess ($1,600)........ ........ $200 ........
---------
Maximum credit (if less than basic credit) ........ ........ $300
Example 2 . Assume the same facts as in example 1 except that A and
B have earned income of $4,000 and adjusted gross income of $7,000. The
earned income credit of $375 is determined as follows:
Basic credit (10 percent of $4,000 under ........ ........ $400
paragraph (a) of this section)...........
Initial limitation amount................. ........ $500 ........
Less: Reduction under paragraph (b)(1) of
this section:
Adjusted gross income for taxable year.... $7,000 ........ ........
Less...................................... 6,000 ........ ........
----------
Excess over $6,000........................ 1,000 ........ ........
==========
12\1/2\ percent of excess ($1,000)........ ........ 125 ........
---------
Maximum credit (if less than basic credit) ........ ........ 375
(e) Coordination of credit with advance payments--(1) Recapture of
excess advance payments. If any advance payment of earned income credit
under
[[Page 87]]
section 3507 is made to an individual by an employer during any calendar
year, then the total amount of these advance payments to the individual
in that calendar year is treated as an additional amount of tax imposed
(by chapter 1 of the Code) upon the individual on the tax return for the
individual's last taxable year beginning in that calendar year.
(2) Reconciliation of payments advanced and credit allowed. Any
additional amount of tax under paragraph (e)(1) of this section is not
treated as a tax imposed by chapter 1 of the Code for purposes of
determining the amount of any credit (other than the earned income
credit) allowable under subpart A, part IV, subchapter A, chapter 1 of
the Code.
[T.D. 7683, 45 FR 16175, Mar. 13, 1980. Redesignated by T.D. 8448, 57 FR
54923, Nov. 23, 1992]
Sec. 1.32-3T Eligibility requirements (Temporary).
(a) In general. A taxpayer who has been denied the earned income
credit (EIC), in whole or in part, as a result of the deficiency
procedures under subchapter B of chapter 63 (deficiency procedures) is
ineligible to file a return claiming the EIC subsequent to the denial
until the taxpayer demonstrates eligibility for the EIC in accordance
with paragraph (c) of this section. If a taxpayer demonstrates
eligibility for a taxable year in accordance with paragraph (c) of this
section, the taxpayer need not comply with those requirements for any
subsequent taxable year unless the Service again denies the EIC as a
result of the deficiency procedures.
(b) Denial of the EIC as a result of the deficiency procedures. For
purposes of this section, denial of the EIC as a result of the
deficiency procedures occurs when a tax on account of the EIC is
assessed as a deficiency (other than as a mathematical or clerical error
under section 6213(b)(1)).
(c) Demonstration of eligibility. In the case of a taxpayer to whom
paragraph (a) of this section applies, and except as otherwise provided
by the Commissioner, no claim for the EIC filed subsequent to the denial
is allowed unless the taxpayer properly completes Form 8862, Information
To Claim Earned Income Credit After Disallowance, demonstrating
eligibility for the EIC, and otherwise is eligible for the EIC. If any
item of information on Form 8862 is incorrect or inconsistent with any
item on the return, the taxpayer will be treated as not demonstrating
eligibility for the EIC. The taxpayer must attach Form 8862 to the
taxpayer's first income tax return on which the taxpayer claims the EIC
after the EIC has been denied as a result of the deficiency procedures.
(d) Failure to demonstrate eligibility. If a taxpayer to whom
paragraph (a) of this section applies fails to satisfy the requirements
of paragraph (c) of this section with respect to a particular taxable
year, the IRS can deny the EIC as a mathematical or clerical error under
section 6213(g)(2)(J) [(K)].
(e) Special rule where one spouse denied EIC. The eligibility
requirements set forth in this section apply to taxpayers filing a joint
return where one spouse was denied the EIC for a taxable year prior to
marriage and has not established eligibility as either an unmarried or
married taxpayer for a subsequent taxable year.
(f) Effective date. This section applies to returns claiming the EIC
for taxable years beginning after December 31, 1997, where the EIC was
denied for a taxable year beginning after December 31, 1996.
[T.D. 8773, 63 FR 34596, June 25, 1998]
Sec. 1.34-1 Credit against tax and exclusion from gross income in case of dividends received by individuals.
(a) In general. (1) Section 34 provides a credit against the income
tax of an individual for certain dividends received after July 31, 1954,
and on or before December 31, 1964. The credit, subject to the
limitations provided in section 34(b), is equal to 4 percent of the
dividends received before January 1, 1964, and 2 percent of the
dividends received during the calendar year 1964. The credit is
allowable with respect to dividends received in any taxable year ending
after July 31, 1954, but applies only to dividends received on or before
December 31, 1964. The credit applies only to dividends which are
received from domestic corporations and which are included in the gross
income of the taxpayer. Section 116 provides for the
[[Page 88]]
exclusion from gross income of the first $100 ($50 for dividends
received in taxable years beginning before January 1, 1964) of certain
dividends received by an individual. See Sec. 1.116-1. In determining
which dividends are entitled to the credit against income tax provided
by section 34, the exclusion from gross income provided in section 116
is applied to the first dividends received in the taxable year. Since
the exclusion applies to dividends received at any time during a taxable
year ending after July 31, 1954, dividends received before August 1,
1954, may be taken into account in determining the exclusion from gross
income under section 116 but do not constitute dividends for which a
credit is allowed.
(2) The application of section 34 (without regard to the limitations
provided in section 34(b)) may be illustrated by the following example:
Example. A, an individual who makes his return on the basis of the
calendar year, receives in the year 1954 the following dividends: $100
on March 1, $100 on June 1, $100 on September 1, and $100 on December 1.
$50 of the dividends received by A on March 1, 1954, is excluded from
gross income under section 116. The balance of the dividends received in
1954, amounting to $350, is includible in the gross income of A. Subject
to the limitation in section 34(b) a credit of $8 is allowed under
section 34 (4 percent of $200, the amount of the dividends received
after July 31, 1954, that is, $100 received on September 1, 1954, and
$100 received on December 1, 1954).
(b) Tax credit. The credit is used to reduce the tax imposed by
Subtitle A of the Code, including the alternative tax under section 1201
in the case of capital gains and the self-employment tax under chapter 2
of the Code; however, it may not be used by the taxpayer as a credit
against penalties, additions to the tax, or interest on delinquent
taxes.
(c) Joint return of husband and wife. (1) In the case of a joint
return the credit is determined on the basis of the dividends received
by both the husband and wife after taking into account the exclusion
allowed by section 116. See Sec. 1.116-1. The credit is allowable in the
case of a joint return on account of the dividends received by each
spouse without regard to whether the spouse would be liable for the tax
imposed by Subtitle A if the joint return had not been filed. However,
the limitations on amount of credit in section 34(b) are determined by
reference to the tax and the credit under section 33 required to be
shown on the joint return and to the combined taxable income of husband
and wife. For this purpose, it makes no difference whether the tax, the
credit, or the taxable income is attributable to one or the other
spouse. If both the husband and wife are entitled to the credit, their
combined credit shall not exceed the amount so computed.
(2) The application of subparagraph (1) of this paragraph may be
illustrated by the following examples:
Example 1. H and W, husband and wife, make a joint return for the
calendar year 1954. The only dividend received by either of them during
the year is a dividend received by H on September 1 in the amount of
$400. Subject to the limitations of section 34(b), the credit amounts to
$14 (4 percent of $350, the dividends included in gross income after
allowance of the exclusion of $50 under section 116).
Example 2. The facts are the same as in example (1) except that W
also received a dividend on September 1 of $30. Since this dividend
(being less than the maximum amount allowable as an exclusion under
section 116(a)) is excluded from W's gross income, it does not affect
the computation of the tax credit and the tax credit is the same as in
example (1).
Example 3. H and W, husband and wife, make a joint return for the
calendar year 1954. H and W each received a $400 dividend on September
1, 1954, and these were the only dividends received by them in 1954.
Since H and W may each exclude $50 of the dividends received by them,
$700 of dividend income is included in gross income. Subject to the
limitations in section 34(b), the credit against the tax of H and W
amounts to $28 (4 percent of $700).
(d) Individuals receiving dividends. Where two or more persons hold
stock as tenants in common, as joint tenants, or as tenants by the
entirety, the dividends received with respect to such stock shall be
considered as being received by each tenant to the extent that he is
entitled under local law to a share of such dividends. Where dividends
constitute community property under local law each spouse shall be
considered as receiving one-half of such dividends.
[[Page 89]]
(e) Time dividends are received. In cases where it is necessary to
determine the time of receipt of dividends, the rules established to
determine in which taxable year dividends must be included in gross
income apply, including the rules relating to constructive receipt. See
section 451 and regulations thereunder.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6777, 29 FR
17806, Dec. 16, 1964]
Sec. 1.34-2 Limitations on amount of credit.
(a) Under section 34(b) the credit may not exceed the lesser of
either--
(1) The amount of the tax imposed by chapter 1 of the Code for the
taxable year reduced by the foreign tax credit allowable under section
33, or
(2) Whichever of the following is applicable:
(i) In the case of a taxable year ending before January 1, 1955, or
beginning after December 31, 1963, 2 percent of the taxable income for
such taxable year;
(ii) In the case of a taxable year ending after December 31, 1954,
and beginning before January 1, 1964, 4 percent of the taxable income
for such taxable year. In the case of a taxpayer who computes his tax
under section 3 or who uses the standard deduction provided by section
141, the taxable income for the taxable year is the adjusted gross
income for the taxable year reduced by the standard deduction prescribed
in section 141 and the deductions for personal exemptions provided in
section 151. Where the alternative tax on capital gains is imposed under
section 1201(b), the taxable income for such taxable year is the taxable
income as defined in section 63, which includes 50 percent of the excess
of net long-term capital gain over net short-term capital loss.
(b) The application of the limitations in paragraph (a) of this
section may be illustrated by the following example:
Example. Assume the following facts in the case of an individual
whose taxable year is the calendar year:
1954
Computation of tax liability without regard to the dividend received
credit:
(1) Gross income............................................ $7,500
(2) Deductions.............................................. 2,900
(3) Taxable income.......................................... 4,600
(4) Income tax liability.................................... 996
(5) Foreign tax credit...................................... 16
(6) Income tax liability minus foreign tax credit........... 980
Computation of limitation under section 34(b)(1):
(7) Dividends for which credit is allowable................. $2,500
(8) Dividends received credit under section 34(a); (2,500 x 100
0.04)......................................................
(9) Dividends received credit, as limited by section 100
34(b)(1); (item (6) or item (8) whichever is lesser).......
Computation of limitation under section 34(b)(2):
(10) Taxable income......................................... $4,600
(11) Dividends received credit under section 34(b)(2); 92
(4,600 x 0.02).............................................
Dividends received credit allowable:
Item (6), item (9), or item (11), whichever is lesser....... $92
1955
Computation of tax liability without regard to the dividend received
credit:
(12) Gross income........................................... $7,500
(13) Deductions............................................. 2,900
(14) Taxable income......................................... 4,600
(15) Income tax liability................................... 996
(16) Foreign tax credit..................................... 816
(17) Income tax liability minus foreign tax credit.......... 180
Computation of limitation under section 34(b)(1):
(18) Dividends for which credit is allowable................ $2,500
(19) Dividends received credit under section 34(a); (2,500 x 100
0.04)......................................................
(20) Dividends received credit as limited by section 100
34(b)(1); (item (17) or item (19) whichever is lesser).....
Computation of limitation under section 34(b)(2):
(21) Taxable income......................................... $4,600
(22) Dividends received credit under section 34(b)(2); 184
(4,600 x 0.04).............................................
Dividends received credit allowable:
Item (17), item (19), or item (22), whichever is lesser..... $100
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6777, 29 FR
17807, Dec. 16, 1964]
Sec. 1.34-3 Dividends to which the credit and exclusion apply.
(a) General rule. The credit under section 34 and the exclusion
under section 116 apply only to distributions of property defined as
dividends by section 316. Thus, the credit and the exclusion are not
allowed with respect to patronage dividends paid by either exempt or
[[Page 90]]
taxable farm cooperatives. Nor are they allowed for distributions to
nonstockholding policyholders by an insurance company having shares of
stock or for any distribution by a mutual insurance company. See
paragraph (b) of this section for an additional restriction with respect
to stock life insurance companies. The credit and the exclusion are,
however, allowed with respect to dividends paid on capital stock by
nonexempt cooperatives and with respect to dividends paid on capital
stock by building and loan associations. However, see paragraph (b) of
this section with respect to so-called dividends paid by building and
loan associations ineligible for the credit and the exclusion. The
credit and the exclusion are allowed with respect to distributions from
any organization taxed as a corporation if the distribution falls within
the definition of a dividend in section 316.
(b) Dividends from certain corporations. (1) Section 34 (c) and (d)
contains further restrictions on the type of distributions which are
treated as dividends for purposes of the credit and exclusion. Thus, no
credit or exclusion is applicable with respect to dividends received
from a corporation organized under the China Trade Act, 1922; from stock
life insurance companies before January 1, 1959, in taxable years ending
before such date; from corporations which during their taxable year of
the distribution or their preceding taxable year were corporations to
which section 931 applies (relating to income from sources within
possessions of the United States); from corporations which during the
taxable year of the distribution or the preceding taxable year are
corporations exempt from tax either under section 501, relating to
charitable, etc., organizations, or under section 521, relating to
farmers' cooperative associations.
(2) So-called dividends paid by mutual savings banks, cooperative
banks, and building and loan associations which are allowed as a
deduction under section 591 are ineligible for the credit and exclusion.
(3) For special rules as to the limitation on the amount of
dividends for which a credit and exclusion are allowable in the case of
dividends paid by a regulated investment company, see section 854 and
the regulations thereunder.
(4) See section 857(c) and paragraph (d) of Sec. 1.857-4 for special
rules which deny a credit under section 34 and exclusion under section
116 in the case of dividends received from a real estate investment
trust with respect to a taxable year for which such trust is taxable
under part II, subchapter M, chapter 1 of the Code.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6598, 27 FR
4092, Apr. 28, 1962; T.D. 6625, 27 FR 12541, Dec. 19, 1962]
Sec. 1.34-4 Taxpayers not entitled to credit and exclusion.
(a) The credit or exclusion is not available to nonresident aliens
with respect to whom a tax is imposed for the taxable year under section
871(a). If the taxpayer elects under section 6014 to have the Government
compute his tax, the credit is not taken into account in such
computation although the taxpayer is allowed the exclusion under section
116.
(b) For treatment of dividends received by estates or trusts, and
the allocation of such dividends between an estate or trust and the
beneficiary thereof, see sections 642, 652, and 662 and the regulations
thereunder. 3
(c) For treatment of dividends received by a partnership see section
702 and the regulations thereunder.
(d) For treatment of dividends received by a common trust fund, see
section 584 and the regulations thereunder.
Sec. 1.34-5 Effective date; taxable years ending after July 31, 1954, subject to the Internal Revenue Code of 1939.
Pursuant to section 7851(a)(1)(C), the regulations prescribed in
Secs. 1.34-1 to 1.34-4, inclusive, shall also apply to taxable years
beginning before January 1, 1954, and ending after July 31, 1954, and to
taxable years beginning after December 31, 1953, and ending after July
31, 1954, but before August 17, 1954, though such years are subject to
the Internal Revenue Code of 1939.
[[Page 91]]
Sec. 1.34-6 Dividends received after December 31, 1964.
In the case of dividends received after December 31, 1964, section
34 and the regulations issued thereunder do not apply.
[T.D. 6777, 29 FR 17807, Dec. 16, 1964]
Sec. 1.35-1 Partially tax-exempt interest received by individuals.
(a) The credit against tax under section 35 shall be allowed only to
individuals and if the requirements of both paragraphs (1) and (2) of
section 35(a) are met. Where the alternative tax on capital gains is
imposed under section 1201(b), the taxable income for such taxable year
is the taxable income as defined in section 63, which includes 50
percent of the excess of net long-term capital gain over net short-term
capital loss.
(b) For the treatment of partially tax-exempt interest in the case
of amounts not allocable to any beneficiary of an estate or trust, see
section 642(a)(1), and for treatment of amounts allocable to a
beneficiary, see sections 652 and 662. For treatment of partially tax-
exempt interest received by a partnership, see section 702(a)(7). For
treatment of such interest received by a common trust fund, see section
584(c)(2).
(c) The application of section 35 may be illustrated by the
following example:
Example. In his taxable year, 1955, A received $4,500 of partially
tax-exempt interest. A's taxable income is $4,000 upon which the tax
prior to any credits against tax is $840. His foreign tax credit under
section 33 is $610, and his dividends received credit under section 34
is $120. A's credit under section 35 for partially tax-exempt interest
is $110, determined as follows:
Section 35(a)
Partially tax-exempt interest................................ $4,500
Credit computed under section 35(a); 3 percent of $4,500..... 135
Section 35(b)(1)
Tax imposed by chapter 1..................................... 840
Less:
Credit allowed under section 33................. $610
Credit allowed under section 34................. 120
-------- $730
----------
Limitation on credit under section 35(b)(1).................. 110
Section 35(b)(2)
Taxable income............................................... 4,000
Limitation on credit under section 35(b)(2); 3 percent of 120
$4,000......................................................
Since of the three figures ($135, $110, and $120), the lesser is $110,
A's credit under section 35 is limited to $110.
Sec. 1.35-2 Taxpayers not entitled to credit.
For taxable years beginning after December 31, 1957, no credit shall
be allowed under section 35 to a nonresident alien individual with
respect to whom a tax is imposed for such taxable year under section
871(a).
Sec. 1.37-1 General rules for the credit for the elderly.
(a) In general. In the case of an individual, section 37 provides a
credit against the tax imposed by chapter 1 of the Internal Revenue Code
of 1954. This section and Secs. 1.37-2 and 1.37-3 provide guidance in
the computation of the credit for the elderly provided under section 37
for taxable years beginning after 1975. For rules relating to the
computation of the retirement income credit provided under section 37
for taxable years beginning before 1976, see 26 CFR 1.37-1 through 1.37-
5 (Rev. as of April 1, 1980). Note that section 403 of the Tax Reduction
and Simplification Act of 1977 provides that a taxpayer may elect to
compute the credit under section 37 for the taxpayer's first taxable
year beginning in 1976 in accordance with the rules applicable to
taxable years beginning before 1976.
(b) Limitation on the amount of the credit. The credit allowed by
section 37 for a taxable year shall not exceed the tax imposed by
chapter 1 of the Code for the taxable year (reduced, in the case of a
taxable year beginning before 1979, by the general tax credit allowed by
section 42).
(c) Married couples must file joint returns. If the taxpayer is
married at the close of the taxable year, the credit provided by section
37 shall be allowed only if the taxpayer and the taxpayer's spouse file
a joint return for the taxable year. The preceding sentence shall not
apply in the case of a husband and wife who are not members of the same
household at any time during the taxable year. For the determination of
marital status, see Secs. 143 and 1.143-1.
(d) Nonresident aliens ineligible. No credit is allowed under
section 37 to any individual for any taxable year
[[Page 92]]
during which that individual is at any time a nonresident alien unless
the individual is treated, by reason of an election under section 6013
(g) or (h), as a resident of the United States for that taxable year.
[T.D. 7743, 45 FR 84049, Dec. 22, 1980]
Sec. 1.37-2 Credit for individuals age 65 or over.
(a) In general. This section illustrates the computation of the
credit for the elderly in the case of an individual who has attained the
age of 65 before the close of the taxable year. This section shall not
apply to an individual for any taxable year for which the individual
makes the election described in section 37(e)(2) and paragraph (b) of
Sec. 1.37-3.
(b) Computation of credit. The credit for the elderly for an
individual to whom this section applies equals 15 percent of the
individual's ``section 37 amount'' for the taxable year. An individual's
``section 37 amount'' for a taxable year is the initial amount
determined under section 37(b)(2), reduced as provided in section
37(b)(3) and (c)(1).
(c) Examples. The computation of the credit for the elderly for
individuals to whom this section applies may be illustrated by the
following examples:
Example 1. A, a single individual who is 67 years old, has adjusted
gross income of $8,000 for the calendar year 1977. A also receives
social security payments of $1,450 during 1977. A does not itemize
deductions. A's credit for the elderly is $120, computed as follows:
Initial amount under section 37(b)(2)......................... $2,500
Reductions required by section 37 (b)(3) and (c)(1):
Social security payments........................ $1,450
One-half the excess of adjusted gross income 250 1,700
over $7,500....................................
----------
Section 37 amount............................................. 800
=========
15 pct. of $800............................................... $120
A's tax from the tax tables, which reflect the allowance of the general
tax credit, is $662. Accordingly, the limitation of section 37(c)(2) and
paragraph (b) of Sec. 1.37-1 does not reduce A's credit for the elderly.
Example 2. H and W, who have both attained the age of 65, file a
joint return for calendar year 1977. For that year H and W have adjusted
gross income of $8,120; H also receives a railroad retirement pension of
$1,550, and W receives social security payments of $1,200. H and W do
not itemize deductions. The credit for the elderly allowed to H and W
for 1977 is $139, computed as follows:
Initial amount under section 37(b)(2)......................... $3,750
Reductions required by section 37 (b)(3):
Railroad retirement pension..................... $1,550
Social Security payments........................ 1,200 2,750
----------
Section 37 amount............................................. 1,000
=========
15 pct. of $1,000............................................. 150
Limitation based upon amount of tax (derived from table $139
reflecting allowance of general tax credit)..................
Since the adjusted gross income of H and W is not greater than $10,000,
no reduction of the initial amount is required under section 37 (c)(1).
[T.D. 7743, 45 FR 84050, Dec. 22, 1980]
Sec. 1.37-3 Credit for individuals under age 65 who have public retirement system income.
(a) In general. This section provides rules for the computation of
the credit for the elderly under section 37(e) in the case of an
individual who has not attained the age of 65 before the close of the
taxable year and whose gross income for the taxable year includes
retirement income within the meaning of paragraph (d)(1)(ii) of this
section (i.e., under a public retirement system). If such an individual
is married within the meaning of section 143 at the close of the taxable
year and the spouse of the individual has attained the age of 65 before
the close of the taxable year, this section shall apply to the
individual for the taxable year only if both spouses make the election
described in paragraph (b) of this section. If both spouses make the
election described in paragraph (b) of this section for the taxable
year, the credit of each spouse shall be determined under the rules of
this section. See paragraph (f)(2) of this section for a limitation on
the effects of community property laws in making determinations and
computations under section 37(e) and this section.
(b) Election by certain married taxpayers. If a married individual
under age 65 at the close of the taxable year has retirement income and
the spouse of that individual has attained the age of 65 before the
close of the taxable year, both spouses may elect to compute the credit
provided by section 37 under the rules of section 37(e) and this
[[Page 93]]
section. The spouses shall signify the election on the return (or
amended return) for the taxable year in the manner prescribed in the
instructions accompanying the return. The election may be made at any
time before the expiration of the period of limitation for filing claim
for credit or return for the taxable year. The election may be revoked
without the consent of the Commissioner at any time before the
expiration of that period by filing an amended return.
(c) Computation of credit. The credit of an individual under section
37(e) and this section equals 15 percent of the individual's credit base
for the taxable year. The credit base of an individual for a taxable
year is the lesser of--
(1) The retirement income of the individual for the taxable year, or
(2) The amount determined under section 37(e)(5), as modified by
section 37(e) (6) and (7).
(d) Retirement income--(1) General rule--(i) For individuals 65 or
over. Section 37(e)(4)(A) enumerates the kinds of income which may be
treated as the retirement income of an individual who has attained the
age of 65 before the close of the taxable year. They include income from
pensions and annuities, interest, rents, dividends, certain bonds
received under a qualified bond purchase plan, and certain individual
retirement accounts or annuities.
(ii) For individuals under 65. In the case of an individual who has
not attained the age of 65 before the close of the taxable year,
retirement income consists only of income from pensions and annuities
(including disability annuity payments) under a public retirement system
which arises from services performed by that individual or by a present
or former spouse of that individual. The term ``public retirement
system'' means a pension, annuity, or retirement, or similar fund or
system established by the United States, a State, a possession of the
United States, any political subdivision of any of the foregoing, or the
District of Columbia.
(2) Rents. For purposes of section 37(e)(4)(A)(iii), income from
rents shall be the gross amount received, not reduced by depreciation or
other expenses, except that beneficiaries of a trust or estate shall
treat as retirement income only their proportionate shares, of the
taxable rents of the trust or estate. In the case of an amount received
for board and lodging, only the portion of the amount received for
lodging is income from rents.
(3) Disability annuity payments received by individual under age 65.
Disability annuity payments received under a public retirement system by
an individual under age 65 at the close of the taxable year shall not be
treated as retirement income unless the payments are for periods after
the date on which the individual reached minimum retirement age, that
is, the age at which the individual would be eligible to receive a
pension or annuity without regard to disability, and any of the
following conditions is satisfied--
(i) The individual is precluded from seeking the benefits of section
105(d) (relating to certain disability payments) for that taxable year
by reason of an irrevocable election;
(ii) The individual was not permanently and totally disabled at the
time of retirement (and was not permanently and totally disabled either
on January 1, 1976, or on January 1, 1977, if the individual retired
before the later date on disability or under circumstances which
entitled the individual to retire on disability); or
(iii) The payments are for periods after the individual reached
mandatory retirement age.
For purposes of this paragraph, disability annuity payments include
payments to an individual who retired on partial or temporary
disability.
(4) Compensation of personal services rendered during taxable year.
Retirement income does not include any amount representing compensation
for personal services rendered during the taxable year. For this
purpose, amounts received as a pension shall not be treated as
representing compensation for personal services rendered during the
taxable year if the period of service during the taxable year is not
substantial when compared with the total years of service. For example,
an individual on the calendar year basis retires on November 30 after 5
years of service and receives a pension during the remainder of his
taxable
[[Page 94]]
year. The pension is not treated as representing compensation for
personal services rendered during such taxable year merely because it is
paid by reason of the services of the individual for a period of 5 years
which includes a portion of the taxable year.
(5) Amounts not includible in gross income. Retirement income does
not include any amount not includible in the gross income of the
individual for the taxable year. For example, if a portion of an annuity
is excluded from gross income under section 72, relating to annuities,
that portion of the annuity is not retirement income; similarly, the
portion of dividend income excluded from gross income under section 116,
relating to the partial exclusion of dividends received by individuals
is not retirement income.
(e) Earned income--(1) In general. The term ``earned income'' in
section 37(e)(5)(B) generally has the same meaning as in section 911(b),
except that earned income does not include any amount received as a
pension or annuity. See section 911(b) and the regulations thereunder.
Section 911(b) provides, in general, that earned income includes wages,
salaries, professional fees, and other amounts received as compensation
for personal services rendered.
(2) Earned income from self-employment. For purposes of section
37(e)(5)(B), the earned income of a taxpayer from self-employment in a
trade or business shall not exceed--
(i) The taxpayer's share of the net profits from the trade or
business if capital is not a material income-producing factor in that
trade or business; or
(ii) Thirty percent of the taxpayer's share of the net profits from
the trade or business if capital is a material income-producing factor
in that trade or business.
For other rules relating to the determination of earned income from
self-employment in a trade or business, see section 911(b) and the
regulations thereunder.
(3) Disability annuity payments received by individuals under age
65. Disability annuity payments received under a public retirement
system by an individual under age 65 at the close of the taxable year
shall be treated as earned income for purposes of section 37(e)(5)(B)
unless the payments are treated as retirement income under paragraph
(d)(3) of this section.
(f) Computation of credit under section 37(e) in the case of joint
returns--(1) In general. In the case of a joint return of husband and
wife, the credit base of each spouse under section 37(e) is computed
separately. The spouses then combine their credit bases and compute a
single credit. The limitation in section 37(c)(2) and paragraph (b) of
Sec. 1.37-1 on the amount of the credit is determined by reference to
the joint tax liability of the spouses. Thus, regardless of whether a
spouse would be liable for the tax imposed by chapter 1 of the Code if
the joint return had not been filed, the credit base of that spouse is
taken into account in computing the credit.
(2) Community property laws. For taxable years beginning after 1977,
married individuals filing joint returns shall disregard community
property laws in making any determination or computation required under
section 37(e) or this section. Each item of income is attributed in full
to the spouse whose income it would have been in the absence of
community property laws. Thus, if a 67-year old individual files a joint
return with a 62-year old spouse for 1979 and the only income of the
couple is from a public pension of the older spouse, that public pension
is attributed in full to the older spouse for purposes of section 37(e)
even though the applicable community property law may treat one-half of
the pension as the income of the 62-year old spouse. Since the younger
spouse consequently has no retirement income within the meaning of
paragraph (d) of this section, the couple may not make the election
described in paragraph (b) of this section.
(g) Examples. The computation of the credit for the elderly under
section 37(e) and this section is illustrated by the following examples:
Example 1. B, who is 62 years old and single, receives a fully
taxable pension of $2,400 from a public retirement system during 1977. B
performed the services giving rise to the pension. During that year, B
also earns $2,650
[[Page 95]]
from a part-time job. B receives no tax-exempt pension or annuity in
1977. Subject to the limitation of section 37(c)(2) and paragraph (b) of
Sec. 1.37-1, B's credit for the elderly for 1977 under section 37(e) is
$195, computed as follows:
Maximum retirement income level under section 37(e)(5)...... $2,500
Earned income offset under section
37(e)(5)(B)(ii):
Earned income in excess of $1,700........... $950 ..........
One-half of earned income in excess of 250 1,200
$1,200, but not in excess of $1,700........
------------
Amount determined under section 37(e)(5).................... 1,300
===========
Retirement income........................................... 2,400
===========
Credit for the elderly (15 pct. of $1,300).................. 195
Example 2. During 1978 H, who is 67 years old, has earnings of
$1,300 and retirement income (rents, interest, etc.) of $6,000. H also
receives social security payments totalling $1,400. During 1978 W, who
is 63 years old, earns $1,600 and receives a fully taxable pension of
$1,400 from a public retirement system that constitutes retirement
income. W performed the services giving rise to the pension. H and W
file a joint return for 1978 and elect to compute the credit for the
elderly under section 37(e). Under the applicable law these items of
income are community income, and both spouses share equally in each
item. Because H and W are filing a joint return, they disregard
community property laws in computing their credit under section 37(e).
The couple allocates $1,600 of the $3,750 referred to in section
37(e)(6) to W and $2,150 to H. Subject to the limitation of section
37(c)(2) and paragraph (b) of Sec. 1.37-1, their credit for the elderly
is $315, computed as follows:
Credit base of H:
Amount allocated to H under section 37(e)(6).............. $2,150
Reductions required by section 37(e)(5):
Social Security payments.................. $1,400 ..........
One-half of excess of earnings over $1,200 50 1,450
------------
Amount determined under section 37(e)(5).................. 700
===========
Retirement income......................................... 6,000
===========
Credit base of H.......................................... 700
Credit base of W:
Amount allocated to W under section 37(e)(6).............. $1,600
Reduction required by section 37(e)(5)(B):
One-half of excess of earnings over $1,200............ $200
-----------
Amount determined under section 37(e)(5).............. 1,400
===========
Retirement income......................................... 1,400
===========
Credit base of W.......................................... 1,400
===========
Computation of credit:
Credit base of H...................................... 700
Credit base of W...................................... 1,400
-----------
Combined credit base.................................. 2,100
===========
Credit for the elderly (15 pct. of $2,100)................ 315
Example 3. (a) Assume the same facts as in example (2) of this
paragraph, except that H and W live apart at all times during 1978 and
file separate returns. Under these circumstances, H and W must give
effect to the applicable community property law in determining their
credits under section 37(e). Thus, each spouse must take into account
one-half of each item of income.
(b) Subject to the limitation of section 37(c)(2) and paragraph (b)
of Sec. 1.37-1, H's credit for the elderly is $157.50, computed as
follows:
Maximum retirement income level under section 37(e)(7)...... $1,875
Reductions required by section 37(e)(5):
Social security payments.................... $700 ..........
One-half of excess of earnings over $1,200 125 825
(taking into account one-half of combined
earnings of $2,900)........................
------------
Amount determined under section 37(e)(5).................... 1,050
===========
Retirement income........................................... 3,700
===========
Credit of H (15 pct. of $1,050)............................. 157.50
(c) Subject to the limitation of section 37(c)(2) and paragraph (b)
of Sec. 1.37-1, W's credit for the elderly is computed as follows:
Maximum retirement income level under section $1,875
37(e)(7).......................................
Reductions required by section 37(e)(5):
Social security payments.................... $700 ..........
One-half of excess of earnings over $1,200.. 125 825
------------
Amount determined under section 37(e)(5)........ 1,050
=============
Retirement income (limited to W's share of 700
public pension)................................
=============
Credit of W (15 pct. of $700)................... 105
[T.D. 7743, 45 FR 84050, Dec. 22, 1980]
[[Page 96]]
Sec. 1.38-1 Investment in certain depreciable property.
Regulations under sections 46 through 50 are prescribed under the
authority granted the Secretary by section 38(b) to prescribe
regulations as may be necessary to carry out the purposes of section 38
and subpart B, part IV, subchapter A, chapter 1 of the Code.
[44 FR 20417, Apr. 5, 1979]
Sec. 1.40-1 Questions and answers relating to the meaning of the term ``qualified mixture'' in section 40(b)(1).
Q-1. What is a ``qualified mixture'' within the meaning of section
40(b)(1)?
A-1. A ``qualified mixture'' is a mixture of alcohol and gasoline or
of alcohol and special fuel which (1) is sold by the taxpayer producing
such mixture to any person for use as a fuel, or (2) is used as a fuel
by the taxpayer producing such mixture.
Q-2. Must alcohol be present in a product in order for that product
to be considered a mixture of alcohol and either gasoline or a special
fuel?
A-2. No. A product is considered to be a mixture of alcohol and
gasoline or of alcohol and a special fuel if the product is derived from
alcohol and either gasoline or a special fuel even if the alcohol is
chemically transformed in producing the product so that the alcohol is
no longer present as a separate chemical in the final product, provided
that there is no significant loss in the energy content of the alcohol.
Thus, a product may be considered to be ``mixture of alcohol and
gasoline or of alcohol and a special fuel'' within the meaning of
section 40(b)(1)(B) if such product is produced in a chemical reaction
between alcohol and either gasoline or a special fuel. Similarly a
product may be considered to be a ``mixture of alcohol and gasoline or
of alcohol and a special fuel'' if such product is produced by blending
a chemical compound derived from alcohol with either gasoline or a
special fuel.
Thus, for example, a blend of gasoline and ethyl tertiary butyl
ether (ETBE), a compound derived from ethanol (a qualified alcohol), in
a chemical reaction in which there is no significant loss in the energy
content of the ethanol, is considered for purposes of section
40(b)(1)(B) to be a mixture of gasoline and the ethanol used to produce
the ETBE, even though the ethanol is chemically transformed in the
production of ETBE and is not present in the final product.
[T.D. 8291, 55 FR 8948, Mar. 9, 1990]
Taxable Years Beginning After December 31, 1986
Source: Sections 1.41-0--1.41-9 appear by T.D. 8251, 54 FR 21204,
May 17, 1989, unless otherwise noted.
Sec. 1.41-0 Table of contents.
This section lists the paragraphs contained in Secs. 1.41-0 through
1.41-9.
Sec. 1.41-0 Table of Contents.
Sec. 1.41-1 Introduction to regulations under section 41.
Sec. 1.41-2 Qualified Research Expenses
(a) Trade or business requirement.
(1) In general.
(2) New business.
(3) Research performed for others.
(i) Taxpayer not entitled to results.
(ii) Taxpayer entitled to results.
(4) Partnerships.
(i) In general.
(ii) Special rule for certain partnerships and joint ventures.
(b) Supplies and personal property used in the conduct of qualified
research.
(1) In general.
(2) Certain utility charges.
(i) In general.
(ii) Extraordinary expenditures.
(3) Right to use personal property.
(4) Use of personal property in taxable years beginning after
December 31, 1985.
(c) Qualified services.
(1) Engaging in qualified research.
(2) Direct supervision.
(3) Direct support.
(d) Wages paid for qualified services.
(1) In general.
(2) ``Substantially all.''
(e) Contract research expenses.
(1) In general.
(2) Performance of qualified research.
(3) ``On behalf of.''
(4) Prepaid amounts.
(5) Examples.
Sec. 1.41-3 Base period research expense
(a) Number of years in base period.
(b) New taxpayers.
(c) Definition of base period research expenses.
(d) Special rules for short taxable years.
[[Page 97]]
(1) Short determination year.
(2) Short base period year.
(3) Years overlapping the effective dates of section 41 (section
44F).
(i) Determination years.
(ii) Base period years.
(4) Number of months in a short taxable year.
(e) Examples.
Sec. 1.41-4 Qualified research for taxable years beginning after
December 31, 1985. [Reserved]
Sec. 1.41-5 Qualified research for taxable years beginning before
January 1, 1986
(a) General rule.
(b) Activities outside the United States.
(1) In-house research.
(2) Contract research.
(c) Social sciences arts or humanities.
(d) Research funded by any grant, contract, or otherwise.
(1) In general.
(2) Research in which taxpayer retains no rights.
(3) Research in which the taxpayer retains substantial rights.
(i) In general.
(ii) Pro rata allocation.
(iii) Project-by-project determination.
(4) Independent research and development under the Federal
Acquisition Regulations System and similar provisions.
(5) Funding determinable only in subsequent taxable year.
(6) Examples.
Sec. 1.41-6 Basic research for taxable years beginning after December
31, 1985. [Reserved]
Sec. 1.41-7 Basic research for taxable years beginning before January
1, 1986
(a) In general.
(b) Trade or business requirement.
(c) Prepaid amounts.
(1) In general.
(2) Transfers of property.
(d) Written research agreement.
(1) In general.
(2) Agreement between a corporation and a qualified organization
after June 30, 1983.
(i) In general.
(ii) Transfers of property.
(3) Agreement between a qualified fund and a qualified educational
organization after June 30, 1983.
(e) Exclusions.
(1) Research conducted outside the United States.
(2) Research in the social sciences or humanities.
(f) Procedure for making an election to be treated as a qualified
fund.
Sec. 1.41-8 Aggregation of expenditures.
(a) Controlled group of corporations; trade or businesses under
common control.
(1) In general.
(2) Definition of trade or business.
(3) Determination of common control.
(4) Examples.
(b) Minimum base period research expenses.
(c) Tax accounting periods used.
(1) In general.
(2) Special rule where timing of research is manipulated.
(d) Membership during taxable year in more than one group.
(e) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease Payments.
(5) Payment for supplies.
Sec. 1.41-9 Special rules.
(a) Allocations.
(1) Corporation making an election under subchapter S.
(i) Pass-through, for taxable years beginning after December 31,
1982, in the case of an S corporation.
(ii) Pass-through, for taxable years beginning before January 1,
1983, in the case of a subchapter S corporation.
(2) Pass-through in the case of an estate or trust.
(3) Pass-through in the case of a partnership.
(i) In general.
(ii) Certain expenditures by joint ventures.
(4) Year in which taken into account.
(5) Credit allowed subject to limitation.
(b) Adjustments for certain acquisitions and dispositions--Meaning
of terms.
(c) Special rule for pass-through of credit.
(d) Carryback and carryover of unused credits.
Sec. 1.41-1 Introduction to regulations under section 41.
Sections 1.41-2 through 1.41-9 deal only with certain provisions of
section 41. The following table identifies the provisions of section 41
that are dealt with, and lists each with the section of the regulations
in which it is covered:
------------------------------------------------------------------------
Section of the regulations Section of the Code
------------------------------------------------------------------------
1.41-2.................................... 41(b)(1)
41(b)(2)(A)(ii)
41(b)(2)(A)(iii)
41(b)(2)(B)
41(b)(3)
1.41-3.................................... 41(c)(2)
41(f)(4)
1.41-5.................................... 41(d)
1.41-7.................................... 41(e)
1.41-8.................................... 41(f)(1)
[[Page 98]]
1.41-9.................................... 41(f)(2)
41(f)(3)
41(g)
------------------------------------------------------------------------
Sections 1.41-4 and 1.41-6 deal with the definition of qualified
research and basic research for taxable years beginning after December
31, 1985. Section 1.41-3 also deals with the special rule in section
221(d)(2) of the Economic Recovery Tax Act of 1981 relating to taxable
years overlapping the effective dates of section 41. Section 41 was
formerly designated sections 30 and 44F. The regulations refer to these
sections as section 41 for conformity purposes. Of course, whether
section 41, 30 or 44F applies to a particular expenditure depends upon
when the expenditure was paid or incurred.
Sec. 1.41-2 Qualified Research Expenses.
(a) Trade or business requirement--(1) In general. An in-house
research expense of the taxpayer or a contract research expense of the
taxpayer is a qualified research expense only if the expense is paid or
incurred by the taxpayer in carrying on a trade or business of the
taxpayer. The phrase ``in carrying on a trade or business'' has the same
meaning for purposes of section 41(b)(1) as it has for purposes of
section 162; thus, expenses paid or incurred in connection with a trade
or business within the meaning of section 174(a) (relating to the
deduction for research and experimental expenses) are not necessarily
paid or incurred in carrying on a trade or business for purposes of
section 41. A research expense must relate to a particular trade or
business being carried on by the taxpayer at the time the expense is
paid or incurred in order to be a qualified research expense. For
purposes of section 41, a contract research expense of the taxpayer is
not a qualified research expense if the product or result of the
research is intended to be transferred to another in return for license
or royalty payments and the taxpayer does not use the product of the
research in the taxpayer's trade or business.
(2) New business. Expenses paid or incurred prior to commencing a
new business (as distinguished from expanding an existing business) may
be paid or incurred in connection with a trade or business but are not
paid or incurred in carrying on a trade or business. Thus, research
expenses paid or incurred by a taxpayer in developing a product the sale
of which would constitute a new trade or business for the taxpayer are
not paid or incurred in carrying on a trade or business.
(3) Research performed for others--(i) Taxpayer not entitled to
results. If the taxpayer performs research on behalf of another person
and retains no substantial rights in the research, that research shall
not be taken into account by the taxpayer for purposes of section 41.
See Sec. 1.41-5(d)(2).
(ii) Taxpayer entitled to results. If the taxpayer in carrying on a
trade or business performs research on behalf of other persons but
retains substantial rights in the research, the taxpayer shall take
otherwise qualified expenses for that research into account for purposes
of section 41 to the extent provided in Sec. 1.41-5(d)(3).
(4) Partnerships--(i) In general. An in-house research expense or a
contract research expense paid or incurred by a partnership is a
qualified research expense of the partnership if the expense is paid or
incurred by the partnership in carrying on a trade or business of the
partnership, determined at the partnership level without regard to the
trade or business of any partner.
(ii) Special rule for certain partnerships and joint ventures. (A)
If a partnership or a joint venture (taxable as a partnership) is not
carrying on the trade or business to which the research relates, then
the general rule in paragraph (a)(4)(i) of this section would not allow
any of such expenditures to qualify as qualified research expenses.
(B) Notwithstanding paragraph (a)(4)(ii)(A) of this section, if all
the partners or venturers are entitled to make independent use of the
results of the research, this paragraph (a)(4)(ii) may allow a portion
of such expenditures to be treated as qualified research expenditures by
certain partners or venturers.
(C) First, in order to determine the amount of credit that may be
claimed by certain partners or venturers, the
[[Page 99]]
amount of qualified research expenditures of the partnership or joint
venture is determined (assuming for this purpose that the partnership or
joint venture is carrying on the trade or business to which the research
relates).
(D) Second, this amount is reduced by the proportionate share of
such expenses allocable to those partners or venturers who would not be
able to claim such expenses as qualified research expenditures if they
had paid or incurred such expenses directly. For this purpose such
partners' or venturers' proportionate share of such expenses shall be
determined on the basis of such partners' or venturers' share of
partnership items of income or gain (excluding gain allocated under
section 704(c)) which results in the largest proportionate share. Where
a partner's or venturer's share of partnership items of income or gain
(excluding gain allocated under section 704(c)) may vary during the
period such partner or venturer is a partner or venturer in such
partnership or joint venture, such share shall be the highest share such
partner or venturer may receive.
(E) Third, the remaining amount of qualified research expenses is
allocated among those partners or venturers who would have been entitled
to claim a credit for such expenses if they had paid or incurred the
research expenses in their own trade or business, in the relative
proportions that such partners or venturers share deductions for
expenses under section 174 for the taxable year that such expenses are
paid or incurred.
(F) For purposes of section 41, research expenditures to which this
paragraph (a)(4)(ii) applies shall be treated as paid or incurred
directly by such partners or venturers. See Sec. 1.41-9(a)(3)(ii) for
special rules regarding these expenses.
(iii) The following examples illustrate the application of the
principles contained in paragraph (a)(4)(ii) of this section.
Example 1. A joint venture (taxable as a partnership) is formed by
corporations A, B, and C to develop and market a supercomputer. A and B
are in the business of developing computers, and each has a 30 percent
distributive share of each item of income, gain, loss, deduction, credit
and basis of the joint venture. C, which is an investment banking firm,
has a 40 percent distributive share of each item of income, gain, loss,
deduction, credit and basis of the joint venture. The joint venture
agreement provides that A's, B's and C's distributive shares will not
vary during the life of the joint venture, liquidation proceeds are to
be distributed in accordance with the partners' capital account
balances, and any partner with a deficit in its capital account
following the distribution of liquidation proceeds is required to
restore the amount of such deficit to the joint venture. Assume in Year
1 that the joint venture incurs $100x of ``qualified research
expenses.'' Assume further that the joint venture cannot claim the
research credit for such expenses because it is not carrying on the
trade or business to which the research relates. In addition A, B, and C
are all entitled to make independent use of the results of the research.
First, the amount of qualified research expenses of the joint venture is
$l00x. Second, this amount is reduced by the proportionate share of such
expenses allocable to C, the venturer which would not have been able to
claim such expenses as qualified research expenditures if it had paid or
incurred them directly, C's proportionate share of such expenses is $40x
(40% of $100x). The reduced amount is $60x. Third, the remaining $60x of
qualified research expenses is allocated between A and B in the relative
proportions that A and B share deductions for expenses under section
174. A is entitled to treat $30x ((30%/(30%+30%)) $60x) as a qualified
research expense. B is also entitled to treat $30x ((30%/(30%+30%))
$60x) as a qualified research expense.
Example 2. Assume the same facts as in example (1) except that the
joint venture agreement provides that during the first 2 years of the
joint venture, A and B are each allocated 10 percent of each item of
income, gain, loss, deduction, credit and basis, and C is allocated 80
percent of each item of income, gain, loss, deduction, credit and basis.
Thereafter the allocations are the same as in example (1). Assume for
purposes of this example that such allocations have substantial economic
effect for purposes of section 704 (b). C's highest share of such items
during the life of the joint venture is 80 percent. Therefore C's
proportionate share of the joint venture's qualified research expenses
is $80x (80% of $100x). The reduced amount of qualified research
expenses is $20x ($100x-$80x). A is entitled to treat $10x ((10%/
(10%+10%)) $20x) as a qualified research expense in Year 1. B is also
entitled to treat $10x ((10%/(10%+10%)) $20x) as a qualified research
expense in Year 1.
(b) Supplies and personal property used in the conduct of qualified
research--(1) In general. Supplies and personal property (except to the
extent provided in
[[Page 100]]
paragraph (b)(4) of this section) are used in the conduct of qualified
research if they are used in the performance of qualified services (as
defined in section 41(b)(2)(B), but without regard to the last sentence
thereof) by an employee of the taxpayer (or by a person acting in a
capacity similar to that of an employee of the taxpayer; see example (6)
of Sec. 1.41-2(e)(5)). Expenditures for supplies or for the use of
personal property that are indirect research expenditures or general and
administrative expenses do not qualify as inhouse research expenses.
(2) Certain utility charges--(i) In general. In general, amounts
paid or incurred for utilities such as water, electricity, and natural
gas used in the building in which qualified research is performed are
treated as expenditures for general and administrative expenses.
(ii) Extraordinary expenditures. To the extent the taxpayer can
establish that the special character of the qualified research required
additional extraordinary expenditures for utilities, the additional
expenditures shall be treated as amounts paid or incurred for supplies
used in the conduct of qualified research. For example, amounts paid for
electricity used for general laboratory lighting are treated as general
and administrative expenses, but amounts paid for electricity used in
operating high energy equipment for qualified research (such as laser or
nuclear research) may be treated as expenditures for supplies used in
the conduct of qualified research to the extent the taxpayer can
establish that the special character of the research required an
extraordinary additional expenditure for electricity.
(3) Right to use personal property. The determination of whether an
amount is paid to or incurred for another person for the right to use
personal property in the conduct of qualified research shall be made
without regard to the characterization of the transaction as a lease
under section 168(f)(8) (as that section read before it was repealed by
the Tax Reform Act of 1986). See Sec. 5c.168(f)(8)-1(b).
(4) Use of personal property in taxable years beginning after
December 31, 1985. For taxable years beginning after December 31, 1985,
amounts paid or incurred for the use of personal property are not
qualified research expenses, except for any amount paid or incurred to
another person for the right to use (time-sharing) computers in the
conduct of qualified research. The computer must be owned and operated
by someone other than the taxpayer, located off the taxpayer's premises,
and the taxpayer must not be the primary user of the computer.
(c) Qualified services--(1) Engaging in qualified research. The term
``engaging in qualified research'' as used in section 41(b)(2)(B) means
the actual conduct of qualified research (as in the case of a scientist
conducting laboratory experiments).
(2) Direct supervision. The term ``direct supervision'' as used in
section 41(b)(2)(B) means the immediate supervision (first-line
management) of qualified research (as in the case of a research
scientist who directly supervises laboratory experiments, but who may
not actually perform experiments). ``Direct supervision'' does not
include supervision by a higher-level manager to whom first-line
managers report, even if that manager is a qualified research scientist.
(3) Direct support. The term ``direct support'' as used in section
41(b)(2)(B) means services in the direct support of either--
(i) Persons engaging in actual conduct of qualified research, or
(ii) Persons who are directly supervising persons engaging in the
actual conduct of qualified research. For example, direct support of
research includes the services of a secretary for typing reports
describing laboratory results derived from qualified research, of a
laboratory worker for cleaning equipment used in qualified research, of
a clerk for compiling research data, and of a machinist for machining a
part of an experimental model used in qualified research. Direct support
of research activities does not include general administrative services,
or other services only indirectly of benefit to research activities. For
example, services of payroll personnel in preparing salary checks of
laboratory scientists,
[[Page 101]]
of an accountant for accounting for research expenses, of a janitor for
general cleaning of a research laboratory, or of officers engaged in
supervising financial or personnel matters do not qualify as direct
support of research. This is true whether general administrative
personnel are part of the research department or in a separate
department. Direct support does not include supervision. Supervisory
services constitute ``qualified services'' only to the extent provided
in paragraph (c)(2) of this section.
(d) Wages paid for qualified services--(1) In general. Wages paid to
or incurred for an employee constitute in-house research expenses only
to the extent the wages were paid or incurred for qualified services
performed by the employee. If an employee has performed both qualified
services and nonqualified services, only the amount of wages allocated
to the performance of qualified services constitutes an in-house
research expense. In the absence of another method of allocation that
the taxpayer can demonstrate to be more appropriate, the amount of in-
house research expense shall be determined by multiplying the total
amount of wages paid to or incurred for the employee during the taxable
year by the ratio of the total time actually spent by the employee in
the performance of qualified services for the taxpayer to the total time
spent by the employee in the performance of all services for the
taxpayer during the taxable year.
(2) ``Substantially all.'' Notwithstanding paragraph (d)(1) of this
section, if substantially all of the services performed by an employee
for the taxpayer during the taxable year consist of services meeting the
requirements of section 41(b)(2)(B) (i) or (ii), then the term
``qualified services'' means all of the services performed by the
employee for the taxpayer during the taxable year. Services meeting the
requirements of section 41(b)(2)(B) (i) or (ii) constitute substantially
all of the services performed by the employee during a taxable year only
if the wages allocated (on the basis used for purposes of paragraph
(d)(1) of this section) to services meeting the requirements of section
41(b)(2)(B) (i) or (ii) constitute at least 80 percent of the wages paid
to or incurred by the taxpayer for the employee during the taxable year.
(e) Contract research expenses--(1) In general. A contract research
expense is 65 percent of any expense paid or incurred in carrying on a
trade or business to any person other than an employee of the taxpayer
for the performance on behalf of the taxpayer of--
(i) Qualified research as defined in Sec. 1.41-5, or
(ii) Services which, if performed by employees of the taxpayer,
would constitute qualified services within the meaning of section
41(b)(2)(B).
Where the contract calls for services other than services described in
this paragraph (e)(1), only 65 percent of the portion of the amount paid
or incurred that is attributable to the services described in this
paragraph (e)(1) is a contract research expense.
(2) Performance of qualified research. An expense is paid or
incurred for the performance of qualified research only to the extent
that it is paid or incurred pursuant to an agreement that--
(i) Is entered into prior to the performance of the qualified
research,
(ii) Provides that research be performed on behalf of the taxpayer,
and
(iii) Requires the taxpayer to bear the expense even if the research
is not successful.
If an expense is paid or incurred pursuant to an agreement under which
payment is contingent on the success of the research, then the expense
is considered paid for the product or result rather than the performance
of the research, and the payment is not a contract research expense. The
previous sentence applies only to that portion of a payment which is
contingent on the success of the research.
(3) ``On behalf of.'' Qualified research is performed on behalf of
the taxpayer if the taxpayer has a right to the research results.
Qualified research can be performed on behalf of the taxpayer
notwithstanding the fact that the taxpayer does not have exclusive
rights to the results.
(4) Prepaid amounts. Notwithstanding paragraph (e)(1) of this
section, if any contract research expense paid or incurred during any
taxable year is attributable to qualified research to be
[[Page 102]]
conducted after the close of such taxable year, the expense so
attributable shall be treated for purposes of section 41(b)(1)(B) as
paid or incurred during the period during which the qualified research
is conducted.
(5) Examples. The following examples illustrate provisions contained
in paragraphs (e) (1) through (4) of this section.
Example 1. A, a cash-method taxpayer using the calendar year as the
taxable year, enters into a contract with B Corporation under which B is
to perform qualified research on behalf of A. The contract requires A to
pay B $300x, regardless of the success of the research. In 1982, B
performs all of the research, and A makes full payment of $300x under
the contract. Accordingly, during the taxable year 1982, $195x (65
percent of the payment of $300x) constitutes a contract research expense
of A.
Example 2. The facts are the same as in example (1), except that B
performs 50 percent of the research in 1983. Of the $195x of contract
research expense paid in 1982, paragraph (e)(4) of this section provides
that $97.5x (50 percent of $195x) is a contract research expense for
1982 and the remaining $97.5x is contract research expense for 1983.
Example 3. The facts are the same as in example (1), except that
instead of calling for a flat payment of $300x, the contract requires A
to reimburse B for all expenses plus pay B $l00x. B incurs expenses
attributable to the research as follows:
Labor.......................................................... $90x
Supplies....................................................... 20x
Depreciation on equipment...................................... 50x
Overhead....................................................... 40x
--------
Total.................................................... 200x
Under this agreement A pays B $300x during 1982. Accordingly, during
taxable year 1982, $195x (65 percent of $300x) of the payment
constitutes a contract research expense of A. RE
Example 4. The facts are the same as in example (3), except that A
agrees to reimburse B for all expenses and agrees to pay B an additional
amount of $100x, but the additional $100x is payable only if the
research is successful. The research is successful and A pays B $300x
during 1982. Paragraph (e)(2) of this section provides that the
contingent portion of the payment is not an expense incurred for the
performance of qualified research. Thus, for taxable year 1982, $130x
(65 percent of the payment of $200x) constitutes a contract research
expense of A.
Example 5. C conducts in-house qualified research in carrying on a
trade or business. In addition, C pays D Corporation, a provider of
computer services, $100x to develop software to be used in analyzing the
results C derives from its research. Because the software services, if
performed by an employee of C, would constitute qualified services, $65x
of the $100x constitutes a contract research expense of C.
Example 6. C conducts in-house qualified research in carrying on C's
trade or business. In addition, C contracts with E Corporation, a
provider of temporary secretarial services, for the services of a
secretary for a week. The secretary spends the entire week typing
reports describing laboratory results derived from C's qualified
research. C pays E $400 for the secretarial service, none of which
constitutes wages within the meaning of section 41(b)(2)(D). These
services, if performed by employees of C, would constitute qualified
services within the meaning of section 41(b)(2)(B). Thus, pursuant to
paragraph (e)(1) of this section, $260 (65 percent of $400) constitutes
a contract research expense of C.
Example 7. C conducts in-house qualified research in carrying on C's
trade or business. In addition, C pays F, an outside accountant, $100x
to keep C's books and records pertaining to the research project. The
activity carried on by the accountant does not constitute qualified
research as defined in section 41(d). The services performed by the
accountant, if performed by an employee of C, would not constitute
qualified services (as defined in section 41(b)(2)(B)). Thus, under
paragraph (e)(1) of this section, no portion of the $100x constitutes a
contract research expense.
Sec. 1.41-3 Base period research expense.
(a) Number of years in base period. The term ``base period''
generally means the 3 taxable years immediately preceding the year for
which a credit is being determined (``determination year''). However, if
the first taxable year of the taxpayer ending after June 30, 1981, ends
in 1981 or 1982, then with respect to that taxable year the term ``base
period'' means the immediately preceding taxable year. If the second
taxable year of the taxpayer ending after June 30, 1981, ends in 1982 or
1983, then with respect to that taxable year the term ``base period''
means the 2 immediately preceding taxable years.
(b) New taxpayers. If, with respect to any determination year, the
taxpayer has not been in existence for the number of preceding taxable
years that are included under paragraph (a) of this section in the base
period for that year, then for purposes of paragraph (c)(1) of
[[Page 103]]
this section (relating to the determination of average qualified
research expenses during the base period), the taxpayer shall be treated
as--
(1) Having been in existence for that number of additional 12-month
taxable years that is necessary to complete the base period specified in
paragraph (a) of this section, and
(2) Having had qualified research expenses of zero in each of those
additional years.
(c) Definition of base period research expenses. For any
determination year, the term ``base period research expenses'' means the
greater of--
(1) The average qualified research expenses for taxable years during
the base period, or
(2) Fifty percent of the qualified research expenses for the
determination year.
(d) Special rules for short taxable years--(1) Short determination
year. If the determination year for which a research credit is being
taken is a short taxable year, the amount taken into account under
paragraph (c)(1) of this section shall be modified by multiplying that
amount by the number of months in the short taxable year and dividing
the result by 12.
(2) Short base period year. For purposes of paragraph (c)(1) of this
section, if a year in the base period is a short taxable year, the
qualified research expenses paid or incurred in the short taxable year
are deemed to be equal to the qualified research expenses actually paid
or incurred in that year multiplied by 12 and divided by the number of
months in that year.
(3) Years overlapping the effective dates of section 41 (section
44F)--(i) Determination years. If a determination year includes months
before July 1981, the determination year is deemed to be a short taxable
year including only the months after June 1981. Accordingly, paragraph
(d)(1) of this section is applied for purposes of determining the base
period expenses for such year. See section 221(d)(2) of the Economic
Recovery Tax Act of 1981.
(ii) Base period years. No adjustment is required in the case of a
base period year merely because it overlaps June 30, 1981.
(4) Number of months in a short taxable year. The number of months
in a short taxable year is equal to the number of whole calendar months
contained in the year plus fractions for any partially included months.
The fraction for a partially included month is equal to the number of
days in the month that are included in the short taxable year divided by
the total number of days in that month. Thus, if a short taxable year
begins on January 1, 1982, and ends on June 9, 1982, it consists of 5
and 9/30 months.
(e) Examples. The following examples illustrate the application of
this section.
Example 1. X Corp., an accrual-method taxpayer using the calendar
year as its taxable year, is organized and begins carrying on a trade or
business during 1979 and subsequently incurs qualified research expenses
as follows:
1979........................................................... $10x
1980........................................................... 150x
1/1/81-6/30/81................................................. 90x
7/1/81-12/31/81................................................ 110x
1982........................................................... 250x
1983........................................................... 450x
(i) Determination year 1981. For determination year 1981, the base
period consists of the immediately preceding taxable year, calendar year
1980. Because the determination year includes months before July 1981,
paragraph (d)(3)(i) of this section requires that the determination year
be treated as a short taxable year. Thus, for purposes of paragraph
(c)(1) of this section, as modified by paragraph (d)(1) of this section,
the average qualified research expenses for taxable years during the
base period are $75x ($150x, the average qualified research expenses for
the base period, multiplied by 6, the number of months in the
determination year after June 30, 1981, and divided by 12). Because this
amount is greater than the amount determined under paragraph (c)(2) of
this section (50 percent of the determination year's qualified research
expense of $110x, or $55x), the amount of base period research expenses
is $75x. The credit for determination year 1981 is equal to 25 percent
of the excess of $110x (the qualified research expenditures incurred
during the determination year including only expenditures accrued on or
after July 1, 1981, through the end of the determination year) over $75x
(the base period research expenses).
(ii) Determination year 1982. For determination year 1982, the base
period consists of the 2 immediately preceding taxable years, 1980 and
1981. The amount determined under paragraph (c)(1) of this section (the
average
[[Page 104]]
qualified research expenses for taxable years during the base period) is
$175x (($150x+$90x+$110x)/2). This amount is greater than the amount
determined under paragraph (c)(2) of this section, (50 percent of $250x,
or $125x). Accordingly, the amount of base period research expenses is
$175x. The credit for determination year 1982 is equal to 25 percent of
the excess of $250x (the qualified research expenses incurred during the
determination year) over $175x (the base period research expenses).
(iii) Determination year 1983. For determination year 1983, the base
period consists of the 3 immediately preceding taxable years 1980, 1981
and 1982. The amount determined under paragraph (c)(1) of this section
(the average qualified research expenses for taxable years during the
base period) is $200x (($150x+$200x+$250x)/3). The amount determined
under paragraph (c)(2) of this section is $225x (50 percent of the $450x
of qualified research expenses in 1983). Accordingly, the amount of base
period research expenses is $225x. The credit for determination year
1983 is equal to 25 percent of the excess of $450x (the qualified
research expenses incurred during the determination year) over $225x
(the base period research expenses).
Examp1e 2. Y, an accrual-basis corporation using the calendar year
as its taxable year comes into existence and begins carrying on a trade
or business on July 1, 1983. Y incurs qualified research expenses as
follows:
7/1/83--12/31/83............................................... $80x
1984........................................................... 200x
1985........................................................... 200x
(i) Determination year 1983. For determination year 1983, the base
period consists of the 3 immediately preceding taxable years: 1980, 1981
and 1982. Although Y was not in existence during 1980, 1981 and 1982, Y
is treated under paragraph (b) of this section as having been in
existence during those years with qualified research expenses of zero.
Thus, the amount determined under paragraph (c)(1) of this section (the
average qualified research expenses for taxable years during the base
period) is $0x (($0x+$0x+$0x)/3). The amount determined under paragraph
(c)(2) of this section is $40x (50 percent of $80x). Accordingly, the
amount of base period research expenses is $40x. The credit for
determination year 1983 is equal to 25 percent of the excess of $80x
(the qualified research expenses incurred during the determination year)
over $40x (the base period research expenses).
(ii) Determination year 1984. For determination year 1984, the base
period consists of the 3 immediately preceding taxable years: 1981,
1982, and 1983. Under paragraph (b) of this section, Y is treated as
having been in existence during years 1981 and 1982 with qualified
research expenses of zero. Because July 1 through December 31, 1983 is a
short taxable year, paragraph (d)(2) of this section requires that the
qualified research expenses for that year be adjusted to $160x for
purposes of determining the average qualified research expenses during
the base period. The $160x results from the actual qualified research
expenses for that year ($80x) multiplied by 12 and divided by 6 (the
number of months in the short taxable year). Accordingly, the amount
determined under paragraph (c)(1) of this section (the average qualified
research expenses for taxable years during the base period) is $53\1/3\x
(($0x+$0x+$160x)/3). The amount determined under paragraph (c)(2) of
this section is $100x (50 percent of $200x). The amount of base period
research expenses is $100x. The credit for determination year 1984 is
equal to 25 percent of the excess of $200x (the qualified research
expenses incurred during the determination year) over $100x (the base
period research expenses).
(iii) Determination year 1985. For determination year 1985, the base
period consists of the 3 immediately preceding taxable years: 1982,
1983, and 1984. Pursuant to paragraph (b) of this section, Y is treated
as having been in existence during 1982 with qualified research expenses
of zero. Because July 1 through December 31, 1982, is a short taxable
year, paragraph (d)(2) of this section requires that the qualified
research expense for that year be adjusted to $160x for purposes of
determining the average qualified research expenses for taxable years
during the base period. This $160x is the actual qualified research
expense for that year ($80x) multiplied by 12 and divided by 6 (the
number of months in the short taxable year). Accordingly, the amount
determined under paragraph (c)(1) of this section (the average qualified
research expenses for taxable years during the base period) is $120x
(($0x+$160x+$200x)/3). The amount determined under paragraph (c)(2) of
this section is $100x (50 percent of $200x). The amount of base period
research expenses is $120x. The credit for determination year 1985 is
equal to 25 percent of the excess of $200x (the qualified research
expenses incurred during the determination year) over $120x (the base
period research expenses).
Sec. 1.41-4 Qualified research for taxable years beginning after December 31, 1985. [Reserved]
Sec. 1.41-5 Qualified research for taxable years beginning before January 1, 1986.
(a) General rule. Except as otherwise provided in section 30(d) (as
that section read before amendment by the Tax Reform Act of 1986) and in
this section, the term ``qualified research'' means research,
expenditures for which would be research and experimental expenditures
within the meaning of section
[[Page 105]]
174. Expenditures that are ineligible for the section 174 deduction
elections are not expenditures for qualified research. For example,
expenditures for the acquisition of land or depreciable property used in
research, and mineral exploration costs described in section 174(d), are
not expenditures for qualified research.
(b) Activities outside the United States--(1) In-house research. In-
house research conducted outside the United States (as defined in
section 7701(a)(9)) cannot constitute qualified research. Thus, wages
paid to an employee scientist for services performed in a laboratory in
the United States and in a test station in Antarctica must be
apportioned between the services performed within the United States and
the services performed outside the United States, and only the wages
apportioned to the services conducted within the United States are
qualified research expenses unless the 80 percent rule of Sec. 1.41-
2(d)(2) applies.
(2) Contract research. If contract research is performed partly
within the United States and partly without, only 65 percent of the
portion of the contract amount that is attributable to the research
performed within the United States can qualify as contract research
expense (even if 80 percent or more of the contract amount was for
research performed in the United States).
(c) Social sciences or humanities. Qualified research does not
include research in the social sciences or humanities. For purposes of
section 30(d)(2) (as that section read before amendment by the Tax
Reform Act of 1986) and of this section, the phrase ``research in the
social sciences or humanities'' encompasses all areas of research other
than research in a field of laboratory science (such as physics or
biochemistry), engineering or technology. Examples of research in the
social sciences or humanities include the development of a new life
insurance contract, a new economic model or theory, a new accounting
procedure or a new cookbook.
(d) Research funded by any grant, contract, or otherwise--(1) In
general. Research does not constitute qualified research to the extent
it is funded by any grant, contract, or otherwise by another person
(including any governmental entity). All agreements (not only research
contracts) entered into between the taxpayer performing the research and
other persons shall be considered in determining the extent to which the
research is funded. Amounts payable under any agreement that are
contingent on the success of the research and thus considered to be paid
for the product or result of the research (see Sec. 1.41-2(e)(2)) are
not treated as funding. For special rules regarding funding between
commonly controlled businesses, see Sec. 1.41-8(e).
(2) Research in which taxpayer retains no rights. If a taxpayer
performing research for another person retains no substantial rights in
research under the agreement providing for the research, the research is
treated as fully funded for purposes of section 41(d)(4)(H), and no
expenses paid or incurred by the taxpayer in performing the research are
qualified research expenses. For example, if the taxpayer performs
research under an agreement that confers on another person the exclusive
right to exploit the results of the research, the taxpayer is not
performing qualified research because the research is treated as fully
funded under this paragraph (d)(2). Incidental benefits to the taxpayer
from performance of the research (for example, increased experience in a
field of research) do not constitute substantial rights in the research.
If a taxpayer performing research for another person retains no
substantial rights in the research and if the payments to the researcher
are contingent upon the success of the research, neither the performer
nor the person paying for the research is entitled to treat any portion
of the expenditures as qualified research expenditures.
(3) Research in which the taxpayer retains substantial rights--(i)
In general. If a taxpayer performing research for another person retains
substantial rights in the research under the agreement providing for the
research, the research is funded to the extent of the payments (and fair
market value of any property) to which the taxpayer becomes entitled by
performing the research. A taxpayer does not retain substantial rights
in the research if the taxpayer must pay
[[Page 106]]
for the right to use the results of the research. Except as otherwise
provided in paragraph (d)(3)(ii) of this section, the taxpayer shall
reduce the amount paid or incurred by the taxpayer for the research that
would, but for section 41(d)(4)(H), constitute qualified research
expenses of the taxpayer by the amount of funding determined under the
preceding sentence.
(ii) Pro rata allocation. If the taxpayer can establish to the
satisfaction of the district director--
(A) The total amount of research expenses,
(B) That the total amount of research expenses exceed the funding,
and
(C) That the otherwise qualified research expenses (that is, the
expenses which would be qualified research expenses if there were no
funding) exceed 65 percent of the funding, then the taxpayer may
allocate the funding pro rata to nonqualified and otherwise qualified
research expenses, rather than allocating it 100 percent to otherwise
qualified research expenses (as provided in paragraph (d)(3)(i) of this
section). In no event, however, shall less than 65 percent of the
funding be applied against the otherwise qualified research expenses.
(iii) Project-by-project determination. The provisions of this
paragraph (d)(3) shall be applied separately to each research project
undertaken by the taxpayer.
(4) Independent research and development under the Federal
Acquisition Regulations System and similar provisions. The Federal
Acquisition Regulations System and similar rules and regulations
relating to contracts (fixed price, cost plus, etc.) with government
entities provide for allocation of certain ``independent research and
development costs'' and ``bid and proposal costs'' of a contractor to
contracts entered into with that contractor. In general, any
``independent research and development costs'' and ``bid and proposal
costs'' paid to a taxpayer by reason of such a contract shall not be
treated as funding the underlying research activities except to the
extent the ``independent research and development costs'' and ``bid and
proposal costs'' are properly severable from the contract. See
Sec. 1.451-3(e); see also section 804(d)(2) of the Tax Reform Act of
1986.
(5) Funding determinable only in subsequent taxable year. If at the
time the taxpayer files its return for a taxable year, it is impossible
to determine to what extent particular research performed by the
taxpayer during that year may be funded, then the taxpayer shall treat
the research as completely funded for purposes of completing that
return. When the amount of funding is finally determined, the taxpayer
should amend the return and any interim returns to reflect the proper
amount of funding.
(6) Examples. The following examples illustrate the application of
the principles contained in this paragraph.
Example 1. A enters into a contract with B Corporation, a cash-
method taxpayer using the calendar year as its taxable year, under which
B is to perform research that would, but for section 41(d)(3)(H), be
qualified research of B. The agreement calls for A to pay B $120x,
regardless of the outcome of the research. In 1982, A makes full payment
of $120x under the contract, B performs all the research, and B pays all
the expenses connected with the research, as follows:
In-house research expenses..................................... $100x
Outside research:
(Amount B paid to third parties for research, 65 percent of 40x
which ($26x) is treated as a contract research expense of B)
Overhead and other expenses.................................... 10x
--------
Total...................................................... 150x
If B has no rights to the research, B is fully funded.
Alternatively, assume that B retains the right to use the results of the
research in carrying on B's business. Of B's otherwise qualified
research expenses of $126x + $26x), $120x is treated as funded by A.
Thus $6x ($126x - $120x) is treated as a qualified research expense of
B. However, if B establishes the facts required under paragraph (d)(3)
of this section, B can allocate the funding pro rata to nonqualified and
otherwise qualified research expenses. Thus $100.8x ($120x ($126x/
$150x)) would be allocated to otherwise qualified research expenses. B's
qualified research expenses would be $25.2x ($126x - $100.8x). For
purposes of the following examples (2), (3) and (4) assume that B
retains substantial rights to use the results of the research in
carrying on B's business.
Example 2. The facts are the same as in example (1) (assuming that B
retains the right to use the results of the research in carrying on B's
business) except that, although A
[[Page 107]]
makes full payment of $120x during 1982, B does not perform the research
or pay the associated expenses until 1983. The computations are
unchanged. However, B's qualified research expenses determined in
example (1) are qualified research expenses during 1983.
Example 3. The facts are the same as in example (1) (assuming that B
retains the right to use the results of the research in carrying on B's
business) except that, although B performs the research and pays the
associated expenses during 1982, A does not pay the $120x until 1983.
The computations are unchanged and the amount determined in example (1)
is a qualified research expense of B during 1982.
Example 4. The facts are the same as in example (1) (assuming that B
retains the right to use the results of the research in carrying on B's
business) except that, instead of agreeing to pay B $120x, A agrees to
pay $100x regardless of the outcome and an additional $20x only if B's
research produces a useful product. B's research produces a useful
product and A pays B $120x during 1982. The $20x payment that is
conditional on the success of the research is not treated as funding.
Assuming that B establishes to the satisfaction of the district director
the actual research expenses, B can allocate the funding to nonqualified
and otherwise qualified research expenses. Thus $84x ($100x ($126x/
$150x)) would be allocated to otherwise qualified research expenses. B's
qualified research expenses would be $42x ($126x - $84x).
Example 5. C enters into a contract with D, a cash-method taxpayer
using the calendar year as its taxable year, under which D is to perform
research in which both C and D will have substantial rights. C agrees to
reimburse D for 80 percent of D's expenses for the research. D performs
part of the research in 1982 and the rest in 1983. At the time that D
files its return for 1982, D is unable to determine the extent to which
the research is funded under the provisions of this paragraph. Under
these circumstances, D may not treat any of the expenses paid by D for
this research during 1982 as qualified research expenses on its 1982
return. When the project is complete and D can determine the extent of
funding, D should file an amended return for 1982 to take into account
any qualified research expense for 1982.
Sec. 1.41-6 Basic research for taxable years beginning after December 31, 1985. [Reserved]
Sec. 1.41-7 Basic research for taxable years beginning before January 1, 1986.
(a) In general. The amount expended for basic research within the
meaning of section 30(e) (before amended by the Tax Reform Act of 1986)
equals the sum of money plus the taxpayer's basis in tangible property
(other than land) transferred for use in the performance of basic
research.
(b) Trade or business requirement. Any amount treated as a contract
research expense under section 30(e) (before amendment by the Tax Reform
Act of 1986) shall be deemed to have been paid or incurred in carrying
on a trade or business, if the corporation that paid or incurred the
expenses is actually engaged in carrying on some trade or business.
(c) Prepaid amounts--(1) In general. If any basic research expense
paid or incurred during any taxable year is attributable to research to
be conducted after the close of such taxable year, the expense so
attributable shall be treated for purposes of section 30(b)(1)(B)
(before amendment by the Tax Reform Act of 1986) as paid or incurred
during the period in which the basic research is conducted.
(2) Transfers of property. In the case of transfers of property to
be used in the performance of basic research, the research in which that
property is to be used shall be considered to be conducted ratably over
a period beginning on the day the property is first so used and
continuing for the number of years provided with respect to property of
that class under section 168(c)(2) (before amendment by the Tax Reform
Act of 1986). For example, if an item of property which is 3-year
property under section 168(c) is transferred to a university for basic
research on January 12, 1983, and is first so used by the university on
March 1, 1983, then the research in which that property is used is
considered to be conducted ratably from March 1, 1983, through February
28, 1986.
(d) Written research agreement--(1) In general. A written research
agreement must be entered into prior to the performance of the basic
research.
(2) Agreement between a corporation and a qualified organization
after June 30, 1983--(i) In general. A written research agreement
between a corporation and a qualified organization (including a
qualified fund) entered into after June 30, 1983, shall provide that
[[Page 108]]
the organization shall inform the corporation within 60 days after the
close of each taxable year of the corporation what amount of funds
provided by the corporation pursuant to the agreement was expended on
basic research during the taxable year of the corporation. In
determining amounts expended on basic research, the qualified
organization shall take into account the exclusions specified in section
30(e)(3) (before amendment by the Tax Reform Act of 1986) and in
paragraph (e) of this section.
(ii) Transfers of property. In the case of transfers of property to
be used in basic research, the agreement shall provide that
substantially all use of the property is to be for basic research, as
defined in section 30(e)(3) (before amendment by the Tax Reform Act of
1986).
(3) Agreement between a qualified fund and a qualified educational
organization after June 30, 1983. A written research agreement between a
qualified fund and a qualified educational organization (see section
30(e)(4)(B)(iii) (before amendment by the Tax Reform Act of 1986))
entered into after June 30, 1983, shall provide that the qualified
educational organization shall furnish sufficient information to the
qualified fund to enable the qualified fund to comply with the written
research agreements it has entered into with grantor corporations,
including the requirement set forth in paragraph (d)(2) of this section.
(e) Exclusions--(1) Research conducted outside the United States. If
a taxpayer pays or incurs an amount for basic research to be performed
partly within the United States and partly without, only 65 percent of
the portion of the amount attributable to research performed within the
United States can be treated as a contract research expense (even if 80
percent or more of the contract amount was for basic research performed
in the United States).
(2) Research in the social sciences or humanities. Basic research
does not include research in the social sciences or humanities, within
the meaning of Sec. 1.41-5(c).
(f) Procedure for making an election to be treated as a qualified
fund. In order to make an election to be treated as a qualified fund
within the meaning of section 30(e)(4)(B)(iii) (before amendment by the
Tax Reform Act of 1986) or as an organization described in section
41(e)(6)(D), the organization shall file with the Internal Revenue
Service center with which it files its annual return a statement that--
(1) Sets out the name, address, and taxpayer identification number
of the electing organization (the ``taxpayer'') and of the organization
that established and maintains the electing organization (the
``controlling organization''),
(2) Identifies the election as an election under section 41(e)(6)(D)
of the Code,
(3) Affirms that the controlling organization and the taxpayer are
section 501(c)(3) organizations,
(4) Provides that the taxpayer elects to be treated as a private
foundation for all Code purposes other than section 4940,
(5) Affirms that the taxpayer satisfies the requirement of section
41(e)(6)(D)(iii), and
(6) Specifies the date on which the election is to become effective.
If an election to be treated as a qualified fund is filed before
February 1, 1982, the election may be made effective as of any date
after June 30, 1981, and before January 1, 1986. If an election is filed
on or after February 1, 1982, the election may be made effective as of
any date on or after the date on which the election is filed.
Sec. 1.41-8 Aggregation of expenditures.
(a) Controlled group of corporations; trades or businesses under
common control--(1) In general. In determining the amount of research
credit allowed with respect to a trade or business that at the end of
its taxable year is a member of a controlled group of corporations or a
member of a group of trades or businesses under common control, all
members of the group are treated as a single taxpayer and the credit (if
any) allowed to the member is determined on the basis of its
proportionate share (if any) of the increase in qualified research
expenses of the aggregated group.
(2) Definition of trade or business. For purposes of this section, a
trade or
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business is a sole proprietorship, a partnership, a trust, an estate, or
a corporation that is carrying on a trade or business (within the
meaning of section 162). For purposes of this section, any corporation
that is a member of a commonly controlled group shall be deemed to be
carrying on a trade or business if any other member of that group is
carrying on any trade or business.
(3) Determination of common control. For rules for determining
whether trades or businesses are under common control, see paragraphs
(b) through (g) of Sec. 1.52-1 except that the words ``singly or'' in
Sec. 1.52-1(d)(1)(i) shall be treated as deleted.
(4) Examples. The following examples illustrate provisions of this
paragraph.
Example 1. (i) Facts. A controlled group of four corporations (all
of which are calendar-year taxpayers) had qualified research expenses
(``research expenses'') during the base period and taxable year as
follows:
------------------------------------------------------------------------
Base period Taxable
Corporation (average) year Change
------------------------------------------------------------------------
A..................................... $60 $40 ($20)
B..................................... 10 15 5
C..................................... 30 70 40
D..................................... 15 25 10
------------------------------------------------------------------------
(ii) Total credit. Because the research expenses of the four
corporations are treated as if made by one taxpayer, the total amount of
incremental expenses eligible for the credit is $35 ($55 increase
attributable to B, C, and D less $20 decrease attributable to A). The
total amount of credit allowable to members of the group is 20% of the
incremental amount or $7.00.
(iii) Allocation of credit. No amount of credit is allocated to A
since A's research expenses did not increase in the taxable year. The
$7.00 credit is allocated to B, C, and D, the members of the group that
increased their research expenses. This allocation is made on the basis
of the ratio of each corporation's increase in its research expenses to
the sum of increases in those expenses. Inasmuch as the total increase
made by those members of the group whose research expenses rose (B, C,
and D) was $55, B's share of the $7.00 credit is 5/55; C's share is 40/
55; and D's share is 10/55.
Example 2. The facts are the same as in example (1) except that A
had zero research expenses in the taxable year. Thus, the controlled
group had a decrease rather than an increase in aggregate research
expenses. Accordingly, no amount of credit is allowable to any member of
the group even though B, C, and D actually increased their research
expenses in comparison with their own base period expenses.
(b) Minimum base period research expenses. For purposes of this
section, the rule in section 41(c)(3) (pertaining to minimum base period
research expenses) shall be applied only to the aggregate amount of base
period research expenses. See the treatment of corporation C in example
(1) of paragraph (a)(4) of this section.
(c) Tax accounting periods used--(1) In general. The credit
allowable to a member of a controlled group of corporations or of a
group of trades or businesses under common control is that member's
share of the aggregate credit computed as of the end of such member's
taxable year. In computing the aggregate credit in the case of a group
whose members have different taxable years, a member shall generally
treat the taxable year of another member that ends with or within the
determination year of the computing member as the determination year of
that other member. The base period research expenses taken into account
with respect to a determination year of another member shall be the base
period research expenses determined for that year under Sec. 1.41-3,
except that Sec. 1.41-3(c)(2) shall be applied only at the aggregate
level.
(2) Special rule where timing of research is manipulated. If the
timing of research by members using different tax accounting periods is
manipulated to generate a credit in excess of the amount that would be
allowable if all members of the group used the same tax accounting
period, the district director may require each member of the group to
calculate the credit in the current taxable year and all future years as
if all members of the group had the same taxable year and base period as
the computing member.
(d) Membership during taxable year in more than one group. A trade
or business may be a member of only one group for a taxable year. If,
without application of this paragraph, a business would be a member of
more than one group at the end of its taxable year, the business shall
be treated as a member of the group in which it was included for its
preceding taxable year.
[[Page 110]]
If the business was not included for its preceding taxable year in any
group in which it could be included as of the end of its taxable year,
the business shall designate in its timely filed (including extensions)
return the group in which it is being included. If the return for a
taxable year is due before July 1, 1983, the business may designate its
group membership through an amended return for that year filed on or
before June 30, 1983. If the business does not so designate, then the
district director with audit jurisdiction of the return will determine
the group in which the business is to be included.
(e) Intra-group transactions--(1) In general. Because all members of
a group under common control are treated as a single taxpayer for
purposes of determining the research credit, transfers between members
of the group are generally disregarded.
(2) In-house research expenses. If one member of a group performs
qualified research on behalf of another member, the member performing
the research shall include in its qualified research expenses any in-
house research expenses for that work and shall not treat any amount
received or accrued as funding the research. Conversely, the member for
whom the research is performed shall not treat any part of any amount
paid or incurred as a contract research expense. For purposes of
determining whether the in-house research for that work is qualified
research, the member performing the research shall be treated as
carrying on any trade or business carried on by the member on whose
behalf the research is performed.
(3) Contract research expenses. If a member of a group pays or
incurs contract research expenses to a person outside the group in
carrying on the member's trade or business, that member shall include
those expenses as qualified research expenses. However, if the expenses
are not paid or incurred in carrying on any trade or business of that
member, those expenses may be taken into account as contract research
expenses by another member of the group provided that the other member--
(i) Reimburses the member paying or incurring the expenses, and
(ii) Carries on a trade or business to which the research relates.
(4) Lease Payments. The amount paid or incurred to another member of
the group for the lease of personal property owned by a member of the
group is not taken into account for purposes of section 41. Amounts paid
or incurred to another member of the group for the lease of personal
property owned by a person outside the group shall be taken into account
as in-house research expenses for purposes of section 41 only to the
extent of the lesser of--
(i) The amount paid or incurred to the other member, or
(ii) The amount of the lease expenses paid to the person outside the
group.
(5) Payment for supplies. Amounts paid or incurred to another member
of the group for supplies shall be taken into account as in-house
research expenses for purposes of section 41 only to the extent of the
lesser of--
(i) The amount paid or incurred to the other member, or
(ii) The amount of the other member's basis in the supplies.
Sec. 1.41-9 Special rules.
(a) Allocations--(1) Corporation making an election under subchapter
S--(i) Pass-through, for taxable years beginning after December 31,
1982, in the case of an S corporation. In the case of an S corporation
(as defined in section 1361) the amount of research credit computed for
the corporation shall be allocated to the shareholders according to the
provisions of section 1366 and section 1377.
(ii) Pass-through, for taxable years beginning before January 1,
1983, in the case of a subchapter S corporation. In the case of an
electing small business corporation (as defined in section 1371 as that
section read before the amendments made by the subchapter S Revision Act
of 1982), the amount of the research credit computed for the corporation
for any taxable year shall be apportioned pro rata among the persons who
are shareholders of the corporation on the last day of the corporation's
taxable year.
(2) Pass-through in the case of an estate or trust. In the case of
an estate or trust, the amount of the research credit computed for the
estate or trust for any taxable year shall be apportioned
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among the estate or trust and the beneficiaries on the basis of the
income of the estate or trust allocable to each.
(3) Pass-through in the case of a partnership--(i) In general. In
the case of a partnership, the research credit computed for the
partnership for any taxable year shall be apportioned among the persons
who are partners during the taxable year in accordance with section 704
and the regulations thereunder. See, for example, Sec. 1.704-
1(b)(4)(ii). Because the research credit is an expenditure-based credit,
the credit is to be allocated among the partners in the same proportion
as section 174 expenditures are allocated for the year.
(ii) Certain expenditures by joint ventures. Research expenses to
which Sec. 1.41-2(a)(4)(ii) applies shall be apportioned among the
persons who are partners during the taxable year in accordance with the
provisions of that section. For purposes of section 41, these expenses
shall be treated as paid or incurred directly by the partners rather
than by the partnership. Thus, the partnership shall disregard these
expenses in computing the credit to be apportioned under paragraph
(a)(3)(i) of this section, and in making the computations under section
41 each partner shall aggregate its distributive share of these expenses
with other research expenses of the partner. The limitation on the
amount of the credit set out in section 41(g) and in paragraph (c) of
this section shall not apply because the credit is computed by the
partner, not the partnership.
(4) Year in which taken into account. An amount apportioned to a
person under this paragraph shall be taken into account by the person in
the taxable year of such person which or within which the taxable year
of the corporation, estate, trust, or partnership (as the case may be)
ends.
(5) Credit allowed subject to limitation. The credit allowable to
any person to whom any amount has been apportioned under paragraph
(a)(1), (2) or (3)(i) of this section is subject to section 41(g) and
sections 38 and 39 of the Code, if applicable.
(b) Adjustments for certain acquisitions and dispositions--Meaning
of terms. For the meaning of ``acquisition,'' ``separate unit,'' and
``major portion,'' see paragraph (b) of Sec. 1.52-2. An ``acquisition''
includes an incorporation or a liquidation.
(c) Special rule for pass-through of credit. The special rule
contained in section 41(g) for the pass-through of the credit in the
case of an individual who owns an interest in an unincorporated trade or
business, is a partner in a partnership, is a beneficiary of an estate
or trust, or is a shareholder in an S corporation shall be applied in
accordance with the principles set forth in Sec. 1.53-3.
(d) Carryback and carryover of unused credits. The taxpayer to whom
the credit is passed through under paragraph (c) of this section shall
not be prevented from applying the unused portion in a carryback or
carryover year merely because the entity that earned the credit changes
its form of conducting business.
Taxable Years Beginning Before January 1, 1987
Sec. 1.41-0A Credit or deduction for political and newsletter fund contributions--scope and note.
Section 41 allows a limited credit against the income tax for
political and newsletter fund contributions. Section 218 allows a
limited deduction for contributions. The Revenue Act of 1978, however,
increases the maximum annual credit under section 41 and repeals section
218. These changes are effective for political and newsletter fund
contributions payment of which is made in taxable years of the
contributor beginning after December 31, 1978. Sections 1.41-1A through
1.41-8A apply to both sections 41 and 218.
[T.D. 7603, 44 FR 18222, Mar. 27, 1979. Redesignated and amended by T.D.
8251, 54 FR 21204, May 17, 1989]
Sec. 1.41-1A Same--definitions of certain items.
(a) Campaign committee. A ``campaign committee'' is any group
described in section 41(c)(1)(B). Thus, to be a campaign committee a
group must be organized and operated exclusively to further the
nomination or election of one or more candidates. That means it may not,
except as otherwise provided in
[[Page 112]]
Sec. 1.41-3A(a), spend any money for any other purpose. Therefore, a
group that engages in any general political, educational, or legislative
activities is not a campaign committee. Such a group may, however,
organize a separate campaign committee exclusively to further the
nomination or election of one or more candidates.
(b) Candidate. A ``candidate'' is an individual described in section
41 (c)(2). A candidate remains a candidate until enough money has been
raised to pay the debts incurred in a previous campaign for elective
public office. For example, A, a candidate for Senator from State X in
1977, is elected to that office in 1978. A sustains a campaign debt with
respect to A's Senatorial campaign. A remains a candidate solely for the
purpose of soliciting contributions to extinguish the campaign debt.
(c) Elective public office. An ``elective public office'' is any
governmental position for which one must be directly chosen by the
casting of votes by the general public or the Electoral College. It does
not, however, include any office or position in any national, state, or
local political party or similar organization, or membership in the
Electoral College.
(d) Furthering a candidacy. Expenditures further a candidacy within
the meaning of section 41(c)(1) (A) and (B) if they are directly related
to, and are intended to support, a candidate's campaign for elective
public office. Examples include payments for--
(1) Researching and polling campaign issues;
(2) Trips in connection with campaigning by the candidate or persons
acting on his or her behalf;
(3) Raising funds; and
(4) Campaign-related debts left over from a previous political
campaign.
(e) Meets the qualifications. An individual ``meets the
qualifications prescribed by law'' to hold an elective public office if
the individual can be reasonably expected to meet those qualifications
on or before the date the office is to be filled.
(f) Newsletter fund contribution. The term ``newsletter fund
contribution'' means a contribution of money or gift of money directly
to a fund described in section 527(g) (relating to the treatment of
newsletter funds as political organizations).
(g) Political contribution. A ``political contribution'' is a
contribution of money or gift of money directly to a person described in
section 41(c)(1). A political contribution is not limited to that
portion of the contribution or gift that is eligible as a credit under
section 41(b) or deduction under section 218(b).
(h) Publicly announces. An individual ``publicly announces'' that he
or she is a candidate by making a positive statement available for media
distribution that he or she is seeking nomination or election to a
specific elective public office. An example is a news release or other
statement by an individual intended for distribution via television,
radio, newspapers, or magazines within the geographic area associated
with the elective public office being sought which states that he or she
seeks nomination or election to the office. Incumbency in an office does
not constitute a public announcement that one is seeking reelection to
that office. Furthermore, if because of death or any other reason an
individual does not make a public announcement, the individual is not a
candidate even though the individual was about to make a public
announcement.
[T.D. 7603, 44 FR 18222, Mar. 27, 1979. Redesignated and amended by T.D.
8251, 54 FR 21204, May 17, 1989]
Sec. 1.41-2A Same--limitations and special rules.
(a) When payment must be made. A taxpayer may elect the credit under
section 41 or the deduction under section 218 only if a political or
newsletter fund contribution is actually paid within the taxable year
for which the taxpayer claims the credit or deduction. The method of
accounting the taxpayer uses and the date the contribution is pledged
are irrelevant. Where a partnership makes a political or newsletter fund
contribution, each partner is considered as having paid his or her
distributive share of the political or newsletter fund contribution.
(b) Campaign committee supporting more than one individual. A
section 41 credit or section 218 deduction may be available for a
contribution of money
[[Page 113]]
to a campaign committee that supports, or intends to support, more than
one candidate if at least one individual it supports is a candidate for
the calendar year in which the contribution is made. However, if a
taxpayer indicates at the time the contribution is made that it is for a
specific individual, and that individual is not a candidate for the
calendar year in which the contribution is made, no credit or deduction
is available.
(c) Examples. The provisions of this section are illustrated by the
following examples:
Example 1. B, an individual, makes a contribution of money in 1977
to the Good Government Committee, which is a campaign committee. The
Good Government Committee supports C and D in 1977. C is a candidate for
1977. D is not a candidate for 1977. B may elect the credit under
section 41 or deduction under section 218 for the contribution in 1977.
Example 2. Assume the same facts as in example (1), except that B
earmarks the contribution solely to further the candidacy of D. B may
not elect the credit under section 41 or deduction under section 218 for
the 1977 contribution.
FT.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.41-3A Same--unspent contributions.
(a) General rule. Except as provided in paragraph (b) of this
section, all unspent political contributions must be used within a
reasonable period of time to make a deposit or contribution described in
section 527 (d).
(b) Special rules--(1) Candidates. An individual who was a candidate
may retain unspent political contributions in reasonable anticipation of
using them solely to support his or her future candidacy for any
Federal, State, or local elective public office.
(2) Campaign committee. A campaign committee may retain unspent
political contributions in reasonable anticipation of using them to
support the future candidacy of any individual for any Federal, State,
or local elective public office.
[T.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.41-4A Same--procedure for electing a credit or deduction.
(a) Scope note. This section prescribes procedures for making the
election under sections 41 and 218 to take either a credit or deduction
for political and newsletter contributions.
(b) How to elect. A taxpayer elects the credit or deduction by
making the appropriate entries on his or her income tax return for the
taxable year in which the contribution is made.
(c) Changing or revoking one's election. The election may be changed
or revoked. Thus, a taxpayer may change an election from credit to
deduction or vice versa. In addition, if a taxpayer elects a credit or
deduction for a particular taxable year to which, it later turns out, he
or she is not entitled, the taxpayer must pay any additional tax that is
due as a result. A taxpayer may change or revoke the election by use of
an amended return.
[T.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.41-5A Same--verifications.
This section prescribes rules under sections 41(b)(3) and 218(b)(2)
to tell a taxpayer how to verify political and newsletter fund
contributions for which a credit or deduction is claimed. A taxpayer
must have a written receipt to substantiate any claim that a
contribution was made. A cancelled check, the payee of which is a person
or fund described in section 41(c) (1) or (5), ordinarily meets this
requirement. However, in appropriate cases, the Internal Revenue Service
may require a taxpayer to furnish additional proof that the payee was a
person or fund described in section 41(c) (1) or (5), or that the
purpose of the payment was to make a political or newsletter fund
contribution.
[T.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.41-6A Same--taxation of certain organizations.
See section 527 and the regulations thereunder for the tax treatment
of a person or fund described in section
[[Page 114]]
41(c) (1) or (5) that is treated as a section 527(e)(1) political
organization.
[T.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.41-7A Same--transitional rule for past contributions.
A credit or deduction for a political contribution the payment of
which was made before January 1, 1980 will be allowed if it meets the
requirements for a credit or deduction under the notice of proposed
rulemaking published on September 19, 1972 (37 FR 19140).
[T.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.41-8A Same--effective dates.
(a) Political contributions. Except as otherwise provided, these
regulations apply to political contributions made in taxable years of
the contributor beginning after December 31, 1971.
(b) Newsletter fund contributions. These regulations apply to
newsletter fund contributions made in taxable years of the contributor
beginning after December 31, 1974.
[T.D. 7603, 44 FR 18223, Mar. 27, 1979. Redesignated by T.D. 8251, 54 FR
21204, May 17, 1989]
Sec. 1.42-0 Table of contents.
This section lists the paragraphs contained in Secs. 1.42-1 and
1.42-2.
Sec. 1.42-1 [Reserved]
Sec. 1.42-2 Waiver of requirement that an existing building
eligible for the low-income housing credit was last placed in service
more than 10 years prior to acquisition by the taxpayer.
(a) Low-income housing credit for existing building
(b) Waiver of 10-year holding period requirement
(c) Waiver requirements
(1) Federally-assisted building
(2) Federal mortgage funds at risk
(3) Statement by the Department of Housing and Urban Development or
the Farmers' Home Administration
(4) No prior credit allowed
(d) Application for waiver
(1) Time and manner
(2) Information required
(3) Other rules
(4) Effective date of waiver
(5) Attachment to return
(e) Effective date of regulations
[T.D. 8302, 55 FR 21189, May 23, 1990]
Sec. 1.42-1 [Reserved]
Sec. 1.42-1T Limitation on low-income housing credit allowed with respect to qualified low-income buildings receiving housing credit allocations from a State
or local housing credit agency (temporary).
(a) In general--(1) Determination of amount of low-income housing
credit. Section 42 provides that, for purposes of section 38, a low-
income housing credit is determined for a building in an amount equal to
the applicable percentage of the qualified basis of the qualified low-
income building. In general, the credit may be claimed annually for a
10-year credit period, beginning with the taxable year in which the
building is placed in service or, at the election of the taxpayer, the
succeeding taxable year. If, after the first year of the credit period,
the qualified basis of a building is increased in excess of the
qualified basis upon which the credit was initially determined, the
allowable credit with respect to such additional qualified basis is
determined using a credit percentage equal to two-thirds of the
applicable percentage for the initial qualified basis. The credit for
additions to qualified basis is generally allowable for the remaining
years in the 15-year compliance period which begins with the first
taxable year of the credit period for the building. In general, the low-
income housing credit is available with respect to buildings placed in
service after December 31, 1986, in taxable years ending after that
date. See section 42 for the definitions of ``qualified low-income
building'', ``applicable percentage'', ``qualified basis'', ``credit
period'', ``compliance period'', and for other rules relating to
determination of the amount of the low-income housing credit.
(2) Limitation on low-income housing credit allowed. Generally, the
low-income housing credit determined under section 42 is allowed and may
be claimed for any taxable year if, and to the extent that, the owner of
a qualified low-income building receives a housing credit allocation
from a State
[[Page 115]]
or local housing credit agency. The aggregate amount of housing credit
allocations that may be made in any calendar year by all housing credit
agencies within a State is limited by a State housing credit ceiling, or
volume cap, described in paragraph (b) of this section. The authority to
make housing credit allocations within the State housing credit ceiling
may be apportioned among the State and local housing credit agencies,
under the rules prescribed in paragraph (c) of this section. Upon
apportionment of the State housing credit volume cap, each State or
local housing credit agency receives an aggregate housing credit dollar
amount that may be used to make housing credit allocations among
qualified low-income buildings located within an agency's geographic
jurisdiction. The rules governing the making of housing credit
allocations by any state or local housing credit agency are provided in
paragraph (d) of this section. Housing credit allocations are required
to be taken into account by owners of qualified low-income buildings
under the rules prescribed in paragraph (e) of this section. Exceptions
to the requirement that a qualified low-income building receive a
housing credit allocation from a State or local housing credit agency
are provided in paragraph (f) of this section. Rules regarding
termination of the authority of State and local housing credit agencies
to make housing credit allocations after December 31, 1989, are
specified in paragraph (g) of this section. Rules concerning information
reporting by State and local housing credit agencies and owners of
qualified low-income buildings are provided in paragraph (h) of this
section. Special statutory transitional rules are incorporated into this
section of the regulations as described in paragraph (i) of this
section.
(b) The State housing credit ceiling. The aggregate amount of
housing credit allocations that may be made in any calendar year by all
State and local housing credit agencies within a State may not exceed
the State's housing credit ceiling for such calendar year. The State
housing credit ceiling for each State for any calendar year is equal to
$1.25 multiplied by the State's population. A State's population for any
calendar year is determined by reference to the most recent census
estimate (whether final or provisional) of the resident population of
the State released by the Bureau of the Census before the beginning of
the calendar year for which the State's housing credit ceiling is set.
Unless otherwise prescribed by applicable revenue procedure,
determinations of population are based on the most recent estimates of
population contained in the Bureau of the Census publication, ``Current
Population Reports, Series P-25: Population Estimates and Projections,
Estimates of the Population of States''. For purposes of this section,
the District of Columbia and United States possessions are treated as
States.
(c) Apportionment of State housing credit ceiling among State and
local housing credit agencies--(1) In general. A State's housing credit
ceiling for any calendar year is apportioned among the State and local
housing credit agencies within such State under the rules prescribed in
this paragraph. A ``State housing credit agency'' is any State agency
specifically authorized by gubernatorial act or State statute to make
housing credit allocations on behalf of the State and to carry out the
provisions of section 42(h). A ``local housing credit agency'' is any
agency of a political subdivision of the State that is specifically
authorized by a State enabling act to make housing credit allocations on
behalf of the State or political subdivision and to carry out the
provisions of section 42(h). A ``State enabling act'' is any
gubernatorial act, State statute, or State housing credit agency
regulation (if authorized by gubernatorial act or State statute). A
State enabling act enacted on or before October 22, 1986, the date of
enactment of the Tax Reform Act of 1986, shall be given effect for
purposes of this paragraph if such State enabling act expressly carries
out the provisions of section 42(h).
(2) Primary apportionment. Except as otherwise provided in
paragraphs (c) (3) and (4) of this section, a State's housing credit
ceiling is apportioned in its entirety to the State housing credit
agency. Such an apportionment is the ``primary apportionment'' of a
State's housing credit ceiling. There shall be
[[Page 116]]
no primary apportionment of the State housing credit ceiling and no
grants of housing credit allocations in such State until a State housing
credit agency is authorized by gubernatorial act or State statute. If a
State has more than one State housing credit agency, such agencies shall
be treated as a single agency for purposes of the primary apportionment.
In such a case, the State housing credit ceiling may be divided among
the multiple State housing credit agencies pursuant to gubernatorial act
or State statute.
(3) States with 1 or more constitutional home rule cities--(i) In
general. Notwithstanding paragraph (c)(2) of this section, in any State
with 1 or more constitutional home rule cities, a portion of the State
housing credit ceiling is apportioned to each constitutional home rule
city. In such a State, except as provided in paragraph (c)(4) of this
section, the remainder of the State housing credit ceiling is
apportioned to the State housing credit agency under paragraph (c)(2) of
this section. See paragraph (c)(3)(iii) of this section. The term
``constitutional home rule city'' means, with respect to any calendar
year, any political subdivision of a State that, under a State
constitution that was adopted in 1970 and effective on July 1, 1971, had
home rule powers on the first day of the calendar year.
(ii) Amount of apportionment to a constitutional home rule city. The
amount of the State housing credit ceiling apportioned to a
constitutional home rule city for any calendar year is an amount that
bears the same ratio to the State housing credit ceiling for that year
as the population of the constitutional home rule city bears to the
population of the entire State. The population of any constitutional
home rule city for any calendar year is determined by reference to the
most recent census estimate (whether final or provisional) of the
resident population of the constitutional home rule city released by the
Bureau of the Census before the beginning of the calendar year for which
the State housing credit ceiling is apportioned. However, determinations
of the population of a constitutional home rule city may not be based on
Bureau of the Census estimates that do not contain estimates for all of
the constitutional home rule cities within the State. If no Bureau of
the Census estimate is available for all such constitutional home rule
cities, the most recent decennial census of population shall be relied
on. Unless otherwise prescribed by applicable revenue procedure,
determinations of population for constitutional home rule cities are
based on estimates of population contained in the Bureau of the Census
publication, ``Current Population Reports, Series P-26: Local Population
Estimates''.
(iii) Effect of apportionments to constitutional home rule cities on
apportionments to other housing credit agencies. The aggregate amounts
of the State housing credit ceiling apportioned to constitutional home
rule cities under this paragraph (c)(3) reduce the State housing credit
ceiling available for apportionment under paragraph (c) (2) or (4) of
this section. Unless otherwise provided in a State constitutional
amendment or by law changing the home rule provisions adopted in a
manner provided by the State constitution, the power of the governor or
State legislature to apportion the State housing credit ceiling among
local housing credit agencies under paragraph (c)(4) of this section
shall not be construed as allowing any reduction of the portion of the
State housing credit ceiling apportioned to a constitutional home rule
city under this paragraph (c)(3). However, any constitutional home rule
city may agree to a reduction in its apportionment of the State housing
credit ceiling under this paragraph (c)(3), in which case the amount of
the State housing credit ceiling not apportioned to the constitutional
home rule city shall be available for apportionment under paragraph (c)
(2) or (4) of this section.
(iv) Treatment of governmental authority within constitutional home
rule city. For purposes of determining which agency within a
constitutional home rule city receives the apportionment of the State
housing credit ceiling under this paragraph (c)(3), the rules of this
paragraph (c) shall be applied by treating the constitutional home rule
city as a ``State'', the chief executive officer of a constitutional
home rule city as a ``governor'', and a city council as
[[Page 117]]
a ``State legislature''. A constitutional home rule city is also treated
as a ``State'' for purposes of the set-aside requirement for housing
credit allocations to projects involving a qualified nonprofit
organization. See paragraph (c)(5) of this section for rules governing
set-aside requirements. In this connection, a constitutional home rule
city may agree with the State housing credit agency to exchange an
apportionment set aside for projects involving a qualified nonprofit
organization for an apportionment that is not so restricted. In such a
case, the authorizing gubernatorial act, State statute, or State housing
credit agency regulation (if authorized by gubernatorial act or State
statute) must ensure that the set-aside apportionment transferred to the
State housing credit agency be used for the purposes described in
paragraph (c)(5) of this section.
(4) Apportionment to local housing credit agencies--(i) In general.
In lieu of the primary apportionment under paragraph (c)(2) of this
section, all or a portion of the State housing credit ceiling may be
apportioned among housing credit agencies of governmental subdivisions.
Apportionments of the State housing credit ceiling to local housing
credit agencies must be made pursuant to a State enabling act as defined
in paragraph (c)(1) of this section. Apportionments of the State housing
credit ceiling may be made to housing credit agencies of constitutional
home rule cities under this paragraph (c)(4), in addition to
apportionments made under paragraph (c)(3) of this section.
Apportionments of the State housing credit ceiling under this paragraph
(c)(4) need not be based on the population of political subdivisions and
may, but are not required to, give balanced consideration to the low-
income housing needs of the entire State.
(ii) Change in apportionments during a calendar year. The
apportionment of the State housing credit ceiling among State and local
housing credit agencies under this paragraph (c)(4) may be changed after
the beginning of a calendar year, pursuant to a State enabling act. No
change in apportionments shall retroactively reduce the housing credit
allocations made by any agency during such year. Any change in the
apportionment of the State housing credit ceiling under this paragraph
(c)(4) that occurs during a calendar year is effective only to the
extent housing credit agencies have not previously made housing credit
allocations during such year from their original apportionments of the
State housing credit ceiling for such year. To the extent apportionments
of the State housing credit ceiling to local housing credit agencies
made pursuant to this paragraph (c)(4) for any calendar year are not
used by such local agencies before a certain date (e.g., November 1) to
make housing credit allocations in such year, the amount of unused
apportionments may revert back to the State housing credit agency for
reapportionment. Such reversion must be specifically authorized by the
State enabling act.
(iii) Exchanges of apportionments. Any State or local housing credit
agency that receives an apportionment of the State housing credit
ceiling for any calendar year under this paragraph (c)(4) may exchange
part or all of such apportionment with another State or local housing
credit agency to the extent no housing credit allocations have been made
in such year from the exchanged portions. Such exchanges must be made
with another housing credit agency in the same State and must be
consistent with the State enabling act. If an apportionment set aside
for projects involving a qualified nonprofit organization is transferred
or exchanged, the transferee housing credit agency shall be required to
use the set-aside apportionment for the purposes described in paragraph
(c)(5) of this section.
(iv) Written records of apportionments. All apportionments,
exchanges of apportionments, and reapportionments of the State housing
credit ceiling which are authorized by this paragraph (c)(4) must be
evidenced in the written records maintained by each State and local
housing credit agency.
(5) Set-aside apportionments for projects involving a qualified
nonprofit organization--(i) In general. Ten percent of the State housing
credit ceiling for a calendar year must be set aside exclusively for
projects involving a qualified nonprofit organization (as defined in
[[Page 118]]
paragraph (c)(5)(ii) of this section). Thus, at least 10 percent of
apportionments of the State housing credit ceiling under paragraphs (c)
(2) and (3) of this section must be used only to make housing credit
allocations to buildings that are part of projects involving a qualified
nonprofit organization. In the case of apportionments of the State
housing credit ceiling under paragraph (c)(4) of this section, the State
enabling act must ensure that the apportionment of at least 10 percent
of the State housing credit ceiling be used exclusively to make housing
credit allocations to buildings that are part of projects involving a
qualified nonprofit organization. The State enabling act shall prescribe
which housing credit agencies in the State receive apportionments that
must be set aside for making housing credit allocations to buildings
that are part of projects involving a qualified nonprofit organization.
These set-aside apportionments may be distributed disproportionately
among the State or local housing credit agencies receiving
apportionments under paragraph (c)(4) of this section. The 10-percent
set-aside requirement of this paragraph (c)(4) is a minimum requirement,
and the State enabling act may set aside more than 10 percent of the
State housing credit ceiling for apportionment to housing credit
agencies for exclusive use in making housing credit allocations to
buildings that are part of projects involving a qualified nonprofit
organization.
(ii) Projects involving a qualified nonprofit organization. The term
``projects involving a qualified nonprofit organization'' means projects
with respect to which a qualified nonprofit organization is to
materially participate (within the meaning of section 469(h)) in the
development and continuing operation of the project throughout the 15-
year compliance period. The term ``qualified nonprofit organization''
means any organization that is described in section 501(c) (3) or (4),
is exempt from tax under section 501(a), and includes as one of its
exempt purposes the fostering of low-income housing.
(6) Expiration of unused apportionments. Apportionments of the State
housing credit ceiling under this paragraph (c) for any calendar year
may be used by housing credit agencies to make housing credit
allocations only in such calendar year. Any part of an apportionment of
the State housing credit ceiling for any calendar year that is not used
for housing credit allocations in such year expires as of the end of
such year and does not carry over to any other year. However, any part
of an apportionment for 1989 that is not used to make a housing credit
allocation in 1989 may be carried over to 1990 and used to make a
housing credit allocation to a qualified low-income building described
in section 42(n)(2)(B). See paragraph (g)(2) of this section.
(d) Housing credit allocations made by State and local housing
credit agencies--(1) In general. This paragraph governs State and local
housing credit agencies in making housing credit allocations to
qualified low-income buildings. The amount of the apportionment of the
State housing credit ceiling for any calendar year received by any State
or local housing credit agency under paragraph (c) of this section
constitutes the agency's aggregate housing credit dollar amount for such
year. The aggregate amount of housing credit allocations made in any
calendar year by a State or local housing credit agency may not exceed
such agency's aggregate housing credit dollar amount for such year. A
State or local housing credit agency may make housing credit allocations
only to qualified low-income buildings located within the agency's
geographic jurisdiction.
(2) Amount of a housing credit allocation. In making a housing
credit allocation, a State or local housing credit agency must specify a
credit percentage, not to exceed the building's applicable percentage
determined under section 42(b), and a qualified basis amount. The amount
of the housing credit allocation for any building is the product of the
specified credit percentage and the specified qualified basis amount. In
specifying the credit percentage and qualified basis amount, the State
or local housing credit agency shall not take account of the first-year
conventions described in section 42(f) (2)(A) and (3)(B). A State or
local housing credit agency may adopt rules or regulations governing
conditions for
[[Page 119]]
specification of less than the maximum credit percentage and qualified
basis amount allowable under section 42 (b) and (c), respectively. For
example, an agency may specify a credit percentage and a qualified basis
amount of less than the maximum credit percentage and qualified basis
amount allowable under section 42 (b) and (c), respectively, when the
financing and rental assistance from all sources for the project of
which the building is a part is sufficient to provide the continuing
operation of the building without the maximum credit amount allowable
under section 42.
(3) Counting housing credit allocations against an agency's
aggregate housing credit dollar amount. The aggregate amount of housing
credit allocations made in any calendar year by a State or local housing
credit agency may not exceed such agency's aggregate housing credit
dollar amount (i.e., the agency's apportionment of the State housing
credit ceiling for such year). This limitation on the aggregate dollar
amount of housing credit allocations shall be computed separately for
set-aside apportionments received pursuant to paragraph (c)(5) of this
section. Housing credit allocations count against an agency's aggregate
housing credit dollar amount without regard to the amount of credit
allowable to or claimed by an owner of a building in the taxable year in
which the allocation is made or in any subsequent year. Thus, housing
credit allocations (which are computed without regard to the first-year
conventions as provided in paragraph (d)(2) of this section) count in
full against an agency's aggregate housing credit dollar amount, even
though the first-year conventions described in section 42(f) (2)(A) and
(3)(B) may reduce the amount of credit claimed by a taxpayer in the
first year in which a credit is allowable. See also paragraph (e)(2) of
this section. Housing credit allocations count against an agency's
aggregate housing credit dollar amount only in the calendar year in
which made and not in subsequent taxable years in the credit period or
compliance period during which a taxpayer may claim a credit based on
the original housing credit allocation. Since the aggregate amount of
housing credit allocations made in any calendar year by a State or local
housing credit agency may not exceed such agency's aggregate housing
credit dollar amount, an agency shall at all times during a calendar
year maintain a record of its cumulative allocations made during such
year and its remaining unused aggregate housing credit dollar amount.
(4) Rules for when applications for housing credit allocations
exceed an agency's aggregate housing credit dollar amount. A State or
local housing credit agency may adopt rules or regulations governing the
awarding of housing credit allocations when an agency expects that
applicants during a calendar year will seek aggregate allocations in
excess of the agency's aggregate housing credit dollar amount. The State
enabling act may provide uniform standards for the awarding of housing
credit allocations when there is actual or anticipated excess demand
from applicants in any calendar year.
(5) Reduced or additional housing credit allocations--(i) In
general. A State or local housing credit agency may not reduce or
rescind a housing credit allocation made to a qualified low-income
building in the manner prescribed in paragraph (d)(8) of this section.
Thus, a housing credit agency may not reduce or rescind a housing credit
allocation made to a qualified low-income building which is acquired by
a new owner who is entitled to a carryover of the allowable credit for
such building under section 42(d)(7). A housing credit agency may make
additional housing credit allocations to a building in any year in the
building's compliance period, whether or not there are additions to
qualified basis for which an increased credit is allowable under section
42(f)(3). Each additional housing credit allocation made to a building
is treated as a separate allocation and is subject to the rules and
requirements of this section. However, in the case of an additional
housing credit allocation made with respect to additions to qualified
basis for which an increased credit is allowable under section 42(f)(3),
the amount of the allocation that counts against the agency's aggregate
housing credit dollar amount shall be computed as if the specified
credit
[[Page 120]]
percentage were unreduced in the manner prescribed in section
42(f)(3)(A) and the specified qualified basis amount were unreduced by
the first-year convention prescribed in section 42(f)(3)(B).
(ii) Examples. The rules of paragraph (d)(5)(i) of this section may
be illustrated by the following examples:
Example 1. For 1987, the County L Housing Credit Agency has an
aggregate housing credit dollar amount of $2 million. D, an individual,
places in service on July 1, 1987, a new qualified low-income building.
As of the close of each month in 1987 in which the building is in
service, the building consists of 100 residential rental units, of which
20 units are both rent-restricted and occupied by individuals whose
income is 50 percent or less of area median gross income. The total
floor space of the residential rental units is 120,000 square feet, and
the total floor space of the low-income units is 20,000 square feet. Tne
building is not Federally subsidized within the meaning of section
42(i)(2). As of the end of 1987, the building has eligible basis under
section 42(d) of $1 million. Thus, the qualified basis of the building
determined without regard to the first-year convention provided in
section 42(f) is $166,666.67 (i.e., $1 million eligible basis times \1/
6\, the floor space fraction which is required to be used instead of the
larger unit fraction). However, the amount of the low-income housing
credit determined for 1987 under section 42 reflects the first-year
convention provided in section 42(f)(2). Since the building has the same
floor space and unit fractions as of the close of each of the six months
in 1987 during which it is in service, upon applying the first-year
convention in section 42(f)(2), the qualified basis of the building in
1987 is $83,333.33 (i.e., $1 million eligible basis times \1/12\, the
fraction determined under section 42(f)(2)(A)). Under paragraph (d)(2)
of this section, the County L Housing Credit Agency may make a housing
credit allocation by specifying a credit percentage, not to exceed 9
percent, and a qualified basis amount, which may be greater or less than
the qualified basis of the building in 1987 as determined under section
42(c), without regard to the first-year convention provided in section
42(f)(2). If the County L Housing Credit Agency specifies a credit
percentage of 8 percent and a qualified basis amount of $100,000, the
amount of the housing credit allocation is $8,000. Under paragraph
(d)(3) of this section, the County L Housing Credit Agency's aggregate
housing credit dollar amount for 1987 is reduced by $8,000,
notwithstanding that D is entitled to claim less than $8,000 of the
credit in 1987 under the rules in paragraph (e) of this section. Under
paragraph (e)(2) of this section, in 1987 D is entitled to claim only
$4,000 of the credit, determined by applying the first-year convention
of \6/12\ to the specified qualified basis amount contained in the
housing credit allocation (i.e., .08 x $100,000 x (\6/12\)).
Example 2. The facts are the same as in Example 1 except that on
July 1, 1988, the number of occupied low-income units increases to 50
units and the floor space of the occupied low-income units increases to
48,000 square feet. These occupancy fractions remain unchanged as of the
close of each month remaining in 1988. Under section 42(c), the
qualified basis of the building in 1988, without regard to the first-
year convention in section 42(f)(3)(B), is $400,000 (i.e., $1 million
eligible basis times .4, the floor space fraction which is required to
be used instead of the larger unit fraction). D's 1987 housing credit
allocation from the County L Housing Credit Agency remains effective in
1988 and entitles D to a credit of $8,000 (i.e., .08, the specified
credit percentage, times $100,000, the specified qualified basis
amount). With respect to the additional $300,000 of qualified basis
which the 1987 housing credit allocation does not cover, D must apply to
the County L Housing Credit Agency for an additional housing credit
allocation. Assume that the County L Housing Credit Agency has a
sufficient aggregate housing credit dollar amount for 1988 to make a
housing credit allocation to D in 1988 by specifying a credit percentage
of 9 percent and a qualified basis amount of $300,000. The amount of the
housing credit allocation that counts against the County L Housing
Credit Agency's aggregate housing credit dollar amount is $27,000 (i.e.,
the amount counted (.09 times $300,000) is unreduced in the manner
prescribed in section 42(f)(3) (A) and (B)). Since D's qualified basis
in 1987 was $166,666.67, D is entitled to claim a credit in 1988 with
respect to such basis of $14,000 (i.e., .08 x $100,000, the 1987 credit
alllocation, +.09 x $66,666.67, the 1988 credit allocation). In
addition, D is entitled to claim a credit in 1988 and subsequent years
in the 15-year compliance period with respect to the additional
$233,333.33 of qualified basis covered by the 1988 housing credit
allocation. However, the allowable credit for 1988 with respect to this
amount of additional qualified basis is subject to reductions prescribed
in section 42(f)(3) (A) and (B). Thus, D is entitled in 1988 to a credit
at a 6-percent rate applied to $116,666.67 of additional qualified
basis, which is reduced to reflect the first-year convention. D's total
allowable low-income housing credit in 1988 is $21,000 (i.e., $14,000
with respect to original qualified basis + $7,000 with respect to 1988
additions to qualified basis). If the County L Housing Credit Agency had
specified an 8-percent credit percentage in 1988 with respect to the
qualified basis not covered by the 1987 housing credit allocation to D,
D's allowable
[[Page 121]]
credit with respect to the $233,333.33 of additions to qualified basis
would not exceed, in 1988 and subsequent years, an amount determined by
applying a specified credit percentage of 5.33 percent (i.e., two-thirds
of 8 percent). In 1988, D's specified qualified basis amount would be
adjusted for the first-year convention.
(6) No carryover of unused aggregate housing credit dollar amount.
Any portion of a State or local housing credit agency's aggregate
housing credit dollar amount for any calendar year that is not used to
make a housing credit allocation in such year may not be carried over to
any other year, except as provided in paragraph (g) of this section. An
agency may not permit owners of qualified low-income buildings to
transfer housing credit allocations to other buildings. However, an
agency may provide a procedure whereby owners may return to the agency,
prior to the end of the calendar year in which housing credit
allocations are made, unusable portions of such allocations. In such a
case, an owner's housing credit allocation is deemed reduced by the
amount of the allocation returned to the agency, and the agency may
reallocate such amount to other qualified low-income buildings prior to
the end of the year.
(7) Effect of housing credit allocations in excess of an agency's
aggregate housing credit dollar amount. In the event that a State or
local housing credit agency makes housing credit allocations in excess
of its aggregate housing credit dollar amount for any calendar year, the
allocations shall be deemed reduced (to the extent of such excess) for
buildings in the reverse order in which such allocations were made
during such year.
(8) Time and manner for making housing credit allocations--(i) Time.
Housing credit allocations are effective for the calendar year in which
made in the manner prescribed in paragraph (d)(8)(ii) of this section. A
State or local housing credit agency may not make a housing credit
allocation to a qualified low-income building prior to the calendar year
in which such building is placed in service. An agency may adopt its own
procedures for receiving applications for housing credit allocations
from owners of qualified low-income buildings. An agency may provide a
procedure for making, in advance of a building's being placed in
service, a binding commitment (e.g., by contract, inducement,
resolution, or other means) to make a housing credit allocation in the
calendar year in which a qualified low-income building is placed in
service or in a subsequent calendar year. Any advance commitment shall
not constitute a housing credit allocation for purposes of this section.
(ii) Manner. Housing credit allocations are deemed made when part I
of IRS Form 8609, Low-Income Housing Credit Allocation Certification, is
completed and signed by an authorized official of the housing credit
agency and mailed to the owner of the qualified low-income building. A
copy of all completed (as to part I) Form 8609 allocations along with a
single completed Form 8610, Annual Low-Income Housing Credit Agencies
Report, must also be mailed to the Internal Revenue Service not later
than the 28th day of the second calendar month after the close of the
calendar year in which the housing credit was allocated to the qualified
low-income building. Housing credit allocations to a qualified low-
income building must be made on Form 8609 and must include--
(A) The address of the building;
(B) The name, address, and taxpayer identification number of the
housing credit agency making the housing credit allocation;
(C) The name, address, and taxpayer identification number of the
owner of the qualified low-income building;
(D) The date of the allocation of housing credit;
(E) The housing credit dollar amount allocated to the building on
such date;
(F) The specified maximum applicable credit percentage allocated to
the building on such date;
(G) The specified maximum qualified basis amount;
(H) The percentage of the aggregate basis financed by tax-exempt
bonds taken into account for purposes of the volume cap under section
146;
(I) A certification under penalties of perjury by an authorized
State or local housing credit agency official that the allocation is
made in compliance with the requirements of section 42(h); and
[[Page 122]]
(J) Any additional information that may be required by Form 8609 or
by an applicable revenue procedure.
See paragraph (h) of this section for additional rules concerning filing
of forms.
(iii) Certification. The certifying official for the State or local
housing credit agency need not perform an independent investigation of
the qualified low-income building in order to certify on part I of Form
8609 that the housing credit allocation meets the requirements of
section 42(h). For example, the certifying official may rely on
information contained in an application for a low-income housing credit
allocation submitted by the building owner which sets forth facts
necessary to determine that the building is eligible for the low-income
housing credit under section 42.
(iv) Fee. A State or local housing credit agency may charge building
owners applying for housing credit allocations a reasonable fee to cover
the agency's administrative expenses for processing applications.
(v) No continuing agency responsibility. The State or local housing
credit agency need not monitor or investigate the continued compliance
of a qualified low-income building with the requirements of section 42
throughout the applicable compliance period.
(e) Housing credit allocation taken into account by owner of a
qualified low-income building--(1) Time and manner for taking housing
credit allocation into account. An owner of a qualified low-income
building may not claim a low-income housing credit determined under
section 42 in any year in excess of an effective housing credit
allocation received from a State or local housing credit agency. A
housing credit allocation made to a qualified low-income building is
effective with respect to any owner of the building beginning with the
owner's taxable year in which the housing credit allocation is received.
A housing credit allocation is deemed received in a taxable year, except
as modified in the succeeding sentence, if that allocation is made (in
the manner described in paragraph (d)(8) of this section) not later than
the earlier of (i) the 60th day after the close of the taxable year, or
(ii) the close of the calendar year in which such taxable year ends. A
housing credit allocation is deemed received in a taxable year ending in
1987, if such allocation is made (in the manner described in paragraph
(d)(8) of this section) on or before December 31, 1987. A housing credit
allocation is not effective for any taxable year if received in a
calendar year which ends prior to when the qualified low-income building
is placed in service. A housing credit allocation made to a qualified
low-income building remains effective for all taxable years in the
compliance period. A taxpayer is required to complete the Form 8609 on
which a housing credit agency made the applicable housing credit
allocation and submit a copy of such Form 8609 with its Federal income
tax return for each year in the compliance period. Failure to comply
with the requirement of the preceding sentence with respect to any
taxable year after the first taxable year in the credit period shall be
treated as a mathematical or clerical error for purposes of the
provisions of section 6213 (b)(1) and (g)(2).
(2) First-year convention limitation on housing credit allocation
taken into account. For purposes of the limitation that the allowable
low-income housing credit may not exceed the effective housing credit
allocation received from a State or local housing credit agency, as
provided in paragraph (e)(1) of this section, the amount of the
effective housing credit allocation shall be adjusted by applying the
first-year convention provided in section 42(f)(2)(A) and (3)(B) and the
percentage credit reduction provided in section 42(f)(3)(A). Under
paragraphs (d) (2) and (5) of this section, the State or local housing
credit agency must specify the credit percentage and qualified basis
amount, the product of which is the amount of the housing credit
allocation, without taking account of the first-year convention
described in section 42(f)(2)(A) and (3)(B) or the percentage credit
reduction prescribed in section 42(f)(3)(A). However, for purposes of
the limitation on the amount of the allowable low-income housing credit,
as provided in paragraph (e)(1) of this section, in a taxable year in
which the first-year convention applies to the
[[Page 123]]
amount of credit determined under section 42(a), the specified qualified
basis amount shall be adjusted by the first-year convention fraction
which is equal to the number of full months (during the first taxable
year) in which the building was in service divided by 12. In addition,
for purposes of the limitation on the amount of the allowable low-income
housing credit, as provided in paragraph (e)(1) of this section, in a
taxable year in which the reduction in credit percentage applies to
additions to qualified basis, as prescribed in section 42(f)(3), the
specified credit percentage shall be reduced by one-third. See examples
in paragraphs (d)(5)(ii) and (e)(3)(ii) of this section.
(3) Use of excess housing credit allocation for increases in
qualified basis--(i) In general. If the housing credit allocation made
to a qualified low-income building exceeds the amount of credit
allowable with respect to such building in any taxable year (without
regard to the first-year conventions under section 42(f)), such excess
is not transferable to another qualified low-income building. However,
if in a subsequent year there are increases in the qualified basis for
which an increased credit is allowable under section 42(f)(3) at a
reduced credit percentage, the original housing credit allocation
(including the specified credit percentage and qualified basis amount)
would be effective with respect to such increased credit.
(ii) Example. The provisions of this paragraph (e)(3) may be
illustrated by the following example:
Example. In 1987, a newly-constructed qualified low-income building
receives a housing credit allocation of $90,000 based on a specified
credit percentage of 9 percent and a specified qualified basis amount of
$1,000,000. The building is placed in service in 1987, but the qualified
basis in such year is only $800,000, resulting in an allowable credit in
1987 (determined without regard to the first-year conventions) of
$72,000. In 1988, the qualified basis is increased to $1,100,000,
resulting in an additional credit allowable under section 42(f)(3)
(without regard to the first-year conventions) of $18,000 (i.e.,
$300,000 x .06, or \2/3\ of .09). The unused portion of the 1987
housing credit allocation ($18,000) is effective in 1988 and in each
subsequent year in the compliance period only with respect to the
specified qualified basis for the 1987 housing credit allocation
($1,000,000). Thus, the owner is allowed to claim a credit in 1988 and
in each subsequent year (without regard to the first-year conventions),
based on the effective housing credit allocation from 1987, of $84,000
(i.e., $72,000 + ($200,000 x .06)). The owner of the qualified low-
income building must obtain a new housing credit allocation in 1988 with
respect to the additional $100,000 of qualified basis in order to claim
a credit on such basis in 1988 and in each subsequent year. If the
applicable first-year convention under section 42(f)(3)(B) entitled the
owner in 1988 to only \1/2\ of the otherwise applicable credit for the
additions to qualified basis, under paragraph (e)(2) of this section the
owner is allowed to claim a credit in 1988, based on the effective
housing credit allocation from 1987, of $78,000 (i.e., $72,000 +
($200,000 x .06 x .5)).
(4) Separate housing credit allocations for new buildings and
increases in qualified basis. Separate housing credit allocations must
be received for each building with respect to which a housing credit may
be claimed. Rehabilitation expenditures with respect to a qualified low-
income building are treated as a separate new building under section
42(e) and must receive a separate housing credit allocation. Increases
in qualified basis in a qualified low-income building are not generally
treated as a new building for purposes of section 42. To the extent that
a prior housing credit allocation received with respect to a qualified
low-income building does not allow an increased credit with respect to
an increase in the qualified basis of such building, an additional
housing credit allocation must be received in order to claim a credit
with respect to that portion of increase in qualified basis. See
paragraph (e)(3) of this section. The amount of credit allowable with
respect to an increase in qualified basis is subject to the credit
percentage limitation of section 42(f)(3)(A) and the first-year
convention of section 42(f)(3)(B). See paragraph (d)(5) of this section
for a rule requiring that the State or local housing credit agency count
a housing credit allocation made with respect to an increase in
qualified basis as if the specified credit percentage were unreduced in
the manner prescribed in section 42(f)(3) and the specified basis amount
were unreduced by the first-year convention prescribed in section
42(f)(3)(B).
[[Page 124]]
(5) Acquisition of building for which a prior housing credit
allocation has been made. If a carryover credit would be allowable to an
acquirer of a qualified low-income building under section 42(d)(7), such
acquirer need not obtain a new housing credit allocation with respect to
such building. Under section 42(d)(7), the acquirer would be entitled to
claim only such credits as would have been allowable to the prior owner
of the building.
(6) Multiple housing credit allocations. A qualified low-income
building may receive multiple housing credit allocations from different
housing credit agencies having overlapping jurisdictions. A qualified
low-income building that receives a housing credit allocation set aside
exclusively for projects involving a qualified nonprofit organization
may also receive a housing credit allocation from a housing credit
agency's aggregate housing credit dollar amount that is not so set
aside.
(f) Exception to housing credit allocation requirement--(1) Tax-
exempt bond financing--(i) In general. No housing credit allocation is
required in order to claim a credit under section 42 with respect to
that portion of the eligible basis (as defined in section 42(d)) of a
qualified low-income building that is financed with the proceeds of an
obligation described in section 103(a) (``tax-exempt bond'') which is
taken into account for purposes of the volume cap under section 146. In
addition, no housing credit allocation is required in order to claim a
credit under section 42 with respect to the entire qualified basis (as
defined in section 42(c)) of a qualified low-income building if 70
percent or more of the aggregate basis of the building and the land on
which the building is located is financed with the proceeds of tax-
exempt bonds which are taken into account for purposes of the volume cap
under section 146. For purposes of this paragraph, ``land on which the
building is located'' includes only land that is functionally related
and subordinate to the qualified low-income building. See Sec. 1.103-
8(b)(4)(iii) for the meaning of the term ``functionally related and
subordinate''. For purposes of this paragraph, the basis of the land
shall be determined using principles that are consistent with the rules
contained in section 42(d).
(ii) Determining use of bond proceeds. For purposes of determining
the portion of proceeds of an issue of tax-exempt bonds used to finance
(A) the eligible basis of a qualified low-income building, and (B) the
aggregate basis of the building and the land on which the building is
located, the proceeds of the issue must be allocated in the bond
indenture or a related document (as defined in Sec. 1.103-13(b)(8)) in a
manner consistent with the method used to allocate the net proceeds of
the issue for purposes of determining whether 95 percent or more of the
net proceeds of the issue are to be used for the exempt purpose of the
issue. If the issuer is not consistent in making this allocation
throughout the bond indenture and related documents, or if neither the
bond indenture nor a related document provides an allocation, the
proceeds of the issue will be allocated on a pro rata basis to all of
the property financed by the issue, based on the relative cost of the
property.
(iii) Example. The provisions of this paragraph may be illustrated
by the following example:
Example. In 1987, County K assigns $500,000 of its volume cap for
private activity bonds under section 146 to a $500,000 issue of exempt
facility bonds to provide a qualified residential rental project to be
owned by A, an individual. The aggregate basis of the building and the
land on which the building is located is $700,000. Under the terms of
the bond indenture, the net proceeds of the issue are to be used to
finance $490,000 of the eligible basis of the building. More than 70
percent of the aggregate basis of the qualified low-income building and
the land on which the building is located is financed with the proceeds
of tax-exempt bonds to which a portion of the volume cap under section
146 was allocated. Accordingly, A may claim a credit under section 42
without regard to whether any housing credit dollar amount was allocated
to that building. If, instead, the aggregate basis of the building and
land were $800,000, A would be able to claim the credit under section 42
without receiving a housing credit allocation for the building only to
the extent that the credit was attributable to eligible basis of the
building financed with tax-exempt bonds.
(g) Termination of authority to make housing credit allocation--(1)
In general. No State or local housing credit agency
[[Page 125]]
shall receive an apportionment of a State housing credit ceiling for
calendar years after 1989. Consequently, no housing credit allocations
may be made after 1989, except as provided in paragraph (g)(2) of this
section. Housing credit allocations made prior to January 1, 1990,
remain effective after such date.
(2) Carryover of unused 1989 apportionment. Any State or local
housing credit agency that has an unused portion of its apportionment of
the State housing credit ceiling for 1989 from which housing credit
allocations have not been made in 1989 may carry over such unused
portion into 1990. Such carryover portion of the 1989 apportionment
shall be treated as the agency's apportionment for 1990. From this 1990
apportionment, the State or local housing credit agency may make housing
credit allocations only to a qualified low-income building meeting the
following requirements:
(i) The building must be constructed, reconstructed, or
rehabilitated by the taxpayer seeking the allocation;
(ii) More than 10 percent of the reasonably anticipated cost of such
construction, reconstruction, or rehabilitation must have been incurred
as of January 1, 1989; and
(iii) The building must be placed in service before January 1, 1991.
(3) Expiration of exception for tax-exempt bond financed projects.
The exception to the requirement that a housing credit allocation be
received with respect to any portion of the eligible basis of a
qualified low-income building, as provided in paragraph (f) of this
section, shall not apply to any building placed in service after 1989,
unless such building is described in paragraphs (g)(2) (i), (ii), and
(iii) of this section.
(h) Filing of forms and special rules--(1) Completed form. For
purposes of this section, a form shall be treated as completed if the
State or local housing credit agency or the building owner has made a
good faith effort to complete the form in accordance with the form and
the instructions for the form.
(2) Manner of filing. A completed Form 8586, Low-Income Housing
Credit, shall be filed with the owner's Federal income tax return for
each taxable year the owner of a qualified low-income building is
claiming the low-income housing credit during the 10-year credit period.
A completed Form 8609 (or copy thereof) shall be filed with the owner's
Federal income tax return for each of the 15 taxable years in the
compliance period. If a housing credit allocation is not required to be
received by an owner under paragraph (f) of this section, the owner
shall obtain a blank copy of Form 8609 and fill in the address of the
building and the name and address of the owner in part I. Part II of
Form 8609 shall be completed by the owner of the qualified low-income
building only for the first year the low-income housing credit is
claimed by the building owner. Part III of Form 8609 (Statement of
Qualification) shall be completed by the owner of the qualified low-
income building for each year of the 15-year compliance period.
(3) Revised or renumbered forms. If any form is revised or
renumbered, any reference in this section to the form shall be treated
as a reference to the revised or renumbered form.
(i) Transitional rules. The transitional rules contained in section
252(f)(1) of the Tax Reform Act of 1986 are incorporated into this
section of the regulations for purposes of determining whether a
qualified low-income building is entitled to receive a housing credit
allocation or is excepted from the requirement that a housing credit
allocation be received. Housing credit allocations made to qualified
low-income buildings described in section 252(f)(1) shall not count
against the State or local housing credit agency's aggregate housing
credit dollar amount. The transitional rules contained in section
252(f)(2) of the Tax Reform Act of 1986 are incorporated into this
section of the regulations for purposes of determining amounts available
to certain State or local housing credit agencies for the making of
housing credit allocations to certain qualified low-income housing
projects. Amounts available to housing credit agencies under section
252(f)(2) shall be treated as special apportionments unavailable for
housing credit allocations to qualified low-income buildings not
described in section 252(f)(2). Housing credit allocations made from the
special apportionments shall not count
[[Page 126]]
against the State or local credit agency's aggregate housing credit
dollar amount. The set-aside requirements shall not apply to these
special apportionments. The transitional rules contained in section
252(f)(3) of the Tax Reform Act 1986 are incorporated in this section of
the regulations for purposes of determining the amount of housing credit
allocations received by certain qualified low-income buildings. Housing
credit allocations deemed received under section 252(f)(3) shall not
count against the State or local housing credit agency's aggregate
housing credit dollar amount.
[T.D. 8144, 52 FR 23433, June 22, 1987; 52 FR 24583, July 1, 1987]
Sec. 1.42-2 Waiver of requirement that an existing building eligible for the low-income housing credit was last placed in service more than 10 years prior to
acquisition by the taxpayer.
(a) Low-income housing credit for existing building. Section 42
provides that, for purposes of section 38, new and existing qualified
low-income buildings are eligible for a low-income housing credit. The
eligibility rules for new and existing buildings differ. Under section
42(d)(2), an existing building may be eligible for the low-income
housing credit based upon the acquisition cost and amounts chargeable to
capital account (to the extent properly included in eligible basis) if--
(1) The taxpayer acquires the building by purchase (as defined in
section 179(d)(2), as applicable under section 42(d)(2)(D)(iii)(I)),
(2) There is a period of at least 10 years between the date of the
building's acquisition by the taxpayer and the later of--(i) The date
the building was last placed in service, or
(ii) The date of the most recent nonqualified substantial
improvement of the building, and
(3) The building was not previously placed in service by the
taxpayer, or by a person who was a related person (as defined in section
42(d)(2)(D)(iii)(II)) with respect to the taxpayer as of the time the
building was last previously placed in service.
(b) Waiver of 10-year holding period requirement. Section 42(d)(6)
provides that a taxpayer may apply for a waiver of the 10-year holding
period requirement specified in paragraph (a)(2) of this section. The
Internal Revenue Service will grant a waiver only if--
(1) The existing building satisfies all of the requirements in
paragraph (c) of this section, and
(2) The taxpayer makes an application in conformity with the
requirements in paragraph (d) of this section.
(c) Waiver requirements--(1) Federally-assisted building. To satisfy
the requirement of this paragraph, a building must be a Federally-
assisted building. The term ``Federally assisted building'' means any
building which is substantially assisted, financed, or operated under
section 8 of the United States Housing Act of 1937, section 221(d)(3) or
236 of the National Housing Act, or section 515 of the Housing Act of
1949, as such acts were in effect on October 22, 1986.
(2) Federal mortgage funds at risk. To satisfy the requirement of
this paragraph, Federal mortgage funds must be at risk with respect to a
mortgage that is secured by the building or a project of which the
building is a part. For purposes of this paragraph, Federal mortgage
funds are at risk if, in the event of a default by the mortgagor on the
mortgage secured by the building or the project of which the building is
a part--
(i) The mortgage could be assigned to the Department of Housing and
Urban Development or the Farmers' Home Administration, or
(ii) There could arise a claim against a Federal mortgage insurance
fund (or such Department or Administration).
(3) Statement by the Department of Housing and Urban Development or
the Farmers' Home Administration. (i) To satisfy the requirement of this
paragraph, a letter or other written statement must be made or received
and approved by the national office of the Department of Housing and
Urban Development or the Farmers' Home Administration (``the Federal
agency''). This letter or statement shall include the following:
(A) A statement that, as of the earlier of the time of the
taxpayer's acquisition of the building or the taxpayer's application for
a waiver, the building is
[[Page 127]]
a Federally-assisted building within the meaning of paragraph (c)(1) of
this section and identifies the source of Federal assistance;
(B) A statement that a waiver of the 10-year holding period
requirement is necessary to avert Federal mortgage funds being at risk
within the meaning of paragraph (c)(2) of this section; and
(C) A statement that the Federal agency has taken a Federal agency
action as described in paragraph (c)(3)(ii) of this section.
(ii) The following specified Federal agency actions shall be the
only means of satisfying the requirement of this paragraph:
(A) The Federal agency intends to accept an assignment of a mortgage
secured by the building or the project of which the building is a part,
and such assignment requires payments by the agency or a mortgage
insurance fund maintained by the agency to the prior mortgagee;
(B) The Federal agency or a mortgage insurance fund maintained by
the agency intends to accept, as a consequence of foreclosure
proceedings or otherwise, conveyance of the building or the project of
which the building is a part;
(C) The Federal agency or a mortgage insurance fund maintained by
the agency intends, as a consequence of default, to take possession of,
hold title to, or otherwise assume ownership of the building or the
project of which the building is a part; or
(D) The Federal agency has designated the building or the project of
which the building is a part as a troubled building or project. A
designation of a troubled building or project must satisfy the following
requirements:
(1) Designation of troubled status must be based on a review by the
Federal agency of the financial condition of the building or project and
on a determination by the Federal agency of a history of financial
distress or mortgage defaults;
(2) Designation of troubled status must be made or received and
approved by the national office of the Federal agency; and
(3) Federal agency regulations or procedures must provide that, in
the event of transfer of the ownership of a designated troubled building
or project, the building or project may be subject to continued review
by the Federal agency. Each Federal agency may prescribe its own
standards and procedures for designating a troubled building or project
so long as such standards are consistent with the requirements of this
paragraph (c)(3)(ii)(D).
(4) No prior credit allowed. The requirement of this paragraph is
satisfied only if no prior owner was allowed a low-income housing credit
under section 42 for the building.
(d) Application for waiver--(1) Time and manner. In order to receive
a waiver of the 10-year holding period requirement specified in
paragraph (a)(2) of this section, a taxpayer must file an application
(including the applicable user fee) that complies with the requirements
of this paragraph (d) and Rev. Proc. 90-1, 1990-1 I.R.B. 8 (or any
subsequent applicable revenue procedure). The application must be filed
by a taxpayer who has acquired the building by purchase or who has a
binding contract to purchase the building. Such binding contract may be
conditioned upon the granting of a waiver under this section. The
application may be filed at any time after a binding contract has been
entered into, but no later than 12 months after the taxpayer's
acquisition of the building. An application for a waiver of the 10-year
holding period requirement must not contain a request for a ruling on
any other issue arising under section 42 or other sections of the
Internal Revenue Code. An application for a waiver of the 10-year
holding period requirement must be mailed or delivered to the address
listed in section 3.01 of Rev. Proc. 90-1 (or any subsequent applicable
revenue procedure).
(2) Information required. An application for a waiver of the 10-year
holding period requirement must contain the following information:
(i) The taxpayer's name, address and taxpayer identification number;
(ii) The name (if any) and address of the acquired building and the
project (if any) of which it is a part;
(iii) The date of acquisition or the date of the binding contract
for acquisition of the building by the taxpayer and the expected date of
acquisition,
[[Page 128]]
the amount of consideration paid or to be paid for the acquisition
(including the value of any liabilities assumed by the taxpayer), and
the taxpayer's certification that such acquisition is by purchase (as
defined in section 179(d)(2), as applicable under section 42
(d)(2)(D)(iii)(I));
(iv) The identity of the person from whom the building is acquired,
and whether such person is a Federal agency, a mortgagee holding title
to the building, or the mortgagor or prior owner;
(v) The date the building was last placed in service and the date of
the most recent (if any) nonqualified substantial improvement of the
building (as defined in section 42 (d)(2)(D)(i));
(vi) The taxpayer's certification that the building was not
previously placed in service by the taxpayer, or by a person who was a
related person (as defined in section 42(d)(2)(D)(iii)(II)) with respect
to the taxpayer as of the time the building was last placed in service;
(vii) The amount and disposition (e.g., discharge, assignment,
assumption, or refinance) of the outstanding mortgage at the time of
acquisition and the identities of the mortgagee and mortgagor;
(viii) The taxpayer's certification that no prior owner was allowed
a low-income housing credit under section 42 for the building (made to
the best of the taxpayer's knowledge, with no documentation from other
persons needed to be submitted); and
(ix) The statement from the Federal agency required by paragraph
(c)(3)(i) of this section.
(3) Other rules. (i) In the event that an acquired building will be
owned by more than one taxpayer, a single application for waiver may be
filed by one taxpayer on behalf of the co-owners if the application
contains the names, addresses and taxpayer identification numbers of the
other owners. A general partner or a designated limited partner may file
an application for waiver on behalf of a partnership.
(ii) In the event that multiple Federally-assisted buildings in a
project are being acquired by the taxpayer, a single application for
waiver with respect to such buildings may be filed if the application
contains the required information set out for the address of each
Federally-assisted building involved.
(iii) In the event that specific Federally-assisted buildings are
being acquired by the taxpayer in a project consisting of multiple
buildings that may or may not be Federally-assisted, a single
application for waiver with respect to the Federally-assisted buildings
being acquired may be filed if the application contains the required
information set out for the address of each Federally-assisted building
being acquired.
(4) Effective date of waiver. A waiver will be effective when
granted in writing by the Internal Revenue Service after submission of a
completed application for waiver filed under this paragraph (d).
(5) Attachment to return. A waiver letter granted by the Internal
Revenue Service shall be filed with the taxpayer's Federal income tax
return for the first taxable year the low-income housing credit is
claimed by the taxpayer.
(e) Effective date of regulations. The provisions of Sec. 1.42-2 are
effective for buildings placed in service by the taxpayer after December
31, 1986.
[T.D. 8302, 55 FR 21189, May 23, 1990; 55 FR 25973, June 26, 1990]
Sec. 1.42-3 Treatment of buildings financed with proceeds from a loan under an Affordable Housing Program established pursuant to section 721 of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA).
(a) Treatment under sections 42(i) and 42(b). A below market loan
funded in whole or in part with funds from an Affordable Housing Program
established under section 721 of FIRREA is not, solely by reason of the
Affordable Housing Program funds, a below market Federal loan as defined
in section 42(i)(2)(D). Thus, any building with respect to which the
proceeds of the loan are used during the tax year is not, solely by
reason of the Affordable Housing Program funds, treated as a federally
subsidized building for that tax year and subsequent tax years for
purposes of determining the applicable percentage for the building under
section 42(b).
[[Page 129]]
(b) Effective date. The rules set forth in paragraph (a) of this
section are effective for loans made after August 8, 1989.
[56 FR 48734, Sept. 26, 1991]
Sec. 1.42-4 Application of not-for-profit rules of section 183 to low-income housing credit activities.
(a) Inapplicability to section 42. In the case of a qualified low-
income building with respect to which the low-income housing credit
under section 42 is allowable, section 183 does not apply to disallow
losses, deductions, or credits attributable to the ownership and
operation of the building.
(b) Limitation. Notwithstanding paragraph (a) of this section,
losses, deductions, or credits attributable to the ownership and
operation of a qualified low-income building with respect to which the
low-income housing credit under section 42 is allowable may be limited
or disallowed under other provisions of the Code or principles of tax
law. See, e.g., sections 38(c), 163(d), 465, 469; Knetsch v. United
States, 364 U.S. 361 (1960), 1961-1 C.B. 34 (``sham'' or ``economic
substance'' analysis); and Frank Lyon Co. v. Commissioner, 435 U.S. 561
(1978), 1978-1 C.B. 46 (``ownership'' analysis).
(c) Effective date. The rules set forth in paragraphs (a) and (b) of
this section are effective with respect to buildings placed in service
after December 31, 1986.
[T.D. 8420, 57 FR 24729, June 11, 1992]
Sec. 1.42-5 Monitoring compliance with low-income housing credit requirements.
(a) Compliance monitoring requirement--(1) In general. Under section
42(m)(1)(B)(iii), an allocation plan is not qualified unless it contains
a procedure that the State or local housing credit agency (``Agency'')
(or an agent of, or other private contractor hired by, the Agency) will
follow in monitoring for noncompliance with the provisions of section 42
and in notifying the Internal Revenue Service of any noncompliance of
which the Agency becomes aware. These regulations only address
compliance monitoring procedures required of Agencies. The regulations
do not address forms and other records that may be required by the
Service on examination or audit. For example, if a building is sold or
otherwise transferred by the owner, the transferee should obtain from
the transferor information related to the first year of the credit
period so that the transferee can substantiate credits claimed.
(2) Requirements for a monitoring procedure--(i) In general. A
procedure for monitoring for noncompliance under section
42(m)(1)(B)(iii) must include--
(A) The recordkeeping and record retention provisions of paragraph
(b) of this section;
(B) The certification and review provisions of paragraph (c) of this
section;
(C) The inspection provision of paragraph (d) of this section; and
(D) The notification-of-noncompliance provisions of paragraph (e) of
this section.
(ii) Order and form. A monitoring procedure will meet the
requirements of section 42 (m)(1)(B)(iii) if it contains the substance
of these provisions. The particular order and form of the provisions in
the allocation plan is not material. A monitoring procedure may contain
additional provisions or requirements.
(b) Recordkeeping and record retention provisions--(1) Recordkeeping
provision. Under the recordkeeping provision, the owner of a low-income
housing project must be required to keep records for each qualified low-
income building in the project that show for each year in the compliance
period--
(i) The total number of residential rental units in the building
(including the number of bedrooms and the size in square feet of each
residential rental unit);
(ii) The percentage of residential rental units in the building that
are low-income units;
(iii) The rent charged on each residential rental unit in the
building (including any utility allowances);
(iv) The number of occupants in each low-income unit, but only if
rent is determined by the number of occupants in each unit under section
42(g)(2) (as in effect before the amendments made by the Revenue
Reconciliation Act of 1989);
[[Page 130]]
(v) The low-income unit vacancies in the building and information
that shows when, and to whom, the next available units were rented;
(vi) The annual income certification of each low-income tenant per
unit. For an exception to this requirement, see section 42(g)(8)(B)
(which provides a special rule for a 100 percent low-income building);
(vii) Documentation to support each low-income tenant's income
certification (for example, a copy of the tenant's federal income tax
return, Forms W-2, or verifications of income from third parties such as
employers or state agencies paying unemployment compensation). For an
exception to this requirement, see section 42(g)(8)(B) (which provides a
special rule for a 100 percent low-income building). Tenant income is
calculated in a manner consistent with the determination of annual
income under section 8 of the United States Housing Act of 1937
(``Section 8''), not in accordance with the determination of gross
income for federal income tax liability. In the case of a tenant
receiving housing assistance payments under Section 8, the documentation
requirement of this paragraph (b)(1)(vii) is satisfied if the public
housing authority provides a statement to the building owner declaring
that the tenant's income does not exceed the applicable income limit
under section 42 (g);
(viii) The eligible basis and qualified basis of the building at the
end of the first year of the credit period; and
(ix) The character and use of the nonresidential portion of the
building included in the building's eligible basis under section 42 (d)
(e.g., tenant facilities that are available on a comparable basis to all
tenants and for which no separate fee is charged for use of the
facilities, or facilities reasonably required by the project).
(2) Record retention provision. Under the record retention
provision, the owner of a low-income housing project must be required to
retain the records described in paragraph (b)(1) of this section for at
least 6 years after the due date (with extensions) for filing the
federal income tax return for that year. The records for the first year
of the credit period, however, must be retained for at least 6 years
beyond the due date (with extensions) for filing the federal income tax
return for the last year of the compliance period of the building.
(c) Certification and review provisions--(1) Certification. Under
the certification provision, the owner of a low-income housing project
must be required to certify at least annually to the Agency that, for
the preceding 12-month period--
(i) The project met the requirements of:
(A) The 20-50 test under section 42 (g)(1)(A), the 40-60 test under
section 42 (g)(1)(B), or the 25-60 test under sections 42 (g)(4) and 142
(d)(6) for New York City, whichever minimum set-aside test was
applicable to the project; and
(B) If applicable to the project, the 15-40 test under sections
42(g)(4) and 142 (d)(4)(B) for ``deep rent skewed'' projects;
(ii) There was no change in the applicable fraction (as defined in
section 42(c)(1)(B)) of any building in the project, or that there was a
change, and a description of the change;
(iii) The owner has received an annual income certification from
each low-income tenant, and documentation to support that certification;
or, in the case of a tenant receiving Section 8 housing assistance
payments, the statement from a public housing authority described in
paragraph (b)(1)(vii) of this section. For an exception to this
requirement, see section 42(g)(8)(B) (which provides a special rule for
a 100 percent low-income building);
(iv) Each low-income unit in the project was rent-restricted under
section 42(g)(2);
(v) All units in the project were for use by the general public and
used on a nontransient basis (except for transitional housing for the
homeless provided under section 42 (i)(3)(B)(iii));
(vi) Each building in the project was suitable for occupancy, taking
into account local health, safety, and building codes;
(vii) There was no change in the eligible basis (as defined in
section 42(d)) of any building in the project, or if there was a change,
the nature of the
[[Page 131]]
change (e.g., a common area has become commercial space, or a fee is now
charged for a tenant facility formerly provided without charge);
(viii) All tenant facilities included in the eligible basis under
section 42(d) of any building in the project, such as swimming pools,
other recreational facilities, and parking areas, were provided on a
comparable basis without charge to all tenants in the building;
(ix) If a low-income unit in the project became vacant during the
year, that reasonable attempts were or are being made to rent that unit
or the next available unit of comparable or smaller size to tenants
having a qualifying income before any units in the project were or will
be rented to tenants not having a qualifying income;
(x) If the income of tenants of a low-income unit in the project
increased above the limit allowed in section 42(g)(2)(D)(ii), the next
available unit of comparable or smaller size in the project was or will
be rented to tenants having a qualifying income; and
(xi) An extended low-income housing commitment as described in
section 42(h)(6) was in effect (for buildings subject to section
7108(c)(1) of the Revenue Reconciliation Act of 1989).
(2) Review. The review provision must--
(i) Require that the Agency review the certifications submitted
under paragraph (c)(1) of this section for compliance with the
requirements of section 42;
(ii) Contain at least one of the following requirements:
(A) The owners of at least 50 percent of all low-income housing
projects in the Agency's jurisdiction must submit to the Agency for
compliance review a copy of the annual income certification, the
documentation the owner has received to support that certification, and
the rent record for each low-income tenant in at least 20 percent of the
low-income units in their projects;
(B) The Agency must inspect at least 20 percent of low-income
housing projects each year and must inspect the low-income
certification, the documentation the owner has received to support that
certification, and the rent record for each low-income tenant in at
least 20 percent of the low-income units in those projects; or
(C) The owners of all low-income housing projects must submit to the
Agency each year information on tenant income and rent for each low-
income unit, in the form and manner designated by the Agency, and the
owners of at least 20 percent of the projects must submit to the Agency
for compliance review a copy of the annual income certification, the
documentation the owner has received to support that certification, and
the rent record for each low-income tenant in at least 20 percent of the
low-income units in their projects; and
(iii) Require that the Agency determine which tenants' records are
to be inspected or submitted by the owners for review. If a monitoring
procedure includes the review provision described in paragraph
(c)(2)(ii)(B) of this section, the records to be inspected must be
chosen in a manner that will not give owners of low-income housing
projects advance notice that their records for a particular year will or
will not be inspected. However, an Agency may give an owner reasonable
notice that an inspection will occur so that the owner may assemble
records (for example, 30 days notice of inspection). See paragraph (d)
of this section for the inspection provision that is required to be
included in all monitoring procedures.
(3) Frequency and form of certification. A monitoring procedure must
require that the certifications and reviews of paragraph (c)(1) and (2)
of this section be made at least annually covering each year of the 15-
year compliance period under section 42(i)(1). The certifications must
be made under penalty of perjury. A monitoring procedure may require
certifications and reviews more frequently than on a 12-month basis,
provided that all months within each 12-month period are subject to
certification.
(4) Exception for certain buildings--(i) In general. The review
requirements under paragraph (c)(2)(ii) (A), (B), and (C) of this
section may provide that owners are not required to submit, and the
Agency is not required to review, the tenant income certifications,
supporting documentation, and rent
[[Page 132]]
records for buildings financed by the Farmers Home Administration (FmHA)
under the section 515 program, or buildings of which 50 percent or more
of the aggregate basis (taking into account the building and the land)
is financed with the proceeds of obligations the interest on which is
exempt from tax under section 103 (tax-exempt bonds). In order for a
monitoring procedure to except these buildings, the Agency must meet the
requirements of paragraph (c)(4)(ii) of this section.
(ii) Agreement and review. The Agency must enter into an agreement
with the FmHA or tax-exempt bond issuer. Under the agreement, the FmHA
or tax-exempt bond issuer must agree to provide information concerning
the income and rent of the tenants in the building to the Agency. The
Agency may assume the accuracy of the information provided by FmHA or
the tax-exempt bond issuer without verification. The Agency must review
the information and determine that the income limitation and rent
restriction of section 42 (g)(1) and (2) are met. However, if the
information provided by the FmHA or tax-exempt bond issuer is not
sufficient for the Agency to make this determination, the Agency must
request the necessary additional income or rent information from the
owner of the buildings. For example, because FmHA determines tenant
eligibility based on its definition of ``adjusted annual income,''
rather than ``annual income'' as defined under Section 8, the Agency may
have to calculate the tenant's income for section 42 purposes and may
need to request additional income information from the owner.
(iii) Example. The exception permitted under paragraph (c)(4)(i) and
(ii) of this section is illustrated by the following example.
Example. An Agency chooses the review requirement of paragraph
(c)(2)(ii)(A) of this section and some of the buildings selected for
review are buildings financed by the FmHA. The Agency has entered into
an agreement described in paragraph (c)(4)(ii) of this section with the
FmHA with respect to those buildings. In reviewing the FmHA-financed
buildings, the Agency obtains the tenant income and rent information
from the FmHA for 20 percent of the low-income units in each of those
buildings. The Agency calculates the tenant income and rent to determine
whether the tenants meet the income and rent limitation of section 42
(g)(1) and (2). In order to make this determination, the Agency may need
to request additional income or rent information from the owners of the
FmHA buildings if the information provided by the FmHA is not
sufficient.
(d) Inspection provision. Under the inspection provision, the Agency
must have the right to perform an on-site inspection of any low-income
housing project at least through the end of the compliance period of the
buildings in the project. The inspection provision of this paragraph (d)
is separate from any review of low-income certifications, supporting
documents, and rent records under paragraph (c)(2)(ii) of this section.
(e) Notification-of-noncompliance provision--(1) In general. Under
the notification-of-noncompliance provisions, the Agency must be
required to give the notice described in paragraph (e)(2) of this
section to the owner of a low-income housing project and the notice
described in paragraph (e)(3) of this section to the Service.
(2) Notice to owner. The Agency must be required to provide prompt
written notice to the owner of a low-income housing project if the
Agency does not receive the certification described in paragraph (c)(1)
of this section, or does not receive or is not permitted to inspect the
tenant income certifications, supporting documentation, and rent records
described in paragraph (c)(2)(ii)(A), (B), or (C) of this section
(whichever is applicable), or discovers by inspection, review, or in
some other manner, that the project is not in compliance with the
provisions of section 42.
(3) Notice to Internal Revenue Service--(i) In general. The Agency
must be required to file Form 8823, ``Low-Income Housing Credit Agencies
Report of Noncompliance,'' with the Service no later than 45 days after
the end of the correction period (as described in paragraph (e)(4) of
this section, including extensions permitted under that paragraph) and
no earlier than the end of the correction period, whether or not the
noncompliance or failure to certify is corrected. The Agency must
explain
[[Page 133]]
on Form 8823 the nature of the noncompliance or failure to certify and
indicate whether the owner has corrected the noncompliance or failure to
certify. Any change in either the applicable fraction or eligible basis
under paragraph (c)(1)(ii) and (vii) of this section, respectively, that
results in a decrease in the qualified basis of the project under
section 42 (c)(1)(A) is noncompliance that must be reported to the
Service under this paragraph (e)(3). If an Agency reports on Form 8823
that a building is entirely out of compliance and will not be in
compliance at any time in the future, the Agency need not file Form 8823
in subsequent years to report that building's noncompliance.
(ii) Agency retention of records. An Agency must retain records of
noncompliance or failure to certify for 6 years beyond the Agency's
filing of the respective Form 8823. In all other cases, the Agency must
retain the certifications and records described in paragraph (c) of this
section for 3 years from the end of the calendar year the Agency
receives the certifications and records.
(4) Correction period. The correction period shall be that period
specified in the monitoring procedure during which an owner must supply
any missing certifications and bring the project into compliance with
the provisions of section 42. The correction period is not to exceed 90
days from the date of the notice to the owner described in paragraph
(e)(2) of this section. An Agency may extend the correction period for
up to 6 months, but only if the Agency determines there is good cause
for granting the extension.
(f) Delegation of Authority--(1) Agencies permitted to delegate
compliance monitoring functions--(i) In general. An Agency may retain an
agent or other private contractor (``Authorized Delegate'') to perform
compliance monitoring. The Authorized Delegate must be unrelated to the
owner of any building that the Authorized Delegate monitors. The
Authorized Delegate may be delegated all of the functions of the Agency,
except for the responsibility of notifying the Service under paragraph
(e)(3) of this section. For example, the Authorized Delegate may be
delegated the responsibility of reviewing tenant certifications and
documentation under paragraph (c) (1) and (2) of this section, the right
to inspect buildings and records as described in paragraph (d) of this
section, and the responsibility of notifying building owners of lack of
certification or noncompliance under paragraph (e)(2) of this section.
The Authorized Delegate must notify the Agency of any noncompliance or
failure to certify.
(ii) Limitations. An Agency that delegates compliance monitoring to
an Authorized Delegate under paragraph (f)(1)(i) of this section must
use reasonable diligence to ensure that the Authorized Delegate properly
performs the delegated monitoring functions. Delegation by an Agency of
compliance monitoring functions to an Authorized Delegate does not
relieve the Agency of its obligation to notify the Service of any
noncompliance of which the Agency becomes aware.
(2) Agencies permitted to delegate compliance monitoring functions
to another Agency. An Agency may delegate all or some of its compliance
monitoring responsibilities for a building to another Agency within the
State. This delegation may include the responsibility of notifying the
Service under paragraph (e)(3) of this section.
(g) Liability. Compliance with the requirements of section 42 is the
responsibility of the owner of the building for which the credit is
allowable. The Agency's obligation to monitor for compliance with the
requirements of section 42 does not make the Agency liable for an
owner's noncompliance.
(h) Effective date. Allocation plans must comply with these
regulations by June 30, 1993. The requirement of section 42
(m)(1)(B)(iii) that allocation plans contain a procedure for monitoring
for noncompliance becomes effective on January 1, 1992, and applies to
buildings for which a low-income housing credit is, or has been,
allowable at any time. Thus, allocation plans must comply with section
42(m)(1)(B)(iii) prior to June 30, 1993, the effective date of these
regulations. An allocation plan that complies with these regulations,
with the notice of proposed rulemaking published in the Federal Register
on December 27,
[[Page 134]]
1991, or with a reasonable interpretation of section 42(m)(1)(B)(iii)
will satisfy the requirements of section 42(m)(1)(B)(iii) for periods
before June 30, 1993. Section 42(m)(1)(B)(iii) and these regulations do
not require monitoring for whether a building or project is in
compliance with the requirements of section 42 prior to January 1, 1992.
However, if an Agency becomes aware of noncompliance that occurred prior
to January 1, 1992, the Agency is required to notify the Service of that
noncompliance.
[T.D.8430, 57 FR 40121, Sept. 2, 1992; 57 FR 57280, Dec. 3, 1992; 58 FR
7748, Feb. 9, 1993; T.D. 8563, 59 FR 50163, Oct. 3, 1994]
Sec. 1.42-6 Buildings qualifying for carryover allocations.
(a) Carryover allocations. A carryover allocation is an allocation
that meets the requirements of section 42(h)(1) (E) or (F). If the
requirements of section 42(h)(1) (E) or (F) that are required to be
satisfied by the close of the calendar year are not satisfied, the
allocation is treated as if it had not been made. For example, if the
taxpayer's basis in the project as of the close of the calendar year of
allocation is not more than 10 percent of the taxpayer's reasonably
expected basis in the project as of the close of the second calendar
year following the year of allocation, the carryover allocation is not
valid and is treated as if it had not been made.
(b) Carryover-allocation basis--(1) In general. Subject to the
limitations of paragraph (b)(2) of this section, a taxpayer's basis in a
project for purposes of section 42(h)(1) (E)(ii) or (F) (carryover-
allocation basis) is the taxpayer's adjusted basis in land or
depreciable property that is reasonably expected to be part of the
project, whether or not these amounts are includible in eligible basis
under section 42(d). Thus, for example, if the project is to include
property that is not residential rental property, such as commercial
space, the basis attributable to the commercial space, although not
includible in eligible basis, is includible in carryover-allocation
basis. The adjusted basis of land and depreciable property is determined
under sections 1012 and 1016, and generally includes the direct and
indirect costs of acquiring, constructing, and rehabilitating the
property. Costs otherwise includible in carryover-allocation basis are
not excluded by reason of having been incurred prior to the calendar
year in which the carryover allocation is made.
(2) Limitations--For purposes of determining carryover-allocation
basis under paragraph (b)(1) of this section, the following limitations
apply.
(i) Taxpayer must have basis in land or depreciable property related
to the project. A taxpayer has carryover-allocation basis to the extent
that it has basis in land or depreciable property and the land or
depreciable property is reasonably expected to be part of the project
for which the carryover allocation is made. This basis includes all
items that are properly capitalizable with respect to the land or
depreciable property. For example, a nonrefundable downpayment for, or
an amount paid to acquire an option to purchase, land or depreciable
property may be included in carryover-allocation basis if properly
capitalizable into the basis of land or depreciable property that is
reasonably expected to be part of a project.
(ii) High cost areas. Any increase in eligible basis that may result
under section 42(d)(5)(C) from a building's location in a qualified
census tract or difficult development area is not taken into account in
determining carryover-allocation basis or reasonably expected basis.
(iii) Amounts not treated as paid or incurred. An amount is not
includible in carryover-allocation basis unless it is treated as paid or
incurred under the method of accounting used by the taxpayer. For
example, a cash method taxpayer cannot include construction costs in
carryover-allocation basis unless the costs have been paid, and an
accrual method taxpayer cannot include construction costs in carryover-
allocation basis unless they have been properly accrued. See paragraph
(b)(2)(iv) of this section for a special rule for fees.
(iv) Fees. A fee is includible in carryover-allocation basis only to
the extent the requirements of paragraph (b)(2)(iii) of this section are
met and--
(A) The fee is reasonable;
[[Page 135]]
(B) The taxpayer is legally obligated to pay the fee;
(C) The fee is capitalizable as part of the taxpayer's basis in land
or depreciable property that is reasonably expected to be part of the
project;
(D) The fee is not paid (or to be paid) by the taxpayer to itself;
and
(E) If the fee is paid (or to be paid) by the taxpayer to a related
person, and the taxpayer uses the cash method of accounting, the
taxpayer could properly accrue the fee under the accrual method of
accounting (considering, for example, the rules of section 461(h)). A
person is a related person if the person bears a relationship to the
taxpayer specified in sections 267(b) or 707(b)(1), or if the person and
the taxpayer are engaged in trades or businesses under common control
(within the meaning of subsections (a) and (b) of section 52).
(3) Reasonably expected basis. Rules similar to the rules of
paragraphs (a) and (b) of this section apply in determining the
taxpayer's reasonably expected basis in a project (land and depreciable
basis) as of the close of the second calendar year following the
calendar year of the allocation.
(4) Examples. The following examples illustrate the rules of
paragraphs (a) and (b) of this section.
Example 1. (i) Facts. C, an accrual-method taxpayer, receives a
carryover allocation from Agency, the state housing credit agency, in
September of 1993. As of that date, C has not begun construction of the
low-income housing building C plans to build. However, C has owned the
land on which C plans to build the building since 1985. C's basis in the
land is $100,000. C reasonably expects that by the end of 1995, C's
basis in the project of which the building is to be a part will be
$2,000,000. C also expects that because the project is located in a
qualified census tract, C will be able to increase its basis in the
project to $2,600,000. Before the close of 1993, C incurs $150,000 of
costs for architects' fees and site preparation. C properly accrues
these costs under its method of accounting and capitalizes the costs.
(ii) Determination of carryover-allocation basis. C's $100,000 basis
in the land is includible in carryover-allocation basis even though C
has owned the land since 1985. The $150,000 of costs C has incurred for
architects' fees and site preparation are also includible in carryover-
allocation basis. The expected increase in basis due to the project's
location in a qualified census tract is not taken into account in
determining C's carryover-allocation basis. Accordingly, C's carryover-
allocation basis in the project of which the building is a part is
$250,000.
(iii) Determination of whether building is qualified. C's reasonably
expected basis in the project at the close of the second calendar year
following the calendar year of allocation is $2,000,000. The expected
increase in eligible basis due to the project's location in a qualified
census tract is not taken into account in determining this amount.
Because C's carryover-allocation basis is more than 10 percent of C's
reasonably expected basis in the project of which the building is a
part, the building for which C received the carryover allocation is a
qualified building for purposes of section 42(h)(1)(E)(ii) and paragraph
(a) of this section.
Example 2 . (i) Facts. D, an accrual-method taxpayer, receives a
carryover allocation from Agency, the state housing credit agency, on
September 11, 1993. As of that date, D has not begun construction of the
low-income housing building D plans to build and D does not have basis
in the land on which D plans to build the building. In 1993, D incurs
some costs related to the planned building, including architects' fees.
However, at the close of 1993, these costs do not exceed 10 percent of
D's reasonably expected basis in the project.
(ii) Determination of whether building is qualified. Because D's
carryover-allocation basis is not more than 10 percent of D's reasonably
expected basis in the project of which the building is a part, the
building for which D received a carryover allocation is not a qualified
building for purposes of section 42(h)(1)(E)(ii) and paragraph (a) of
this section. The carryover allocation to D is not valid, and is treated
as if it had not been made.
(c) Verification of basis by Agency--(1) Verification requirement.
An Agency that makes a carryover allocation to a taxpayer must verify
that, as of the close of the calendar year of allocation, the taxpayer
has incurred more than 10 percent of the reasonably expected basis in
the project (land and depreciable basis).
(2) Manner of verification. An Agency may verify that a taxpayer has
incurred more than 10 percent of its reasonably expected basis in a
project by obtaining a certification from the taxpayer, in writing and
under penalty of perjury, that the taxpayer has incurred by the close of
the calendar year of the allocation more than 10 percent of the
reasonably expected basis in the
[[Page 136]]
project. The certification must be accompanied by supporting
documentation that the Agency must review. Supporting documentation may
include, for example, copies of checks or other records of payments.
Alternatively, an Agency may verify that the taxpayer has incurred
adequate basis by requiring that the taxpayer obtain from an attorney or
certified public accountant a written certification to the Agency, that
the attorney or accountant has examined all eligible costs incurred with
respect to the project and that, based upon this examination, it is the
attorney's or accountant's belief that the taxpayer has incurred more
than 10 percent of its reasonably expected basis in the project by the
close of the calendar year of the allocation.
(3) Time of verification. An Agency may require that the basis
certification be submitted to or received by the Agency prior to the
close of the calendar year of allocation or within a reasonable time
after the close of the calendar year of allocation. The Agency will need
to verify basis in order to accurately complete the Form 8610, Annual
Low-Income Housing Credit Agencies Report, for the calendar year. If
certification is not timely made, or supporting documentation is
lacking, inadequate, or does not actually support the certification, the
Agency should notify the taxpayer and try to get adequate documentation.
If the Agency cannot verify before the Form 8610 is filed that the
taxpayer has satisfied the basis requirement for a carryover allocation,
the allocation is treated as if it had not been made and the carryover
allocation document should not be filed with the Form 8610.
(d) Requirements for making carryover allocations--(1) In general.
Generally, an allocation is made when an Agency issues the Form 8609,
Low-Income Housing Credit Allocation Certification, for a building. See
Sec. 1.42-1T(d)(8)(ii). An Agency does not issue the Form 8609 for a
building until the building is placed in service. However, in cases
where allocations of credit are made pursuant to section 42(h)(1)(E)
(relating to carryover allocations for buildings) or section 42(h)(1)(F)
(relating to carryover allocations for multiple-building projects), Form
8609 is not used as the allocating document because the buildings are
not yet in service. When an allocation is made pursuant to section
42(h)(1) (E) or (F), the allocating document is the document meeting the
requirements of paragraph (d)(2) of this section. In addition, when an
allocation is made pursuant to section 42(h)(1)(F), the requirements of
paragraph (d)(3) of this section must be met for the allocation to be
valid. An allocation pursuant to section 42(h)(1) (E) or (F) reduces the
state housing credit ceiling for the year in which the allocation is
made, whether or not the Form 8609 is also issued in that year.
(2) Requirements for allocation. An allocation pursuant to section
42(h)(1) (E) or (F) is made when an allocation document containing the
following information is completed, signed, and dated by an authorized
official of the Agency--
(i) The address of each building in the project, or if none exists,
a specific description of the location of each building;
(ii) The name, address, and taxpayer identification number of the
taxpayer receiving the allocation;
(iii) The name and address of the Agency;
(iv) The taxpayer identification number of the Agency;
(v) The date of the allocation;
(vi) The housing credit dollar amount allocated to the building or
project, as applicable;
(vii) The taxpayer's reasonably expected basis in the project (land
and depreciable basis) as of the close of the second calendar year
following the calendar year in which the allocation is made;
(viii) The taxpayer's basis in the project (land and depreciable
basis) as of the close of the calendar year in which the allocation is
made and the percentage that basis bears to the reasonably expected
basis in the project (land and depreciable basis) as of the close of the
second following calendar year;
(ix) The date that each building in the project is expected to be
placed in service; and
(x) The Building Identification Number (B.I.N.) to be assigned to
each
[[Page 137]]
building in the project. The B.I.N. must reflect the year an allocation
is first made to the building, regardless of the year that the building
is placed in service. This B.I.N. must be used for all allocations of
credit for the building. For example, rehabilitation expenditures
treated as a separate new building under section 42(e) should not have a
separate B.I.N. if the building to which the rehabilitation expenditures
are made has a B.I.N. In this case, the B.I.N. used for the
rehabilitation expenditures shall be the B.I.N. previously assigned to
the building, although the rehabilitation expenditures must have a
separate Form 8609 for the allocation. Similarly, a newly constructed
building that receives an allocation of credit in different calendar
years must have a separate Form 8609 for each allocation. The B.I.N.
assigned to the building for the first allocation must be used for the
subsequent allocation.
(3) Special rules for project-based allocations--(i) In general. An
allocation pursuant to section 42(h)(1)(F) (a project-based allocation)
must meet the requirements of this section as well as the requirements
of section 42(h)(1)(F), including the minimum basis requirement of
section 42(h)(1)(E)(ii).
(ii) Requirement of section 42(h)(1)(F)(i)(III). An allocation
satisfies the requirement of section 42(h)(1)(F)(i)(III) if the Form
8609 that is issued for each building that is placed in service in the
project states the portion of the project-based allocation that is
applied to that building.
(4) Recordkeeping requirements--(i) Taxpayer. When an allocation is
made pursuant to section 42(h)(1) (E) or (F), the taxpayer must retain a
copy of the allocation document and file an additional copy with the
Form 8609 that is issued to the taxpayer for a building after the
building is placed in service. The taxpayer need only file a copy of the
allocation document with the Form 8609 for the building for the first
year the credit is claimed. However, the Form 8609 must be filed for the
first taxable year in which the credit is claimed and for each taxable
year thereafter throughout the compliance period, whether or not a
credit is claimed for the taxable year.
(ii) Agency. The Agency must retain a copy of the allocation
document and file the original with the Agency's Form 8610 that accounts
for the year the allocation is made. The Agency must also retain a copy
of the Form 8609 that is issued to the taxpayer and file the original
with the Agency's Form 8610 that reflects the year the form is issued.
(5) Separate procedure for election of appropriate percentage month.
If a taxpayer receives an allocation under section 42(h)(1) (E) or (F)
and wishes to elect under section 42(b)(2)(A)(ii) to use the appropriate
percentage for a month other than the month in which a building is
placed in service, the requirements specified in Sec. 1.42-8 must be met
for the election to be effective.
(e) Special rules. The following rules apply for purposes of this
section.
(1) Treatment of partnerships and other flow-through entities. With
respect to taxpayers that own projects through partnerships or other
flow-through entities (e.g., S corporations, estates, or trusts),
carryover-allocation basis is determined at the entity level using the
rules provided by this section. In addition, the entity is responsible
for providing to the Agency the certification and documentation required
under the basis verification requirement in paragraph (c) of this
section.
(2) Transferees. If land or depreciable property that is expected to
be part of a project is transferred after a carryover allocation has
been made for a building that is reasonably expected to be part of the
project, but before the close of the calendar year of the allocation,
the transferee's carryover-allocation basis is determined under the
principles of this section and section 42(d)(7). See also Rev. Rul. 91-
38, 1991-2 C.B. 3 (see Sec. 601.601(d)(2)(ii)(b) of this chapter). In
addition, the transferee is treated as the taxpayer for purposes of the
basis verification requirement of this section, and therefore, is
responsible for providing to the Agency the required certifications and
documentation.
[T.D. 8520, 59 FR 10069, Mar. 3, 1994]
[[Page 138]]
Sec. 1.42-7 Substantially bond-financed buildings. [Reserved]
Sec. 1.42-8 Election of appropriate percentage month.
(a) Election under section 42(b)(2)(A)(ii)(I) to use the appropriate
percentage for the month of a binding agreement--(1) In general. For
purposes of section 42(b)(2)(A)(ii)(I), an agreement between a taxpayer
and an Agency as to the housing credit dollar amount to be allocated to
a building is considered binding if it--
(i) Is in writing;
(ii) Is binding under state law on the Agency, the taxpayer, and all
successors in interest;
(iii) Specifies the type(s) of building(s) to which the housing
credit dollar amount applies (i.e., a newly constructed or existing
building, or substantial rehabilitation treated as a separate new
building under section 42(e));
(iv) Specifies the housing credit dollar amount to be allocated to
the building(s); and
(v) Is dated and signed by the taxpayer and the Agency during the
month in which the requirements of paragraphs (a)(1) (i) through (iv) of
this section are met.
(2) Effect on state housing credit ceiling. Generally, a binding
agreement described in paragraph (a)(1) of this section is an agreement
by the Agency to allocate credit to the taxpayer at a future date. The
binding agreement may include a reservation of credit or a binding
commitment (under section 42(h)(1)(C)) to allocate credit in a future
taxable year. A reservation or a binding commitment to allocate credit
in a future year has no effect on the state housing credit ceiling until
the year the Agency actually makes an allocation. However, if the
binding agreement is also a carryover allocation under section 42(h)(1)
(E) or (F), the state housing credit ceiling is reduced by the amount
allocated by the Agency to the taxpayer in the year the carryover
allocation is made. For a binding agreement to be a valid carryover
allocation, the requirements of paragraph (a)(1) of this section and
Sec. 1.42-6 must be met.
(3) Time and manner of making election. An election under section
42(b)(2)(A)(ii)(I) may be made either as part of the binding agreement
under paragraph (a)(1) of this section to allocate a specific housing
credit dollar amount or in a separate document that references the
binding agreement. In either case, the election must--
(i) Be in writing;
(ii) Reference section 42(b)(2)(A)(ii)(I);
(iii) Be signed by the taxpayer;
(iv) If it is in a separate document, reference the binding
agreement that meets the requirements of paragraph (a)(1) of this
section; and
(v) Be notarized by the 5th day following the end of the month in
which the binding agreement was made.
(4) Multiple agreements--(i) Rescinded agreements. A taxpayer may
not make an election under section 42(b)(2)(A)(ii)(I) for a building if
an election has previously been made for the building for a different
month. For example, assume a taxpayer entered into a binding agreement
for allocation of a specific housing credit dollar amount to a building
and made the election under section 42(b)(2)(A)(ii)(I) to apply the
appropriate percentage for the month of the binding agreement. If the
binding agreement subsequently is rescinded under state law, and the
taxpayer enters into a new binding agreement for allocation of a
specific housing credit dollar amount to the building, the taxpayer must
apply to the building the appropriate percentage for the elected month
of the rescinded binding agreement. However, if no prior election was
made with respect to the rescinded binding agreement, the taxpayer may
elect the appropriate percentage for the month of the new binding
agreement.
(ii) Increases in credit. The election under section
42(b)(2)(A)(ii)(I), once made, applies to any increase in the credit
amount allocated for a building, whether the increase occurs in the same
or in a subsequent year. However, in the case of a binding agreement (or
carryover allocation that is treated as a binding agreement) to allocate
a credit amount under section 42(e)(1) for substantial rehabilitation
treated as a separate new building, a taxpayer may make the election
under section 42(b)(2)(A)(ii)(I) notwithstanding that a
[[Page 139]]
prior election under section 42(b)(2)(A)(ii)(I) is in effect for a prior
allocation of credit for a substantial rehabilitation that was
previously placed in service under section 42(e).
(5) Amount allocated. The housing credit dollar amount eventually
allocated to a building may be more or less than the amount specified in
the binding agreement. Depending on the Agency's determination pursuant
to section 42(m)(2) as to the financial feasibility of the building (or
project), the Agency may allocate a greater housing credit dollar amount
to the building (provided that the Agency has additional housing credit
dollar amounts available to allocate for the calendar year of the
allocation) or the Agency may allocate a lesser housing credit dollar
amount. Under section 42(h)(7)(D), in allocating a housing credit dollar
amount, the Agency must specify the applicable percentage and maximum
qualified basis of the building. The applicable percentage may be less,
but not greater than, the appropriate percentage for the month the
building is placed in service, or the month elected by the taxpayer
under section 42(b)(2)(A)(ii)(I). Whether the appropriate percentage is
the appropriate percentage for the 70-percent present value credit or
the 30-percent present value credit is determined under section 42(i)(2)
when the building is placed in service.
(6) Procedures--(i) Taxpayer. The taxpayer must give the original
notarized election statement to the Agency before the close of the 5th
calendar day following the end of the month in which the binding
agreement is made. The taxpayer must retain a copy of the binding
agreement and the election statement and must file an additional copy of
each with the taxpayer's Form 8609, Low-Income Housing Credit Allocation
Certification, for the first taxable year in which credit is claimed for
the building.
(ii) Agency. The Agency must file with the Internal Revenue Service
the original of the binding agreement and the election statement with
the Agency's Form 8610, Annual Low-Income Housing Credit Agencies
Report, that accounts for the year the allocation is actually made. The
Agency must also retain a copy of the binding agreement and the election
statement.
(7) Examples. The following examples illustrate the provisions of
this section. In each example, X is the taxpayer, Agency is the state
housing credit agency, and the carryover allocations meet the
requirements of Sec. 1.42-6 and are otherwise valid.
Example 1. (i) In August 1993, X and Agency enter into an agreement
that Agency will allocate $100,000 of housing credit dollar amount for
the low-income housing building X is constructing. The agreement is
binding and meets all the requirements of paragraph (a)(1) of this
section. The agreement is a reservation of credit, not an allocation,
and therefore, has no effect on the state housing credit ceiling. On or
before September 5, 1993, X signs and has notarized a written election
statement that meets the requirements of paragraph (a)(3) of this
section. The applicable percentage for the building is the appropriate
percentage for the month of August 1993.
(ii) Agency makes a carryover allocation of $100,000 of housing
credit dollar amount for the building on October 2, 1993. The carryover
allocation reduces Agency's state housing credit ceiling for 1993. Due
to unexpectedly high construction costs, when X places the building in
service in July 1994, the product of the building's qualified basis and
the applicable percentage for the building (the appropriate percentage
for the month of August 1993) is $150,000, rather than $100,000.
Notwithstanding that only $100,000 of credit was allocated for the
building in 1993, Agency may allocate an additional $50,000 of housing
credit dollar amount for the building from its state housing credit
ceiling for 1994. The appropriate percentage for the month of August
1993 is the applicable percentage for the building for the entire
$150,000 of credit allocated for the building, even though separate
allocations were made in 1993 and 1994. Because allocations were made
for the building in two separate calendar years, Agency must issue two
Forms 8609 to X. One Form 8609 must reflect the $100,000 allocation made
in 1993, and the other Form 8609 must reflect the $50,000 allocation
made in 1994.
(iii) X gives the original notarized statement to Agency on or
before September 5, 1993, and retains a copy of the binding agreement,
election statement, and carryover allocation document. X files a copy of
the binding agreement, election statement, and carryover allocation
document with X's Form 8609 for the first taxable year in which X claims
credit for the building.
(iv) Agency files the original of the binding agreement, election
statement, and 1993 carryover allocation document with its 1993
[[Page 140]]
Form 8610. Agency retains a copy of the binding agreement, election
statement, and carryover allocation document. After the building is
placed in service in 1994, Agency issues to X a copy of the Form 8609
reflecting the 1993 carryover allocation of $100,000 and files the
original of that form with its 1994 Form 8610. Agency also files the
original of the 1994 Form 8609 reflecting the $50,000 allocation with
its 1994 Form 8610 and issues to X a copy of the 1994 Form 8609. Agency
retains copies of the Forms 8609 that are issued to X.
Example 2. (i) In September 1993, X and Agency enter into an
agreement that Agency will allocate $70,000 of housing credit dollar
amount for rehabilitation expenditures that X is incurring and that X
will treat as a new low-income housing building under section 42(e)(1).
The agreement is binding and meets all the requirements of paragraph
(a)(1) of this section. The agreement is a reservation of credit, not an
allocation, and therefore, has no effect on Agency's state housing
credit ceiling. On or before October 5, 1993, X signs and has notarized
a written election statement that meets the requirements of paragraph
(a)(3) of this section. The applicable percentage for the building is
the appropriate percentage for the month of September 1993. Agency makes
a carryover allocation of $70,000 of housing credit dollar amount for
the building on November 15, 1993. The carryover allocation reduces by
$70,000 Agency's state housing credit ceiling for 1993.
(ii) In October 1994, X and Agency enter into another binding
agreement meeting the requirements of paragraph (a)(1) of this section.
Under the agreement, Agency will allocate $50,000 of housing credit
dollar amount for additional rehabilitation expenditures by X that
qualify as a second separate new building under section 42(e)(1). On or
before November 5, 1994, X signs and has notarized a written election
statement meeting the requirements of paragraph (a)(3) of this section.
On December 1, 1994, X receives a carryover allocation under section
42(h)(1)(E) for $50,000. The carryover allocation reduces by $50,000
Agency's state housing credit ceiling for 1994. The applicable
percentage for the rehabilitation expenditures treated as the second
separate new building is the appropriate percentage for the month of
October 1994, not September 1993. The appropriate percentage for the
month of September 1993 still applies to the allocation of $70,000 for
the rehabilitation expenditures treated as the first separate new
building. Because allocations were made for the building in two separate
calendar years, Agency must issue two Forms 8609 to X. One Form 8609
must reflect the $70,000 allocation made in 1993, and the other Form
8609 must reflect the $50,000 allocation made in 1994.
(iii) X gives the first original notarized statement to Agency on or
before October 5, 1993, and retains a copy of the first binding
agreement, election statement, and carryover allocation document issued
in 1993. X gives the second original notarized statement to Agency on or
before November 5, 1994, and retains a copy of the second binding
agreement, election statement, and carryover allocation document issued
in 1994. X files a copy of the binding agreements, election statements,
and carryover allocation documents with X's Forms 8609 for the first
taxable year in which X claims credit for the buildings.
(iv) Agency retains a copy of the binding agreements, election
statements, and carryover allocation documents. Agency files the
original of the first binding agreement, election statement, and 1993
carryover allocation document with its 1993 Form 8610. Agency files the
original of the second binding agreement, election statement, and 1994
carryover allocation document with its 1994 Form 8610. After X notifies
Agency of the date each building is placed in service, the Agency will
issue copies of the respective Forms 8609 to X, and file the originals
of those forms with the Agency's Form 8610 that reflects the year each
form is issued. The Agency also retains copies of the Forms 8609.
(b) Election under section 42(b)(2)(A)(ii)(II) to use the
appropriate percentage for the month tax-exempt bonds are issued--(1)
Time and manner of making election. In the case of any building to which
section 42(h)(4)(B) applies, an election under section
42(b)(2)(A)(ii)(II) to use the appropriate percentage for the month tax-
exempt bonds are issued must--
(i) Be in writing;
(ii) Reference section 42(b)(2)(A)(ii)(II);
(iii) Specify the percentage of the aggregate basis of the building
and the land on which the building is located that is financed with the
proceeds of obligations described in section 42(h)(4)(A) (tax-exempt
bonds);
(iv) State the month in which the tax-exempt bonds are issued;
(v) State that the month in which the tax-exempt bonds are issued is
the month elected for the appropriate percentage to be used for the
building;
(vi) Be signed by the taxpayer; and
(vii) Be notarized by the 5th day following the end of the month in
which the bonds are issued.
[[Page 141]]
(2) Bonds issued in more than one month. If a building described in
section 42(h)(4)(B) (substantially bond-financed building) is financed
with tax-exempt bonds issued in more than one month, the taxpayer may
elect the appropriate percentage for any month in which the bonds are
issued. Once the election is made, the appropriate percentage elected
applies for the building even if all bonds are not issued in that month.
The requirements of this paragraph (b), including the time limitation
contained in paragraph (b)(1)(vii) of this section, must also be met.
(3) Limitations on appropriate percentage. Under section
42(m)(2)(D), the credit allowable for a substantially bond- financed
building is limited to the amount necessary to assure the project's
feasibility. Accordingly, in making the determination under section
42(m)(2), an Agency may use an applicable percentage that is less, but
not greater than, the appropriate percentage for the month the building
is placed in service, or the month elected by the taxpayer under section
42(b)(2)(A)(ii)(II).
(4) Procedures--(i) Taxpayer. The taxpayer must provide the original
notarized election statement to the Agency before the close of the 5th
calendar day following the end of the month in which the bonds are
issued. If an authority other than the Agency issues the tax-exempt
bonds, the taxpayer must also give the Agency a signed statement from
the issuing authority that certifies the information described in
paragraphs (b)(1)(iii) and (iv) of this section. The taxpayer must file
a copy of the election statement with the taxpayer's Form 8609 for the
first taxable year in which credit is claimed for the building. The
taxpayer must also retain a copy of the election statement.
(ii) Agency. The Agency must file with the Internal Revenue Service
the original of the election statement and the corresponding Form 8609
for the building with the Agency's Form 8610 that reflects the year the
Form 8609 is issued. The Agency must also retain a copy of the election
statement and the Form 8609.
[T.D. 8520, 59 FR 10071, Mar. 3, 1994]
Sec. 1.42-9 For use by the general public.
(a) General rule. If a residential rental unit in a building is not
for use by the general public, the unit is not eligible for a section 42
credit. A residential rental unit is for use by the general public if
the unit is rented in a manner consistent with housing policy governing
non-discrimination, as evidenced by rules or regulations of the
Department of Housing and Urban Development (HUD) (24 CFR subtitle A and
chapters I through XX). See HUD Handbook 4350.3 (or its successor). A
copy of HUD Handbook 4350.3 may be requested by writing to: HUD,
Directives Distribution Section, room B-100, 451 7th Street, SW.,
Washington, DC 20410.
(b) Limitations. Notwithstanding paragraph (a) of this section, if a
residential rental unit is provided only for a member of a social
organization or provided by an employer for its employees, the unit is
not for use by the general public and is not eligible for credit under
section 42. In addition, any residential rental unit that is part of a
hospital, nursing home, sanitarium, lifecare facility, trailer park, or
intermediate care facility for the mentally and physically handicapped
is not for use by the general public and is not eligible for credit
under section 42.
(c) Treatment of units not for use by the general public. The costs
attributable to a residential rental unit that is not for use by the
general public are not excludable from eligible basis by reason of the
unit's ineligibility for the credit under this section. However, in
calculating the applicable fraction, the unit is treated as a
residential rental unit that is not a low-income unit.
[T.D. 8520, 59 FR 10073, Mar. 3, 1994]
Sec. 1.42-10 Utility allowances.
(a) Inclusion of utility allowances in gross rent. If the cost of
any utilities (other than telephone) for a residential rental unit are
paid directly by the tenant(s), the gross rent for that unit includes
the applicable utility allowance determined under this section. This
section only applies for purposes of determining gross rent under
section 42(g)(2)(B)(ii) as to rent-restricted units.
[[Page 142]]
(b) Applicable utility allowances--(1) FmHA-assisted buildings. If a
building receives assistance from the Farmers Home Administration (FmHA-
assisted building), the applicable utility allowance for all rent-
restricted units in the building is the utility allowance determined
under the method prescribed by the Farmers Home Administration (FmHA)
for the building. For example, if a building receives assistance under
FmHA's section 515 program (whether or not the building or its tenants
also receive other state or federal assistance), the applicable utility
allowance for all rent-restricted units in the building is determined
using Exhibit A-6 of 7 CFR part 1944, subpart E (or a successor method
of determining utility allowances).
(2) Buildings with FmHA assisted tenants. If any tenant in a
building receives FmHA rental assistance payments (FmHA tenant
assistance), the applicable utility allowance for all rent-restricted
units in the building (including any units occupied by tenants receiving
HUD rental assistance payments) is the applicable FmHA utility
allowance.
(3) HUD-regulated buildings. If neither a building nor any tenant in
the building receives FmHA housing assistance, and the rents and utility
allowances of the building are reviewed by HUD on an annual basis (HUD-
regulated building), the applicable utility allowance for all rent-
restricted units in the building is the applicable HUD utility
allowance.
(4) Other buildings. If a building is neither an FmHA-assisted nor a
HUD-regulated building, and no tenant in the building receives FmHA
tenant assistance, the applicable utility allowance for rent-restricted
units in the building is determined under the following methods.
(i) Tenants receiving HUD rental assistance. The applicable utility
allowance for any rent-restricted units occupied by tenants receiving
HUD rental assistance payments (HUD tenant assistance) is the applicable
Public Housing Authority (PHA) utility allowance established for the
Section 8 Existing Housing Program.
(ii) Other tenants--(A) General rule. If none of the rules of
paragraphs (b)(1), (2), (3), and (4)(i) of this section apply to any
rent-restricted units in a building, the appropriate utility allowance
for the units is the applicable PHA utility allowance. However, if a
local utility company estimate is obtained for any unit in the building
in accordance with paragraph (b)(4)(ii)(B) of this section, that
estimate becomes the appropriate utility allowance for all rent-
restricted units of similar size and construction in the building. This
local utility company estimate procedure is not available for and does
not apply to units to which the rules of paragraphs (b) (1), (2), (3),
or (4)(i) of this section apply.
(B) Utility company estimate. Any interested party (including a low-
income tenant, a building owner, or an Agency) may obtain a local
utility company estimate for a unit. The estimate is obtained when the
interested party receives, in writing, information from a local utility
company providing the estimated cost of that utility for a unit of
similar size and construction for the geographic area in which the
building containing the unit is located. The local utility company
estimate may be obtained by an interested party at any time during the
building's extended use period (see section 42(h)(6)(D)) or, if the
building does not have an extended use period, during the building's
compliance period (see section 42(i)(1)). Unless the parties agree
otherwise, costs incurred in obtaining the estimate are borne by the
initiating party. The interested party that obtains the local utility
company estimate (the initiating party) must retain the original of the
utility company estimate and must furnish a copy of the local utility
company estimate to the owner of the building (where the initiating
party is not the owner), and the Agency that allocated credit to the
building (where the initiating party is not the Agency). The owner of
the building must make available copies of the utility company estimate
to the tenants in the building.
(c) Changes in applicable utility allowance. If at any time during
the building's extended use period (or, if the building does not have an
extended use period, the building's compliance period), the applicable
utility allowance
[[Page 143]]
for a unit changes, the new utility allowance must be used to compute
gross rents of rent-restricted units due 90 days after the change. For
example, if rent must be lowered because a local utility company
estimate is obtained that shows a higher utility cost than the otherwise
applicable PHA utility allowance, the lower rent must be in effect for
rent due more than 90 days after the date of the local utility company
estimate.
[T.D. 8520, 59 FR 10073, Mar. 3, 1994]
Sec. 1.42-11 Provision of services.
(a) General rule. The furnishing to tenants of services other than
housing (whether or not the services are significant) does not prevent
the units occupied by the tenants from qualifying as residential rental
property eligible for credit under section 42. However, any charges to
low-income tenants for services that are not optional generally must be
included in gross rent for purposes of section 42(g).
(b) Services that are optional--(1) General rule. A service is
optional if payment for the service is not required as a condition of
occupancy. For example, for a qualified low-income building with a
common dining facility, the cost of meals is not included in gross rent
for purposes of section 42(g)(2)(A) if payment for the meals in the
facility is not required as a condition of occupancy and a practical
alternative exists for tenants to obtain meals other than from the
dining facility.
(2) Continual or frequent services. If continual or frequent
nursing, medical, or psychiatric services are provided, it is presumed
that the services are not optional and the building is ineligible for
the credit, as is the case with a hospital, nursing home, sanitarium,
lifecare facility, or intermediate care facility for the mentally and
physically handicapped. See also Sec. 1.42-9(b).
(3) Required services--(i) General rule. The cost of services that
are required as a condition of occupancy must be included in gross rent
even if federal or state law requires that the services be offered to
tenants by building owners.
(ii) Exceptions--(A) Supportive services. Section 42(g)(2)(B)(iii)
provides an exception for certain fees paid for supportive services. For
purposes of section 42(g)(2)(B)(iii), a supportive service is any
service provided under a planned program of services designed to enable
residents of a residential rental property to remain independent and
avoid placement in a hospital, nursing home, or intermediate care
facility for the mentally or physically handicapped. For a building
described in section 42(i)(3)(B)(iii) (relating to transitional housing
for the homeless), a supportive service includes any service provided to
assist tenants in locating and retaining permanent housing.
(B) Specific project exception. Gross rent does not include the cost
of mandatory meals in any federally-assisted project for the elderly and
handicapped (in existence on or before January 9, 1989) that is
authorized by 24 CFR 278 to provide a mandatory meals program.
[T.D. 8520, 59 FR 10074, Mar. 3, 1994]
Sec. 1.42-12 Effective dates and transitional rules.
(a) Effective date. The rules set forth in Secs. 1.42-6 and 1.42-8
through 1.42-12 are effective May 2, 1994. However, binding agreements,
election statements, and carryover allocation documents entered into
before May 2, 1994, that follow the guidance set forth in Notice 89-1,
1989-1 C.B. 620 (see Sec. 601.601(d)(2)(ii)(b) of this chapter) need not
be changed to conform to the rules set forth in Secs. 1.42-6 and 1.42-8
through 1.42-12.
(b) Prior periods. Notice 89-1, 1989-1 C.B. 620 and Notice 89-6,
1989-1 C.B. 625 (see Sec. 601.601(d)(2)(ii)(b) of this chapter) may be
applied for periods prior to May 2, 1994.
[T.D. 8520, 59 FR 10074, Mar. 3, 1994; 59 FR 15501, Apr. 1, 1994]
Sec. 1.42-13 Rules necessary and appropriate; housing credit agencies' correction of administrative errors and omissions.
(a) Publication of guidance. Under section 42(n), the Secretary has
authority to prescribe regulations as may be necessary or appropriate to
carry out the purposes of section 42. The Secretary may also provide
guidance through various publications in the Internal Revenue Bulletin.
(See Sec. 601.601(d)(2)(ii)(b) of this chapter.)
(b) Correcting administrative errors and omissions--(1) In general.
An Agency
[[Page 144]]
may correct an administrative error or omission with respect to
allocations and recordkeeping, as described in paragraph (b)(2) of this
section, within a reasonable period after the Agency discovers the
administrative error or omission. Whether a correction is made within a
reasonable period depends on the facts and circumstances of each
situation. Except as provided in paragraph (b)(3)(iii) of this section,
an Agency need not obtain the prior approval of the Secretary to correct
an administrative error or omission, if the correction is made in
accordance with paragraph (b)(3)(i) of this section. The administrative
errors and omissions to which this paragraph (b) applies are strictly
limited to those described in paragraph (b)(2) of this section, and,
thus, do not include, for example, any misinterpretation of the
applicable rules and regulations under section 42. Accordingly, an
Agency's allocation of a particular calendar year's low-income housing
credit dollar amount made after the close of that calendar year, or the
use of an incorrect population amount in calculating a State's housing
credit ceiling for a calendar year are not administrative errors that
can be corrected under this paragraph (b).
(2) Administrative errors and omissions described. An administrative
error or omission is a mistake that results in a document that
inaccurately reflects the intent of the Agency at the time the document
is originally completed or, if the mistake affects a taxpayer, a
document that inaccurately reflects the intent of the Agency and the
affected taxpayer at the time the document is originally completed.
Administrative errors and omissions described in this paragraph (b)(2)
include the following--
(i) A mathematical error;
(ii) An entry on a document that is inconsistent with another entry
on the same or another document regarding the same property, or
taxpayer;
(iii) A failure in tracking the housing credit dollar amount an
Agency has allocated (or that remains to be allocated) in the current
calendar year (e.g., a failure to include in its State housing credit
ceiling a previously allocated credit dollar amount that has been
returned by a taxpayer);
(iv) An omission of information that is required on a document; and
(v) Any other type of error or omission identified by guidance
published in the Internal Revenue Bulletin (see
Sec. 601.601(d)(2)(ii)(b) of this chapter) as an administrative error or
omission covered by this paragraph (b).
(3) Procedures for correcting administrative errors or omissions--
(i) In general. An Agency's correction of an administrative error or
omission, as described in paragraph (b)(2) of this section, must amend
the document so that the corrected document reflects the original intent
of the Agency, or the Agency and the affected taxpayer, and complies
with applicable rules and regulations under section 42.
(ii) Specific procedures. If a document corrects a document
containing an administrative error or omission that has not yet been
filed with the Internal Revenue Service, the Agency, or the Agency and
the affected taxpayer, should complete and file the corrected document
as the original. When a document containing an administrative error or
omission has already been filed with the Service, the Agency, or the
Agency and the affected taxpayer, should refile a copy of the document
containing the administrative error or omission, and prominently and
clearly note the correction thereon or on an attached new document. The
Agency should indicate at the top of the document(s) that the correction
is being made under Sec. 1.42-13 of the Income Tax Regulations.
(iii) Secretary's prior approval required. An Agency must obtain the
Secretary's prior approval to correct an administrative error or
omission, as described in paragraph (b)(2) of this section, if the
correction is not made before the close of the calendar year of the
error or omission and the correction--
(A) Is a numerical change to the housing credit dollar amount
allocated for the building or project;
(B) Affects the determination of any component of the State's
housing credit ceiling under section 42(h)(3)(C); or
(C) Affects the State's unused housing credit carryover that is
assigned to the Secretary under section 42(h)(3)(D).
[[Page 145]]
(iv) Requesting the Secretary's approval. To obtain the Secretary's
approval under paragraph (b)(3)(iii) of this section, an Agency must
submit a request for the Secretary's approval within a reasonable period
after discovering the administrative error or omission, and must agree
to any conditions that may be required by the Secretary under paragraph
(b)(3)(v) of this section. When requesting the Secretary's approval, the
Agency, or the Agency and the affected taxpayer, must file an
application that complies with the requirements of this paragraph
(b)(3)(iv). For further information on the application procedure see
Rev. Proc. 93-1, 1993-1 I.R.B. 10 (or any subsequent applicable revenue
procedure). (See Sec. 601.601(d)(2)(ii)(b) of this chapter.) The
application requesting the Secretary's approval must contain the
following information--
(A) The name, address, and identification number of each affected
taxpayer;
(B) The Building Identification Number (B.I.N.) and address of each
building or project affected by the administrative error or omission;
(C) A statement explaining the administrative error or omission and
the intent of the Agency, or of the Agency and the affected taxpayer,
when the document was originally completed;
(D) Copies of any supporting documentation;
(E) A statement explaining the effect, if any, that a correction of
the administrative error or omission would have on the housing credit
dollar amount allocated for any building or project; and
(F) A statement explaining the effect, if any, that a correction of
the administrative error or omission would have on the determination of
the components of the State's housing credit ceiling under section
42(h)(3)(C) or on the State's unused housing credit carryover that is
assigned to the Secretary under section 42(h)(3)(D).
(v) Agreement to conditions. To obtain the Secretary's approval
under paragraph (b)(3)(iii) of this section, an Agency, or the Agency
and the affected taxpayer, must agree to the conditions the Secretary
considers appropriate.
(c) Examples. The following examples illustrate the scope of this
section:
Example 1. Individual B applied to Agency X for a reservation of a
low-income housing credit dollar amount for a building that is part of a
low-income housing project. When applying for the low-income housing
credit dollar amount, B informed Agency X that B intended to form
Partnership Y to finance the project. After receiving the reservation
letter and prior to receiving an allocation, B formed Partnership Y and
sold partnership interests to a number of limited partners. B
contributed the low-income housing project to Partnership Y in exchange
for a partnership interest. B and Partnership Y informed Agency X of the
ownership change. When actually allocating the housing credit dollar
amount, Agency X sent Partnership Y a document listing B, rather than
Partnership Y, as the building's owner. Partnership Y promptly notified
Agency X of the error. After reviewing related documents, Agency X
determined that it had incorrectly listed B as the building's owner on
the allocation document. Since the parties originally intended that
Partnership Y would receive the allocation as the owner of the building,
Agency X may correct the error without obtaining the Secretary's
approval, and insert Partnership Y as the building's owner on the
allocation document.
Example 2. Agency Y allocated a lower low-income housing credit
dollar amount for a low-income housing building than Agency Y originally
intended. After the close of the calendar year of the allocation, B, the
building's owner, discovered the error and promptly notified Agency Y.
Agency Y reviewed relevant documents and agreed that an error had
occurred. Agency Y and B must apply, as provided in paragraph (b)(3)(iv)
of this section, for the Secretary's approval before Agency Y may
correct the error.
(d) Effective date. This section is effective February 24, 1994.
However, an Agency may elect to apply these regulations to
administrative errors or omissions that occurred before the publication
of these regulations. Any reasonable method used by a State or local
housing credit agency to correct an administrative error or omission
prior to February 24, 1994, will be considered proper, provided that the
method is consistent with the rules of section 42.
[T.D. 8521, 59 FR 8861, Feb. 24, 1994]
[[Page 146]]
Sec. 1.42-14 Allocation rules for post-1989 State housing credit ceiling amounts.
(a) In general. The State housing credit ceiling for a State for any
calendar year after 1989 is comprised of four components. The four
components are--
(1) $1.25 multiplied by the State population (the population
component);
(2) The unused State housing credit ceiling, if any, of the State
for the preceding calendar year (the unused carryforward component);
(3) The amount of State housing credit ceiling returned in the
calendar year (the returned credit component); plus
(4) The amount, if any, allocated to the State by the Secretary
under section 42(h)(3)(D) from a national pool of unused credit (the
national pool component).
(b) The population component. The population component of the State
housing credit ceiling of a State for any calendar year is determined
pursuant to section 146(j). Thus, a State's population for any calendar
year is determined by reference to the most recent census estimate,
whether final or provisional, of the resident population of the State
released by the Bureau of the Census before the beginning of the
calendar year for which the State's housing credit ceiling is set.
Unless otherwise prescribed by applicable revenue procedure,
determinations of population are based on the most recent estimates of
population contained in the Bureau of the Census publication, Current
Population Report, Series P-25; Population Estimates and Projections,
Estimates of the Population of States. For convenience, the Internal
Revenue Service publishes the population estimates annually in the
Internal Revenue Bulletin. (See Sec. 601.601(d)(2)(ii)(b)).
(c) The unused carryforward component. The unused carryforward
component of the State housing credit ceiling of a State for any
calendar year is the excess, if any, of the sum of the population and
returned credit components, over the aggregate housing credit dollar
amount allocated for the year. Any credit amounts attributable to the
national pool component of the State housing credit ceiling that remain
unallocated at the close of a calendar year are not carried forward to
the succeeding calendar year; instead, the credit expires and cannot be
reallocated by any Agency.
(d) The returned credit component--(1) In general. The returned
credit component of the State housing credit ceiling of a State for any
calendar year equals the housing credit dollar amount returned during
the calendar year that was validly allocated within the State in a prior
calendar year to any project that does not become a qualified low-income
housing project within the period required by section 42, or as required
by the terms of the allocation. The returned credit component also
includes credit allocated in a prior calendar year that is returned as a
result of the cancellation of an allocation by mutual consent or by an
Agency's determination that the amount allocated is not necessary for
the financial feasibility of the project. For purposes of this section,
credit is allocated within a State if it is allocated from the State's
housing credit ceiling by an Agency of the State or of a constitutional
home rule city in the State.
(2) Limitations and special rules. The following limitations and
special rules apply for purposes of this paragraph (d).
(i) General limitations. Notwithstanding any other provision of this
paragraph (d), returned credit does not include any credit that was--
(A) Allocated prior to calendar year 1990;
(B) Allowable under section 42(h)(4) (relating to the portion of
credit attributable to eligible basis financed by certain tax-exempt
bonds under section 103); or
(C) Allocated during the same calendar year that it is received back
by the Agency.
(ii) Credit period limitation. Notwithstanding any other provision
of this paragraph (d), an allocation of credit may not be returned any
later than 180 days following the close of the first taxable year of the
credit period for the building that received the allocation. After this
date, credit that might otherwise be returned expires, and cannot be
returned to or reallocated by any Agency.
[[Page 147]]
(iii) Three-month rule for returned credit. An Agency may, in its
discretion, treat any portion of credit that is returned from a project
after September 30 of a calendar year and that is not reallocated by the
close of the calendar year as returned on January 1 of the succeeding
calendar year. In this case, the returned credit becomes part of the
returned credit component of the State housing credit ceiling for the
succeeding calendar year. Any portion of credit that is returned from a
project after September 30 of a calendar year that is reallocated by the
close of the calendar year is treated as part of the returned credit
component of the State housing credit ceiling for the calendar year that
the credit was returned.
(iv) Returns of credit. Subject to the limitations of paragraphs
(d)(2) (i) and (ii) of this section, credit is returned to the Agency in
the following instances in the manner described in paragraph (d)(3) of
this section.
(A) Building not qualified within required time period. If a
building is not a qualified building within the time period required by
section 42, it loses its credit allocation and the credit is returned.
For example, a building is not qualified within the required time period
if it is not placed in service within the period required by section 42
or if the project of which the building is a part fails to meet the
minimum set-aside requirements of section 42(g)(1) by the close of the
first year of the credit period.
(B) Noncompliance with terms of the allocation. If a building does
not comply with the terms of its allocation, it loses the credit
allocation and the credit is returned. The terms of an allocation are
the written conditions agreed to by the Agency and the allocation
recipient in the allocation document.
(C) Mutual consent. If the Agency and the allocation recipient
cancel an allocation of an amount of credit by mutual consent, that
amount of credit is returned.
(D) Amount not necessary for financial feasibility. If an Agency
determines under section 42(m)(2) that an amount of credit allocated to
a project is not necessary for the financial feasibility of the project
and its viability as a qualified low-income housing project throughout
the credit period, that amount of credit is returned.
(3) Manner of returning credit--( i) Taxpayer notification. After an
Agency determines that a building or project no longer qualifies under
paragraph (d)(2)(iv)(A), (B), or (D) of this section for all or part of
the allocation it received, the Agency must provide written notification
to the allocation recipient, or its successor in interest, that all or
part of the allocation is no longer valid. The notification must also
state the amount of the allocation that is no longer valid. The date of
the notification is the date the credit is returned to the Agency. If an
allocation is cancelled by mutual consent under paragraph (d)(2)(iv)(C)
of this section, there must be a written agreement signed by the Agency,
and the allocation recipient, or its successor in interest, indicating
the amount of the allocation that is returned to the Agency. The
effective date of the agreement is the date the credit is returned to
the Agency.
(ii) Internal Revenue Service notification. If a credit is returned
within 180 days following the close of the first taxable year of a
building's credit period as provided in paragraph (d)(2)(ii) of this
section, and a Form 8609, Low-Income Housing Credit Allocation
Certification, has been issued for the building, the Agency must notify
the Internal Revenue Service that the credit has been returned. If only
part of the credit has been returned, this notification requirement is
satisfied when the Agency attaches to an amended Form 8610, Annual Low-
Income Housing Credit Agencies Report, the original of an amended Form
8609 reflecting the correct amount of credit attributed to the building
together with an explanation for the filing of the amended Forms. The
Agency must send a copy of the amended Form 8609 to the taxpayer that
owns the building. If the building is not issued an amended Form 8609
because all of the credit allocated to the building is returned,
notification to the Internal Revenue Service is satisfied by following
the requirements prescribed in Sec. 1.42-5(e)(3) for filing a Form
[[Page 148]]
8823, Low-Income Housing Credit Agencies Report of Noncompliance.
(e) The national pool component. The national pool component of the
State housing credit ceiling of a State for any calendar year is the
portion of the National Pool allocated to the State by the Secretary for
the calendar year. The national pool component for any calendar year is
zero unless a State is a qualified State. (See paragraph (i) of this
section for rules regarding the National Pool and the description of a
qualified State.) Credit from the national pool component of a State
housing credit ceiling must be allocated prior to the close of the
calendar year or the credit expires and cannot be reallocated by any
Agency. A national pool component credit that is allocated during a
calendar year and returned after the close of the calendar year may
qualify as part of the returned credit component of the State housing
credit ceiling for the calendar year that the credit is returned.
(f) When the State housing credit ceiling is determined. For
purposes of accounting for the State housing credit ceiling on Form 8610
and for purposes of determining the set-aside apportionment for projects
involving qualified nonprofit organizations described in section
42(h)(5) and Sec. 1.42-1T(c)(5), the State housing credit ceiling for
any calendar year is determined at the close of the calendar year.
(g) Stacking order. Under section 42(h)(3)(C), credit is treated as
allocated from the various components of the State housing credit
ceiling in the following order. The first credit allocated for any
calendar year is treated as credit from the sum of the population and
returned credit components of the State housing credit ceiling. Once all
of the credit in these components has been allocated, the next credit
allocated is treated as credit from the unused carryforward component of
the State housing credit ceiling. Finally, after all of the credit from
the population component, returned credit component, and unused
carryforward component has been allocated, any further credit allocated
is treated as credit from the national pool component.
(h) Nonprofit set-aside--(1) Determination of set-aside. Under
section 42(h)(5) and Sec. 1.42-1T(c)(5), at least 10 percent of a State
housing credit ceiling in any calendar year must be set aside
exclusively for projects involving qualified nonprofit organizations
(the nonprofit set-aside). However, credit allocated from the nonprofit
set-aside in a calendar year and returned in a subsequent calendar year
does not retain its nonprofit set-aside character. The credit becomes
part of the returned credit component of the State housing credit
ceiling for the calendar year that the credit is returned and must be
included in determining the nonprofit set-aside of the State housing
credit ceiling for that calendar year. Similarly, credit amounts that
are not allocated from the nonprofit set-aside in a calendar year and
are returned in a subsequent calendar year become part of the returned
credit component of the State housing credit ceiling for that year and
are also included in determining the set-aside for that year.
(2) Allocation rules. An Agency may allocate credit from any
component of the State housing credit ceiling as part of the nonprofit
set-aside and need not reserve 10 percent of each component for the
nonprofit set-aside. Thus, an Agency may satisfy the nonprofit set-aside
requirement of section 42(h)(5) and Sec. 1.42-1T(c)(5) in any calendar
year by setting aside for allocation an amount equal to at least 10
percent of the total State housing credit ceiling for the calendar year.
(i) National Pool--(1) In general. The unused housing credit
carryover of a State for any calendar year is assigned to the Secretary
for inclusion in a national pool of unused housing credit carryovers
(National Pool) that is reallocated among qualified States the
succeeding calendar year. The assignment to the Secretary is made on
Form 8610.
(2) Unused housing credit carryover. The unused housing credit
carryover of a State for any calendar year is the excess, if any, of the
unused carryforward component of the State housing credit ceiling for
the calendar year over the excess, if any, of--
(i) The total housing credit dollar amount allocated for the year;
over
[[Page 149]]
(ii) The sum of the population and returned credit components of the
State housing credit ceiling for the year.
(3) Qualified State--(i) In general. The term qualified State means,
with respect to any calendar year, any State that has allocated its
entire State housing credit ceiling for the preceding calendar year and
for which a request is made by the State, not later than May 1 of the
calendar year, to receive an allocation of credit from the National Pool
for that calendar year. Except as provided in paragraph (i)(3)(ii) of
this section, a State is not a qualified State in a calendar year if
there remains any unallocated credit in its State housing credit ceiling
at the close of the preceding calendar year that was apportioned to any
Agency within the State for the calendar year.
(ii) Exceptions--(A) De minimis amount. If the amount remaining
unallocated at the close of a calendar year is only a de minimis amount
of credit, the State is a qualified State eligible to participate in the
National Pool. For that purpose, a credit amount is de minimis if it
does not exceed 1 percent of the aggregate State housing credit ceiling
of the State for the calendar year.
(B) Other circumstances. Pursuant to the authority under section
42(n), the Internal Revenue Service may determine that a State is a
qualified State eligible to participate in the National Pool even though
the State's unallocated credit is in excess of the 1 percent safe harbor
set forth in paragraph (A) of this section. The Internal Revenue Service
will make this determination based on all the facts and circumstances,
weighing heavily the interests of the States who would otherwise qualify
for the National Pool. The Internal Revenue Service will generally grant
relief under this paragraph only where a State's unallocated credit is
not substantial.
(iii) Time and manner for making request. For further guidance as to
the time and manner for making a request of housing credit dollar
amounts from the National Pool by a qualified State, see Rev. Proc. 92-
31, 1992-1 C.B. 775. (See 601.601(d)(2)(ii)(b)).
(4) Formula for determining the National Pool. The amount allocated
to a qualified State in any calendar year is an amount that bears the
same ratio to the aggregate unused housing credit carryovers of all
States for the preceding calendar year as that State's population for
the calendar year bears to the population of all qualified States for
the calendar year.
(j) Coordination between Agencies. The Agency responsible for filing
Form 8610 on behalf of all Agencies within a State and making any
request on behalf of the State for credit from the National Pool (the
Filing Agency) must coordinate with each Agency within the State to
ensure that the various requirements of this section are complied with.
For example, the Filing Agency of a State must ensure that all Agencies
within the State that were apportioned a credit amount for the calendar
year have allocated all of their respective credit amounts for the
calendar year before the Filing Agency can make a request on behalf of
the State for a distribution of credit from the National Pool.
(k) Examples. (1) The operation of the rules of this section may be
illustrated by the following examples. Unless otherwise stated in an
example, Agency A is the sole Agency authorized to make allocations of
housing credit dollar amounts in State M, all of Agency A's allocations
are valid, and for calendar year 1994 Agency A has available for
allocation a State housing credit ceiling consisting of the following
housing credit dollar amounts:
A. Population component........................................ $100
B. Unused carryforward component............................... 50
C. Returned credit component................................... 10
D. National pool component..................................... 0
--------
Total.................................................... 160
(2) In addition, the $10 of returned credit component was returned
before October 1, 1994.
Example 1--(i) Additional facts. By the close of 1994, Agency A had
allocated $80 of the State M housing credit ceiling. Of the $80
allocated, $16 was allocated to projects involving qualified nonprofit
organizations.
(ii) Application of stacking rules. The first credit allocated is
treated as allocated from the population and returned credit components
of the State housing credit ceiling, to the extent of those components.
In this case, the $80 of credit allocated is less than the sum of the
population and returned credit
[[Page 150]]
components. The excess of the sum of the population and returned credit
components over the total amount allocated for the calendar year
($110-80=$30) becomes the unused carryforward component of State M's
1995 State housing credit ceiling. Because Agency A did not allocate
credit in excess of the sum of the population and returned credit
components, no credit is treated as allocated from State M's $50 unused
carryforward component in 1994. Because none of this component may be
carried forward, all $50 is assigned to the Secretary for inclusion in
the National Pool. Under paragraph (i)(3) of this section, State M does
not qualify for credit from the National Pool for the 1995 calendar
year.
(iii) Nonprofit set-aside. Agency A allocated exactly the amount of
credit to projects involving qualified nonprofit organizations as
necessary to meet the nonprofit set-aside requirement ($16, 10% of the
$160 ceiling).
Example 2--(i) Additional facts. By the close of 1994, Agency A had
allocated $130 of the State M housing credit ceiling. Of the $130
allocated, $20 was allocated to projects involving qualified nonprofit
organizations.
(ii) Application of stacking rules. The first $110 of credit
allocated is treated as allocated from the population and returned
credit components. In this case, because all of the population and
returned credit components are allocated, no amount is included in State
M's 1995 State housing credit ceiling as an unused carryforward
component. The next $20 of credit allocated is treated as allocated from
the $50 unused carryforward component. The $30 remaining in the unused
carryforward component is assigned to the Secretary for inclusion in the
National Pool for the 1995 calendar year. Under paragraph (i)(3) of this
section, State M does not qualify for credit from the National Pool for
the 1995 calendar year.
(iii) Nonprofit set-aside. Agency A allocated $4 more credit to
projects involving qualified nonprofit organizations than necessary to
meet the nonprofit set-aside requirement. This does not reduce the
application of the 10% nonprofit set-aside requirement to the State M
housing credit ceiling for the succeeding year.
Example 3--(i) Additional fact. None of the applications for credit
that Agency A received for 1994 are for projects involving qualified
nonprofit organizations.
(ii) Nonprofit set-aside. Because at least 10% of the State housing
credit ceiling must be set aside for projects involving a qualified
nonprofit organization, Agency A can allocate only $144 of the $160
State housing credit ceiling for calendar year 1994 ($160-16=$144). If
Agency A allocates $144 of credit, the credit is treated as allocated
$110 from the population and returned credit components and $34 from the
unused carryforward component. The $16 of unallocated credit that is set
aside for projects involving qualified nonprofit organizations is
treated as the balance of the unused carryforward component, and is
assigned to the Secretary for inclusion in the National Pool. Under
paragraph (i)(3) of this section, State M does not qualify for credit
from the National Pool for the 1995 calendar year.
Example 4--(i) Additional facts. The $10 of returned credit
component was returned prior to October 1, 1994. However, a $40 credit
that had been allocated in calendar year 1993 to a project involving a
qualified nonprofit organization was returned to the Agency by a mutual
consent agreement dated November 15, 1994. By the close of 1994, Agency
A had allocated $160 of the State M housing credit ceiling, including
$16 of credit to projects involving qualified nonprofit organizations.
(ii) Effect of three-month rule. Under the three-month rule of
paragraph (d)(2)(iii) of this section, Agency A may treat all or part of
the $40 of previously allocated credit as returned on January 1, 1995.
If Agency A treats all of the $40 amount as having been returned in
calendar year 1995, the State M housing credit ceiling for 1994 is $160.
This entire amount, including the $16 nonprofit set-aside, has been
allocated in 1994. Under paragraph (i)(3) of this section, State M
qualifies for the National Pool for the 1995 calendar year.
(iii) If three-month rule not used. If Agency A treats all of the
$40 of previously allocated credit as returned in calendar year 1994,
the State housing credit ceiling for the 1994 calendar year will be $200
of which $50 will be attributable to the returned credit component
($10+$40=$50). Because credit amounts allocated in a prior calendar year
that are returned in a subsequent calendar year do not retain their
nonprofit character, the nonprofit set-aside for calendar year 1994 is
$20 (10% of $200). The $160 that Agency A allocated during 1994 is first
treated as allocated from the population and returned credit components,
which total $150. The next $10 of credit allocated is treated as
allocated from the unused carryforward component. The $40 of unallocated
credit from the unused carryforward component includes the $4 of
unallocated nonprofit set-aside. The entire $40 of credit from the
carryforward component is assigned to the Secretary for inclusion in the
National Pool for the 1995 calendar year. State M does not qualify for
credit from the National Pool for the 1995 calendar year.
Example 5--(i) (A) Additional facts. For calendar year 1994, Agency
A has a State housing credit ceiling that consists of the following
housing credit dollar amounts:
A. Population component........................................ $100
B. Unused carryforward component............................... 0
[[Page 151]]
C. Returned credit component................................... 20
D. National pool component..................................... 10
--------
Total.................................................... 130
Minimum nonprofit set-aside.................................... 13
Ceiling amount not set-aside................................... 117
In addition, the $20 of returned credit component was returned
before October 1, 1994. By the close of 1994, Agency A had allocated
$100 of the State housing credit ceiling.
(ii) Application of stacking rules. The $20 excess of the sum of the
population component and the returned credit component over the total
amount allocated for the calendar year ($120-100=$20) becomes the unused
carryforward component of the State housing credit ceiling for the 1995
calendar year. The $10 of unallocated credit from the national pool
component expires and cannot be reallocated. This amount is neither
carried over to 1995 by State M nor assigned to the Secretary for
inclusion in the National Pool. Under paragraph (i)(3) of this section,
State M does not qualify for credit from the National Pool for the 1995
calendar year.
(l) Effective date. The rules set forth in Sec. 1.42-14 are
effective January 1, 1994.
[T.D. 8563, 59 FR 50163, Oct. 3, 1994; 60 FR 3345, Jan. 17, 1995]
Sec. 1.42-15 Available unit rule.
(a) Definitions. The following definitions apply to this section:
Applicable income limitation means the limitation applicable under
section 42(g)(1) or, for deep rent skewed projects described in section
142(d)(4)(B), 40 percent of area median gross income.
Available unit rule means the rule in section 42(g)(2)(D)(ii).
Comparable unit means a residential unit in a low-income building
that is comparably sized or smaller than an over-income unit or, for
deep rent skewed projects described in section 142(d)(4)(B), any low-
income unit. For purposes of determining whether a residential unit is
comparably sized, a comparable unit must be measured by the same method
used to determine qualified basis for the credit year in which the
comparable unit became available.
Current resident means a person who is living in the low-income
building.
Low-income unit is defined by section 42(i)(3)(A).
Nonqualified resident means a new occupant or occupants whose
aggregate income exceeds the applicable income limitation.
Over-income unit means a low-income unit in which the aggregate
income of the occupants of the unit increases above 140 percent of the
applicable income limitation under section 42(g)(1), or above 170
percent of the applicable income limitation for deep rent skewed
projects described in section 142(d)(4)(B).
Qualified resident means an occupant either whose aggregate income
(combined with the income of all other occupants of the unit) does not
exceed the applicable income limitation and who is otherwise a low-
income resident under section 42, or who is a current resident.
(b) General section 42(g)(2)(D)(i) rule. Except as provided in
paragraph (c) of this section, notwithstanding an increase in the income
of the occupants of a low-income unit above the applicable income
limitation, if the income of the occupants initially met the applicable
income limitation, and the unit continues to be rent-restricted--
(1) The unit continues to be treated as a low-income unit; and
(2) The unit continues to be included in the numerator and the
denominator of the ratio used to determine whether a project satisfies
the applicable minimum set-aside requirement of section 42(g)(1).
(c) Exception. A unit ceases to be treated as a low-income unit if
it becomes an over-income unit and a nonqualified resident occupies any
comparable unit that is available or that subsequently becomes available
in the same low-income building. In other words, the owner of a low-
income building must rent to qualified residents all comparable units
that are available or that subsequently become available in the same
building to continue treating the over-income unit as a low-income unit.
Once the percentage of low-income units in a building (excluding the
over-income units) equals the percentage of low-income units on which
the credit is based, failure to maintain the over-income units as low-
income units has no immediate significance. The failure to maintain the
over-income units as low-income units, however, may affect the decision
of
[[Page 152]]
whether or not to rent a particular available unit at market rate at a
later time. A unit is not available for purposes of the available unit
rule when the unit is no longer available for rent due to contractual
arrangements that are binding under local law (for example, a unit is
not available if it is subject to a preliminary reservation that is
binding on the owner under local law prior to the date a lease is signed
or the unit is occupied).
(d) Effect of current resident moving within building. When a
current resident moves to a different unit within the building, the
newly occupied unit adopts the status of the vacated unit. Thus, if a
current resident, whose income exceeds the applicable income limitation,
moves from an over-income unit to a vacant unit in the same building,
the newly occupied unit is treated as an over-income unit. The vacated
unit assumes the status the newly occupied unit had immediately before
it was occupied by the current resident.
(e) Available unit rule applies separately to each building in a
project. In a project containing more than one low-income building, the
available unit rule applies separately to each building.
(f) Result of noncompliance with available unit rule. If any
comparable unit that is available or that subsequently becomes available
is rented to a nonqualified resident, all over-income units for which
the available unit was a comparable unit within the same building lose
their status as low-income units; thus, comparably sized or larger over-
income units would lose their status as low-income units.
(g) Relationship to tax-exempt bond provisions. Financing
arrangements that purport to be exempt-facility bonds under section 142
must meet the requirements of sections 103 and 141 through 150 for
interest on the obligations to be excluded from gross income under
section 103(a). This section is not intended as an interpretation under
section 142.
(h) Examples. The following examples illustrate this section:
Example 1. This example illustrates noncompliance with the available
unit rule in a low-income building containing three over-income units.
On January 1, 1998, a qualified low-income housing project, consisting
of one building containing ten identically sized residential units,
received a housing credit dollar amount allocation from a state housing
credit agency for five low-income units. By the close of 1998, the first
year of the credit period, the project satisfied the minimum set-aside
requirement of section 42(g)(1)(B). Units 1, 2, 3, 4, and 5 were
occupied by individuals whose incomes did not exceed the income
limitation applicable under section 42(g)(1) and were otherwise low-
income residents under section 42. Units 6, 7, 8, and 9 were occupied by
market-rate tenants. Unit 10 was vacant. To avoid recapture of credit,
the project owner must maintain five of the units as low-income units.
On November 1, 1999, the certificates of annual income state that annual
incomes of the individuals in Units 1, 2, and 3 increased above 140
percent of the income limitation applicable under section 42(g)(1),
causing those units to become over-income units. On November 30, 1999,
Units 8 and 9 became vacant. On December 1, 1999, the project owner
rented Units 8 and 9 to qualified residents who were not current
residents at rates meeting the rent restriction requirements of section
42(g)(2). On December 31, 1999, the project owner rented Unit 10 to a
market-rate tenant. Because Unit 10, an available comparable unit, was
leased to a market-rate tenant, Units 1, 2, and 3 ceased to be treated
as low-income units. On that date, Units 4, 5, 8, and 9 were the only
remaining low-income units. Because the project owner did not maintain
five of the residential units as low-income units, the qualified basis
in the building is reduced, and credit must be recaptured. If the
project owner had rented Unit 10 to a qualified resident who was not a
current resident, eight of the units would be low-income units. At that
time, Units 1, 2, and 3, the over-income units, could be rented to
market-rate tenants because the building would still contain five low-
income units.
Example 2. This example illustrates the provisions of paragraph (d)
of this section. A low-income project consists of one six-floor
building. The residential units in the building are identically sized.
The building contains two over-income units on the sixth floor and two
vacant units on the first floor. The project owner, desiring to maintain
the over-income units as low-income units, wants to rent the available
units to qualified residents. J, a resident of one of the over-income
units, wishes to occupy a unit on the first floor. J's income has
recently increased above the applicable income limitation. The project
owner permits J to move into one of the units on the first floor.
Despite J's income exceeding the applicable income limitation, J is a
qualified resident under the available unit rule because J is a current
resident of the building. The unit newly occupied by J becomes an over-
income unit
[[Page 153]]
under the available unit rule. The unit vacated by J assumes the status
the newly occupied unit had immediately before J occupied the unit. The
over-income units in the building continue to be treated as low-income
units.
(i) Effective date. This section applies to leases entered into or
renewed on and after September 26, 1997.
[T.D. 8732, 62 FR 50505, Sept. 26, 1997]
Sec. 1.42-16 Eligible basis reduced by federal grants.
(a) In general. If, during any taxable year of the compliance period
(described in section 42(i)(1)), a grant is made with respect to any
building or the operation thereof and any portion of the grant is funded
with federal funds (whether or not includible in gross income), the
eligible basis of the building for the taxable year and all succeeding
taxable years is reduced by the portion of the grant that is so funded.
(b) Grants do not include certain rental assistance payments. A
federal rental assistance payment made to a building owner on behalf or
in respect of a tenant is not a grant made with respect to a building or
its operation if the payment is made pursuant to--
(1) Section 8 of the United States Housing Act of 1937 (42 U.S.C.
1437f)
(2) A qualifying program of rental assistance administered under
section 9 of the United States Housing Act of 1937 (42 U.S.C. 1437g); or
(3) A program or method of rental assistance as the Secretary may
designate by publication in the Federal Register or in the Internal
Revenue Bulletin (see Sec. 601.601(d)(2) of this chapter).
(c) Qualifying rental assistance program. For purposes of paragraph
(b)(2) of this section, payments are made pursuant to a qualifying
rental assistance program administered under section 9 of the United
States Housing Act of 1937 to the extent that the payments--
(1) Are made to a building owner pursuant to a contract with a
public housing authority with respect to units the owner has agreed to
maintain as public housing units (PH-units) in the building;
(2) Are made with respect to units occupied by public housing
tenants, provided that, for this purpose, units may be considered
occupied during periods of short term vacancy (not to exceed 60 days);
and
(3) Do not exceed the difference between the rents received from a
building's PH-unit tenants and a pro rata portion of the building's
actual operating costs that are reasonably allocable to the PH-units
(based on square footage, number of bedrooms, or similar objective
criteria), and provided that, for this purpose, operating costs do not
include any development costs of a building (including developer's fees)
or the principal or interest of any debt incurred with respect to any
part of the building.
(d) Effective date. This section is effective September 26, 1997.
[T.D. 8731, 62 FR 50503, Sept. 26, 1997]
Sec. 1.42A-1 General tax credit for taxable years ending after December 31, 1975, and before January 1, 1979.
(a)(1) Allowance of credit for taxable years ending after December
31, 1975, and beginning before January 1, 1977. Subject to the special
rules of paragraphs (b)(1), (c) and (d) and the limitation of paragraph
(e)(1) of this section, an individual is allowed as a credit against the
tax imposed by chapter 1 for the taxable year in the case of taxable
years ending after December 31, 1975, and beginning before January 1,
1977, an amount equal to the greater of--
(i) 2 percent of so much of the individual's taxable income as does
not exceed $9,000, or
(ii) $35 multiplied by the total number of deductions for personal
exemptions to which the individual is entitled for the taxable year
under section 151 (b) and (e) and the regulations thereunder (relating
to allowance of deductions for personal exemptions with respect to the
individual, the individual's spouse, and dependents).
For purposes of applying subdivision (ii) of this paragraph (a)(1), the
total number of deductions for personal exemptions shall not include any
additional exemptions to which the individual or his spouse may be
entitled based upon age of 65 or more or blindness under section 151 (c)
or (d) and the regulations thereunder.y
[[Page 154]]
(2) Allowance of credit for taxable years beginning after December
31, 1976, and ending before January 1, 1979. Subject to the special
rules of paragraphs (b)(2), (c) and (d) and the limitation of paragraph
(e)(2) of this section, an individual is allowed as a credit against the
tax imposed by section 1, or against the tax imposed in lieu of the tax
imposed by section 1, for the taxable year in the case of taxable years
beginning after December 31, 1976, and ending before January 1, 1979, an
amount equal to the greater of--
(i) 2 percent of so much of the individual's taxable income for the
taxable year, reduced by the zero bracket amount determined under
section 63 (d), as does not exceed $9,000, or
(ii) $35 multiplied by the total number of deductions for personal
exemptions to which the individual is entitled for the taxable year
under section 151 and the regulations thereunder (relating to allowance
of deductions for personal exemptions).
(b) Married individuals filing separate returns--(1) For taxable
years ending after December 31, 1975, and beginning before January 1,
1977. In the case of taxable years ending after December 31, 1975, and
beginning before January 1, 1977, a married individual who files a
separate return for the taxable year is allowed as a credit for the
taxable year an amount equal to either--
(i) 2 percent of so much of the individual's taxable income as does
not exceed $4,500, or
(ii) $35 multiplied by the total number of deductions for personal
exemptions to which the individual is entitled for the taxable year
under section 151 (b) and (e) and the regulations thereunder, but only
if both the individual and the individual's spouse elect to have the
credit determined in the manner described in this subdivision (ii) for
their corresponding taxable years. The elections shall be made by both
married individuals separately calculating and claiming the credit in
the manner and amount described in this subdivision (ii) on their
separate returns for their corresponding taxable years. The rules of
section 142 (a) and the regulations thereunder (relating to individuals
not eligible for the standard deduction) in effect for taxable years
beginning before January 1, 1977, apply to determine whether the taxable
years of the individual and the individual's spouse correspond to each
other. For purposes of applying this subdivision (ii), the total number
of deductions for personal exemptions shall not include any additional
exemptions to which the individual may be entitled based upon age of 65
or more or blindness under section 151 (c) or (d) and the regulations
thereunder.
(2) For taxable years beginning after December 31, 1976, and ending
before January 1, 1979. In the case of taxable years beginning after
December 31, 1976, and ending before January 1, 1979, a married
individual who files a separate return for the taxable year shall
determine the amount of the credit for the taxable year under section
42(a)(2) and Sec. 1.42A-1(a)(2)(ii).
(3) Determination of marital status. For purposes of this paragraph,
the determination of marital status shall be made as provided by section
143 and the regulations thereunder (relating to the determination of
marital status).
(c) Return for short period on change of annual accounting period.
In computing the credit provided by section 42 and this section for a
period of less than 12 months (hereinafter referred to as a ``short
period''), where income is to be annualized under section 443(b)(1) in
order to determine the tax--
(1) The credit allowed by paragraphs (a) (1)(i) and (2)(i) of this
section shall be computed based upon the amount of the taxable income
annualized under the rules of section 443(b)(1) and Sec. 1.443-1(b)(1),
or
(2)(i) The credit allowed by paragraph (a)(1)(ii) of this section
shall be computed based upon the total number of deductions for personal
exemptions to which the individual is entitled for the short period
under section 151 (b) and (e) and the regulations thereunder (relating
to allowance of deductions for personal exemptions with respect to the
individual, the individual's spouse, and dependents), and
(ii) The credit allowed by paragraph (a)(2)(ii) of this section
shall be computed based upon the total number of deductions for personal
exemptions to which the individual is entitled for the short period
under section 151 and the
[[Page 155]]
regulations thereunder (relating to allowance of deductions for personal
exemptions).
As so computed, the credit allowed by section 42 and this section shall
be allowed against the tax computed on the basis of the annualized
taxable income. See Sec. 1.443-1(b)(1)(vi).
(d) Certain persons not eligible--(1) Estates and trusts. The credit
provided by section 42 and this section shall not be allowed in the case
of any estate or trust. Thus, the credit shall not be allowed to an
estate of an individual in bankruptcy or to an estate of a deceased
individual. However, in the case of a deceased individual, the credit
shall be allowed on the decedent's final return filed by his executor or
other representative. Also, the credit provided by section 42 and this
section shall be allowed in the case of a return filed by an estate of
an infant, incompetent, or an individual under a disability.
(2) Nonresident alien individuals. The credit provided by section 42
and this section shall not be allowed in the case of any nonresident
alien individual. As used in this subparagraph, the term ``nonresident
alien individual'' has the meaning provided by Sec. 1.871-2. See,
however, section 6013(g) for election to treat nonresident alien
individual as resident of the United States. The credit shall be allowed
to an alien individual who is a resident of the United States for part
of the taxable year. See Sec. 1.871-2(b) for rules relating to the
determination of residence of an alien individual. For purposes of
paragraphs (a) (1)(i) and (2)(i) of this section, the credit allowed
shall be computed by taking into account only that portion of the
individual's taxable income which is attributable to the period of his
residence in the United States. For purposes of paragraph (a)(1)(ii) of
this section, the credit allowed shall be computed by taking into
account only the total number of deductions for personal exemptions to
which the individual is entitled under section 151 (b) and (e) for the
period of his residence in the United States. For purposes of paragraph
(a)(2)(ii) of this section, the credit allowed shall be computed by
taking into account only the total number of deductions for personal
exemptions to which the individual is entitled under section 151 for the
period of his residence in the United States. See Sec. 1.871-13 for
rules relating to changes of residence status during a taxable year.
(e) Limitation--(1) For taxable years ending after December 31,
1975, and beginning before January 1, 1977. For taxable years ending
after December 31, 1975, and beginning before January 1, 1977, the
credit allowed by section 42 and this section shall not exceed the
amount of tax imposed by chapter 1 for the taxable year. In the case of
an alien individual who is a resident of the United States for a part of
the taxable year, the credit allowed by section 42 and this section
shall not exceed the amount of tax imposed by chapter 1 for that portion
of the taxable year during which the alien individual was a resident of
the United States. See Sec. 1.871-13.
(2) For taxable years beginning after December 31, 1976, and ending
before January 1, 1979. For taxable years beginning after December 31,
1976, and ending before January 1, 1979, the credit allowed by section
42 and this section shall not exceed the amount of tax imposed by
section 1, or the amount of tax imposed in lieu of the tax imposed by
section 1, for the taxable year. In the case of an alien individual who
is a resident of the United States for a part of the taxable year, the
credit allowed by section 42 and this section shall not exceed the
amount of tax imposed by section 1, or the amount of tax imposed in lieu
of the tax imposed by section 1, for that portion of the taxable year
during which the alien individual was a resident of the United States.
See Sec. 1.871-13.
(f) Application with other credits. In determining the credits
allowed under--
(1) Section 33 (relating to foreign tax credit),
(2) Section 37 (relating to credit for the elderly),
(3) Section 38 (relating to investment in certain depreciable
property),
(4) Section 40 (relating to expenses of work incentive programs),
and
(5) Section 41 (relating to contributions to candidates for public
office),
the tax imposed for the taxable year shall first be reduced (before any
other
[[Page 156]]
reduction) by the credit allowed by section 42 and this section for the
taxable year.
(g) Income tax tables to reflect credit. The tables prescribed under
section 3 shall reflect the credit allowed by section 42 and this
section.
(h) Effective dates. The credit allowed by section 42 and this
section applies only for taxable years ending after December 31, 1975,
and before January 1, 1979.
[T.D. 7547, 43 FR 19653, May 8, 1978]
Sec. 1.43-0 Table of contents.
This section lists the captions contained in Secs. 1.43-0 through
1.43-7.
Sec. 1.43-1 The enhanced oil recovery credit--general rules.
(a) Claiming the credit.
(1) In general.
(2) Examples.
(b) Amount of the credit.
(c) Phase-out of the credit as crude oil prices increase.
(1) In general.
(2) Inflation adjustment.
(3) Examples.
(d) Reduction of associated deductions.
(1) In general.
(2) Certain deductions by an integrated oil company.
(e) Basis adjustment.
(f) Passthrough entity basis adjustment.
(1) Partners' interests in a partnership.
(2) Shareholders' stock in an S corporation.
(g) Examples.
Sec. 1.43-2 Qualified enhanced oil recovery project.
(a) Qualified enhanced oil recovery project.
(b) More than insignificant increase.
(c) First injection of liquids, gases, or other matter.
(1) In general.
(2) Example.
(d) Significant expansion exception.
(1) In general.
(2) Substantially unaffected reservoir volume.
(3) Terminated projects.
(4) Change in tertiary recovery method.
(5) Examples.
(e) Qualified tertiary recovery methods.
(1) In general.
(2) Tertiary recovery methods that qualify.
(3) Recovery methods that do not qualify.
(4) Examples.
Sec. 1.43-3 Certification.
(a) Petroleum engineer's certification of a project.
(1) In general.
(2) Timing of certification.
(3) Content of certification.
(b) Operator's continued certification of a project.
(1) In general.
(2) Timing of certification.
(3) Content of certification.
(c) Notice of project termination.
(1) In general.
(2) Timing of notice.
(3) Content of notice.
(d) Failure to submit certification.
(e) Effective date.
Sec. 1.43-4 Qualified enhanced oil recovery costs.
(a) Qualifying costs.
(1) In general.
(2) Costs paid or incurred for an asset which is used to implement
more than one qualified enhanced oil recovery project or for other
activities.
(b) Costs defined.
(1) Qualified tertiary injectant expenses.
(2) Intangible drilling and development costs.
(3) Tangible property costs.
(4) Examples.
(c) Primary purpose.
(1) In general.
(2) Tertiary injectant costs.
(3) Intangible drilling and development costs.
(4) Tangible property costs.
(5) Offshore drilling platforms.
(6) Examples.
(d) Costs paid or incurred prior to first injection.
(1) In general.
(2) First injection after filing of return for taxable year costs
are allowable.
(3) First injection more than 36 months after close of taxable year
costs are paid or incurred.
(4) Injections in volumes less than the volumes specified in the
project plan.
(5) Examples.
(e) Other rules.
(1) Anti-abuse rule.
(2) Costs paid or incurred to acquire a project.
(3) Examples.
Sec. 1.43-5 At-risk limitation.
Sec. 1.43-6 Election out of section 43.
(a) Election to have the credit not apply.
(1) In general.
(2) Time for making the election.
(3) Manner of making the election.
(b) Election by partnerships and S corporations.
Sec. 1.43-7 Effective date of regulations.
[T.D. 8448, 57 FR 54923, Nov. 23, 1992]
[[Page 157]]
Sec. 1.43-1 The enhanced oil recovery credit--general rules.
(a) Claiming the credit--(1) In general. The enhanced oil recovery
credit (the ``credit'') is a component of the section 38 general
business credit. A taxpayer that owns an operating mineral interest (as
defined in Sec. 1.614-2(b)) in a property may claim the credit for
qualified enhanced oil recovery costs (as described in Sec. 1.43-4) paid
or incurred by the taxpayer in connection with a qualified enhanced oil
recovery project (as described in Sec. 1.43-2) undertaken with respect
to the property. A taxpayer that does not own an operating mineral
interest in a property may not claim the credit. To the extent a credit
included in the current year business credit under section 38(b) is
unused under section 38, the credit is carried back or forward under the
section 39 business credit carryback and carryforward rules.
(2) Examples. The following examples illustrate the principles of
this paragraph (a).
Example 1. Credit for operating mineral interest owner. In 1992, A,
the owner of an operating mineral interest in a property, begins a
qualified enhanced oil recovery project using cyclic steam. B, who owns
no interest in the property, purchases and places in service a steam
generator. B sells A steam, which A uses as a tertiary injectant
described in section 193. Because A owns an operating mineral interest
in the property with respect to which the project is undertaken, A may
claim a credit for the cost of the steam. Although B owns the steam
generator used to produce steam for the project, B may not claim a
credit for B's costs because B does not own an operating mineral
interest in the property.
Example 2. Credit for operating mineral interest owner. C and D are
partners in CD, a partnership that owns an operating mineral interest in
a property. In 1992, CD begins a qualified enhanced oil recovery project
using cyclic steam. D purchases a steam generator and sells steam to CD.
Because CD owns an operating mineral interest in the property with
respect to which the project is undertaken, CD may claim a credit for
the cost of the steam. Although D owns the steam generator used to
produce steam for the project, D may not claim a credit for the costs of
the steam generator because D paid these costs in a capacity other than
that of an operating mineral interest owner.
(b) Amount of the credit. A taxpayer's credit is an amount equal to
15 percent of the taxpayer's qualified enhanced oil recovery costs for
the taxable year, reduced by the phase-out amount, if any, determined
under paragraph (c) of this section.
(c) Phase-out of the credit as crude oil prices increase--(1) In
general. The amount of the credit (determined without regard to this
paragraph (c)) for any taxable year is reduced by an amount which bears
the same ratio to the amount of the credit (determined without regard to
this paragraph (c)) as--
(i) The amount by which the reference price determined under section
29(d)(2)(C) for the calendar year immediately preceding the calendar
year in which the taxable year begins exceeds $28 (as adjusted under
paragraph (c)(2) of this section); bears to
(ii) $6.
(2) Inflation adjustment--(i) In general. For any taxable year
beginning in a calendar year after 1991, an amount equal to $28
multiplied by the inflation adjustment factor is substituted for the $28
amount under paragraph (c)(1)(i) of this section.
(ii) Inflation adjustment factor. For purposes of this paragraph
(c), the inflation adjustment factor for any calendar year is a
fraction, the numerator of which is the GNP implicit price deflator for
the preceding calendar year and the denominator of which is the GNP
implicit price deflator for 1990. The ``GNP implicit price deflator'' is
the first revision of the implicit price deflator for the gross national
product as computed and published by the Secretary of Commerce. As early
as practicable, the inflation adjustment factor for each calendar year
will be published by the Internal Revenue Service in the Internal
Revenue Bulletin.
(3) Examples. The following examples illustrate the principles of
this paragraph (c).
Example 1. Reference price exceeds $28. In 1992, E, the owner of an
operating mineral interest in a property, incurs $100 of qualified
enhanced oil recovery costs. The reference price for 1991 determined
under section 29(d)(2)(C) is $30 and the inflation adjustment factor for
1992 is 1. E's credit for 1992 determined without regard to the phase-
out for crude oil price increases is $15 ($100 x 15%). In determining
E's credit, the credit is reduced
[[Page 158]]
by $5 ($15 x ($30 - ($28 x 1))/6). Accordingly, E's credit for 1992
is $10 ($15 - $5).
Example 2. Inflation adjustment. In 1993, F, the owner of an
operating mineral interest in a property, incurs $100 of qualified
enhanced oil recovery costs. The 1992 reference price is $34, and the
1993 inflation adjustment factor is 1.10. F's credit for 1993 determined
without regard to the phase-out for crude oil price increases is $15
($100 x 15%). In determining F's credit, $30.80 (1.10 x $28) is
substituted for $28, and the credit is reduced by $8 ($15 x ($34 -
$30.80)/6). Accordingly, F's credit for 1993 is $7 ($15 - $8).
(d) Reduction of associated deductions--(1) In general. Any
deduction allowable under chapter 1 for an expenditure taken into
account in computing the amount of the credit determined under paragraph
(b) of this section is reduced by the amount of the credit attributable
to the expenditure.
(2) Certain deductions by an integrated oil company. For purposes of
determining the intangible drilling and development costs that an
integrated oil company must capitalize under section 291(b), the amount
allowable as a deduction under section 263(c) is the deduction allowable
after paragraph (d)(1) of this section is applied. See Sec. 1.43-4(b)(2)
(extent to which integrated oil company intangible drilling and
development costs are qualified enhanced oil recovery costs).
(e) Basis adjustment. For purposes of subtitle A, the increase in
the basis of property which would (but for this paragraph (e)) result
from an expenditure with respect to the property is reduced by the
amount of the credit determined under paragraph (b) of this section
attributable to the expenditure.
(f) Passthrough entity basis adjustment--(1) Partners' interests in
a partnership. To the extent a partnership expenditure is not deductible
under paragraph (d)(1) of this section or does not increase the basis of
property under paragraph (e) of this section, the expenditure is treated
as an expenditure described in section 705(a)(2)(B) (concerning
decreases to basis of partnership interests). Thus, the adjusted bases
of the partners' interests in the partnership are decreased (but not
below zero).
(2) Shareholders' stock in an S corporation. To the extent an S
corporation expenditure is not deductible under paragraph (d)(1) of this
section or does not increase the basis of property under paragraph (e)
of this section, the expenditure is treated as an expenditure described
in section 1367(a)(2)(D) (concerning decreases to basis of S corporation
stock). Thus, the bases of the shareholders' S corporation stock are
decreased (but not below zero).
(g) Examples. The following examples illustrate the principles of
paragraphs (d) through (f) of this section.
Example 1. Deductions reduced for credit amount. In 1992, G, the
owner of an operating mineral interest in a property, incurs $100 of
intangible drilling and development costs in connection with a qualified
enhanced oil recovery project undertaken with respect to the property. G
elects under section 263(c) to deduct these intangible drilling and
development costs. The amount of the credit determined under paragraph
(b) of this section attributable to the $100 of intangible drilling and
development costs is $15 ($100 x 15%). Therefore, G's otherwise
allowable deduction of $100 for the intangible drilling and development
costs is reduced by $15. Accordingly, in 1992, G may deduct under
section 263(c) only $85 ($100 - $15) for these costs.
Example 2. Integrated oil company deduction reduced. The facts are
the same as in Example 1, except that G is an integrated oil company. As
in Example 1, the amount of the credit determined under paragraph (b) of
this section attributable to the $100 of intangible drilling and
development costs is $15, and G's allowable deduction under section
263(c) is $85. Because G is an integrated oil company, G must capitalize
25.50 ($85 x 30%) under section 291(b). Therefore, in 1992, G may
deduct under section 263(c) only $59.50 ($85 - $25.50) for these
intangible drilling and development costs.
Example 3. Basis of property reduced. In 1992, H, the owner of an
operating mineral interest in a property, pays $100 to purchase tangible
property that is an integral part of a qualified enhanced oil recovery
project undertaken with respect to the property. The amount of the
credit determined under paragraph (b) of this section attributable to
the $100 is $15 ($100 x 15%). Therefore, for purposes of subtitle A,
H's basis in the tangible property is $85 ($100 - $15).
Example 4. Basis of interest in passthrough entity reduced. In 1992,
I is a $50% partner in IJ, a partnership that owns an operating mineral
interest in a property. IJ pays $200 to purchase tangible property that
is an integral part of a qualified enhanced oil recovery project
undertaken with respect to the
[[Page 159]]
property. The amount of the credit determined under paragraph (b) of
this section attributable to the $200 is $30 ($200 x 15%). Therefore,
for purposes of subtitle A, IJ's basis in the tangible property is $170
($200 - $30). Under paragraph (f) of this section, the amount of the
purchase price that does not increase the basis of the property ($30) is
treated as an expenditure described in section 705(a)(2)(B). Therefore,
I's basis in the partnership interest is reduced by $15 (I's allocable
share of the section 705(a)(2)(B) expenditure ($30 x 50%)).
[T.D. 8448, 57 FR 54923, Nov. 23, 1992; 58 FR 7987, Feb. 11, 1993]
Sec. 1.43-2 Qualified enhanced oil recovery project.
(a) Qualified enhanced oil recovery project. A ``qualified enhanced
oil recovery project'' is any project that meets all of the following
requirements--
(1) The project involves the application (in accordance with sound
engineering principles) of one or more qualified tertiary recovery
methods (as described in paragraph (e) of this section) that is
reasonably expected to result in more than an insignificant increase in
the amount of crude oil that ultimately will be recovered;
(2) The project is located within the United States (within the
meaning of section 638(1));
(3) The first injection of liquids, gases, or other matter for the
project (as described in paragraph (c) of this section) occurs after
December 31, 1990; and
(4) The project is certified under Sec. 1.43-3.
(b) More than insignificant increase. For purposes of paragraph
(a)(1) of this section, all the facts and circumstances determine
whether the application of a tertiary recovery method can reasonably be
expected to result in more than an insignificant increase in the amount
of crude oil that ultimately will be recovered. Certain information
submitted as part of a project certification is relevant to this
determination. See Sec. 1.43-3(a)(3)(i)(D). In no event is the
application of a recovery method that merely accelerates the recovery of
crude oil considered an application of one or more qualified tertiary
recovery methods that can reasonably be expected to result in more than
an insignificant increase in the amount of crude oil that ultimately
will be recovered.
(c) First injection of liquids, gases, or other matter--(1) In
general. The ``first injection of liquids, gases, or other matter''
generally occurs on the date a tertiary injectant is first injected into
the reservoir. The ``first injection of liquids, gases, or other
matter'' does not include--
(i) The injection into the reservoir of any liquids, gases, or other
matter for the purpose of pretreating or preflushing the reservoir to
enhance the efficiency of the tertiary recovery method; or
(ii) Test or experimental injections.
(2) Example. The following example illustrates the principles of
this paragraph (c).
Example. Injections to pretreat the reservoir. In 1989, A, the owner
of an operating mineral interest in a property, began injecting water
into the reservoir for the purpose of elevating reservoir pressure to
obtain miscibility pressure to prepare for the injection of miscible gas
in connection with an enhanced oil recovery project. In 1992, A obtains
miscibility pressure in the reservoir and begins injecting miscible gas
into the reservoir. The injection of miscible gas, rather than the
injection of water, is the first injection of liquids, gases, or other
matter into the reservoir for purposes of determining whether the first
injection of liquids, gases, or other matter occurs after December 31,
1990.
(d) Significant expansion exception--(1) In general. If a project
for which the first injection of liquids, gases, or other matter (within
the meaning of paragraph (c)(1) of this section) occurred before January
1, 1991, is significantly expanded after December 31, 1990, the
expansion is treated as a separate project for which the first injection
of liquids, gases, or other matter occurs after December 31, 1990.
(2) Substantially unaffected reservoir volume. A project is
considered significantly expanded if the injection of liquids, gases, or
other matter after December 31, 1990, is reasonably expected to result
in more than an insignificant increase in the amount of crude oil that
ultimately will be recovered from reservoir volume that was
substantially unaffected by the injection of
[[Page 160]]
liquids, gases, or other matter before January 1, 1991.
(3) Terminated projects. Except as otherwise provided in this
paragraph (d)(3), a project is considered significantly expanded if each
qualified tertiary recovery method implemented in the project prior to
January 1, 1991, terminated more than 36 months before implementing an
enhanced oil recovery project that commences after December 31, 1990.
Notwithstanding the provisions of the preceding sentence, if a project
implemented prior to January 1, 1991, is terminated for less than 36
months before implementing an enhanced oil recovery project that
commences after December 31, 1990, a taxpayer may request permission to
treat the project that commences after December 31, 1990, as a
significant expansion. Permission will not be granted if the Internal
Revenue Service determines that a project was terminated to make an
otherwise nonqualifying project eligible for the credit. For purposes of
section 43, a qualified tertiary recovery method terminates at the point
in time when the method no longer results in more than an insignificant
increase in the amount of crude oil that ultimately will be recovered.
All the facts and circumstances determine whether a tertiary recovery
method has terminated. Among the factors considered is the project plan,
the unit plan of development, or other similar plan. A tertiary recovery
method is not necessarily terminated merely because the injection of the
tertiary injectant has ceased. For purposes of this paragraph (d)(1), a
project is implemented when costs that will be taken into account in
determining the credit with respect to the project are paid or incurred.
(4) Change in tertiary recovery method. If the application of a
tertiary recovery method or methods with respect to an enhanced oil
recovery project for which the first injection of liquids, gases, or
other matter occurred before January 1, 1991, has not been terminated
for more than 36 months, a taxpayer may request a private letter ruling
from the Internal Revenue Service whether the application of a different
tertiary recovery method or methods after December 31, 1990, that does
not affect reservoir volume substantially unaffected by the previous
tertiary recovery method or methods, is treated as a significant
expansion. All the facts and circumstances determine whether a change in
tertiary recovery method is treated as a significant expansion. Among
the factors considered are whether the change in tertiary recovery
method is in accordance with sound engineering principles and whether
the change in method will result in more than an insignificant increase
in the amount of crude oil that would be recovered using the previous
method. A more intensive application of a tertiary recovery method after
December 31, 1990, is not treated as a significant expansion.
(5) Examples. The following examples illustrate the principles of
this paragraph (d).
Example 1. Substantially unaffected reservoir volume. In January
1988, B, the owner of an operating mineral interest in a property, began
injecting steam into the reservoir in connection with a cyclic steam
enhanced oil recovery project. The project affected only a portion of
the reservoir volume. In 1992, B begins cyclic steam injections with
respect to reservoir volume that was substantially unaffected by the
previous cyclic steam project. Because the injection of steam into the
reservoir in 1992 affects reservoir volume that was substantially
unaffected by the previous cyclic steam injection, the cyclic steam
injection in 1992 is treated as a separate project for which the first
injection of liquids, gases, or other matter occurs after December 31,
1990.
Example 2. Tertiary recovery method terminated more than 36 months.
In 1982, C, the owner of an operating mineral interest in a property,
implemented a tertiary recovery project using cyclic steam injection as
a method for the recovery of crude oil. The project was certified as a
tertiary recovery project for purposes of the windfall profit tax. In
May 1988, the application of the cyclic steam tertiary recovery method
terminated. In July 1992, C begins drilling injection wells as part of a
project to apply the steam drive tertiary recovery method with respect
to the same project area affected by the cyclic steam method. C begins
steam injections in September 1992. Because C commences an enhanced oil
recovery project more than 36 months after the previous tertiary
recovery method was terminated, the project is treated as a separate
project for which the first injection of liquids, gases, or other matter
occurs after December 31, 1990.
[[Page 161]]
Example 3. Change in tertiary recovery method affecting
substantially unaffected reservoir volume. In 1984, D, the owner of an
operating mineral interest in a property, implemented a tertiary
recovery project using cyclic steam as a method for the recovery of
crude oil. The project was certified as a tertiary recovery project for
purposes of the windfall profit tax. D continued the cyclic steam
injection until 1992, when the tertiary recovery method was changed from
cyclic steam injection to steam drive. The steam drive affects reservoir
volume that was substantially unaffected by the cyclic steam injection.
Because the steam drive affects reservoir volume that was substantially
unaffected by the cyclic steam injection, the steam drive is treated as
a separate project for which the first injection of liquids, gases, or
other matter occurs after December 31, 1990.
Example 4. Change in tertiary recovery method not affecting
substantially unaffected reservoir volume. In 1988, E, the owner of an
operating mineral interest in a property, undertook an immiscible
nitrogen enhanced oil recovery project that resulted in more than an
insignificant increase in the ultimate recovery of crude oil from the
property. E continued the immiscible nitrogen project until 1992, when
the project was converted from immiscible nitrogen displacement to
miscible nitrogen displacement by increasing the injection of nitrogen
to increase reservoir pressure. The miscible nitrogen displacement
affects the same reservoir volume that was affected by the immiscible
nitrogen displacement. Because the miscible nitrogen displacement does
not affect reservoir volume that was substantially unaffected by the
immiscible nitrogen displacement nor was the immiscible nitrogen
displacement project terminated for more than 36 months before the
miscible nitrogen displacement project was implemented, E must obtain a
ruling whether the change from immiscible nitrogen displacement to
miscible nitrogen displacement is treated as a separate project for
which the first injection of liquids, gases, or other matter occurs
after December 31, 1990. If E does not receive a ruling, the miscible
nitrogen displacement project is not a qualified project.
Example 5. More intensive application of a tertiary recovery method.
In 1989, F, the owner of an operating mineral interest in a property,
undertook an immiscible carbon dioxide displacement enhanced oil
recovery project. F began injecting carbon dioxide into the reservoir
under immiscible conditions. The injection of carbon dioxide under
immiscible conditions resulted in more than an insignificant increase in
the ultimate recovery of crude oil from the property. F continues to
inject the same amount of carbon dioxide into the reservoir until 1992,
when new engineering studies indicate that an increase in the amount of
carbon dioxide injected is reasonably expected to result in a more than
insignificant increase in the amount of crude oil that would be
recovered from the property as a result of the previous injection of
carbon dioxide. The increase in the amount of carbon dioxide injected
affects the same reservoir volume that was affected by the previous
injection of carbon dioxide. Because the additional carbon dioxide
injected in 1992 does not affect reservoir volume that was substantially
unaffected by the previous injection of carbon dioxide and the previous
immiscible carbon dioxide displacement method was not terminated for
more than 36 months before additional carbon dioxide was injected, the
increase in the amount of carbon dioxide injected into the reservoir is
not a significant expansion. Therefore, it is not a separate project for
which the first injection of liquids, gases, or other matter occurs
after December 31, 1990.
(e) Qualified tertiary recovery methods--(1) In general. For
purposes of paragraph (a)(1) of this section, a ``qualified tertiary
recovery method'' is any one or any combination of the tertiary recovery
methods described in paragraph (e)(2) of this section. To account for
advances in enhanced oil recovery technology, the Internal Revenue
Service may by revenue ruling prescribe that a method not described in
paragraph (e)(2) of this section is a ``qualified tertiary recovery
method.'' In addition, a taxpayer may request a private letter ruling
that a method not described in paragraph (e)(2) of this section or in a
revenue ruling is a qualified tertiary recovery method. Generally, the
methods identified in revenue rulings or private letter rulings will be
limited to those methods that involve the displacement of oil from the
reservoir rock by means of modifying the properties of the fluids in the
reservoir or providing the energy and drive mechanism to force the oil
to flow to a production well. The recovery methods described in
paragraph (e)(3) of this section are not ``qualified tertiary recovery
methods.''
(2) Tertiary recovery methods that qualify--(i) Thermal recovery
methods--(A) Steam drive injection. The continuous injection of steam
into one set of wells (injection wells) or other injection source to
effect oil displacement toward and production from a second set of wells
(production wells);
[[Page 162]]
(B) Cyclic steam injection--The alternating injection of steam and
production of oil with condensed steam from the same well or wells; and
(C) In situ combustion. The combustion of oil or fuel in the
reservoir sustained by injection of air, oxygen-enriched air, oxygen, or
supplemental fuel supplied from the surface to displace unburned oil
toward producing wells. This process may include the concurrent,
alternating, or subsequent injection of water.
(ii) Gas Flood recovery methods--(A) Miscible fluid displacement.
The injection of gas (e.g., natural gas, enriched natural gas, a
liquified petroleum slug driven by natural gas, carbon dioxide,
nitrogen, or flue gas) or alcohol into the reservoir at pressure levels
such that the gas or alcohol and reservoir oil are miscible;
(B) Carbon dioxide augmented waterflooding. The injection of
carbonated water, or water and carbon dioxide, to increase waterflood
efficiency;
(C) Immiscible carbon dioxide displacement. The injection of carbon
dioxide into an oil reservoir to effect oil displacement under
conditions in which miscibility with reservoir oil is not obtained. This
process may include the concurrent, alternating, or subsequent injection
of water; and
(D) Immiscible nonhydrocarbon gas displacement. The injection of
nonhydrocarbon gas (e.g., nitrogen) into an oil reservoir, under
conditions in which miscibility with reservoir oil is not obtained, to
obtain a chemical or physical reaction (other than pressure) between the
oil and the injected gas or between the oil and other reservoir fluids.
This process may include the concurrent, alternating, or subsequent
injection of water.
(iii) Chemical flood recovery methods--(A) Microemulsion flooding.
The injection of a surfactant system (e.g., a surfactant, hydrocarbon,
cosurfactant, electrolyte, and water) to enhance the displacement of oil
toward producing wells; and
(B) Caustic flooding--The injection of water that has been made
chemically basic by the addition of alkali metal hydroxides, silicates,
or other chemicals.
(iv) Mobility control recovery method--Polymer augmented
waterflooding. The injection of polymeric additives with water to
improve the areal and vertical sweep efficiency of the reservoir by
increasing the viscosity and decreasing the mobility of the water
injected. Polymer augmented waterflooding does not include the injection
of polymers for the purpose of modifying the injection profile of the
wellbore or the relative permeability of various layers of the
reservoir, rather than modifying the water-oil mobility ratio.
(3) Recovery methods that do not qualify. The term ``qualified
tertiary recovery method'' does not include--
(i) Waterflooding--The injection of water into an oil reservoir to
displace oil from the reservoir rock and into the bore of the producing
well;
(ii) Cyclic gas injection--The increase or maintenance of pressure
by injection of hydrocarbon gas into the reservoir from which it was
originally produced;
(iii) Horizontal drilling--The drilling of horizontal, rather than
vertical, wells to penetrate hydrocarbon bearing formations;
(iv) Gravity drainage--The production of oil by gravity flow from
drainholes that are drilled from a shaft or tunnel dug within or below
the oil bearing zones; and
(v) Other methods--Any recovery method not specifically designated
as a qualified tertiary recovery method in either paragraph (e)(2) of
this section or in a revenue ruling or private letter ruling described
in paragraph (e)(1) of this section.
(4) Examples. The following examples illustrate the principles of
this paragraph (e).
Example 1. Polymer augmented waterflooding. In 1992 G, the owner of
an operating mineral interest in a property, begins a waterflood project
with respect to the property. To reduce the relative permeability in
certain areas of the reservoir and minimize water coning, G injects
polymers to plug thief zones and improve the areal and vertical sweep
efficiency of the reservoir. The injection of polymers into the
reservoir does not modify the water-oil mobility ratio. Accordingly, the
injection of polymers into the reservoir in connection with the
waterflood
[[Page 163]]
project does not constitute polymer augmented waterflooding and the
project is not a qualified enhanced oil recovery project.
Example 2. Polymer augmented waterflooding. In 1993 H, the owner of
an operating mineral interest in a property, begins a caustic flooding
project with respect to the property. Engineering studies indicate that
the relative permeability of various layers of the reservoir may result
in the loss of the injectant to thief zones, thereby reducing the areal
and vertical sweep efficiency of the reservoir. As part of the caustic
flooding project, H injects polymers to plug the thief zones and improve
the areal and vertical sweep efficiency of the reservoir. Because the
polymers are injected into the reservoir to improve the effectiveness of
the caustic flooding project, the project is a qualified enhanced oil
recovery project.
[T.D. 8448, 57 FR 54925, Nov. 23, 1992; 58 FR 6678, Feb. 1, 1993]
Sec. 1.43-3 Certification
(a) Petroleum engineer's certification of a project--(1) In general.
A petroleum engineer must certify, under penalties of perjury, that an
enhanced oil recovery project meets the requirements of section
43(c)(2)(A). A petroleum engineer's certification must be submitted for
each project. The petroleum engineer certifying a project must be duly
registered or certified in any State.
(2) Timing of certification. The operator of an enhanced oil
recovery project or any other operating mineral interest owner
designated by the operator (``designated owner'') must submit a
petroleum engineer's certification to the Internal Revenue Service
Center, Austin, Texas, or such other place as may be designated by
revenue procedure or other published guidance, not later than the last
date prescribed by law (including extensions) for filing the operator's
or designated owner's federal income tax return for the first taxable
year for which the enhanced oil recovery credit (the ``credit'') is
allowable. The operator may designate any other operating mineral
interest owner (the ``designated owner'') to file the petroleum
engineer's certification.
(3) Content of certification--(i) In general. A petroleum engineer's
certification must contain the following information--
(A) The name and taxpayer identification number of the operator or
the designated owner submitting the certification;
(B) A statement identifying the project, including its geographic
location;
(C) A statement that the project involves a tertiary recovery method
(as defined in section 43(c)(2)(A)(i)) and a description of the process
used, including--
(1) A description of the implementation and operation of the project
sufficient to establish that it is implemented and operated in
accordance with sound engineering practices;
(2) If the project involves the application of a tertiary recovery
method approved in a private letter ruling described in paragraph (e)(1)
of Sec. 1.43-2, a copy of the private letter ruling, and
(3) The date on which the first injection of liquids, gases, or
other matter occurred or is expected to occur.
(D) A statement that the application of a qualified tertiary
recovery method or methods is expected to result in more than an
insignificant increase in the amount of crude oil that ultimately will
be recovered, including--
(1) Data on crude oil reserve estimates covering the project area
with and without the enhanced oil recovery process,
(2) Production history prior to implementation of the project and
estimates of production after implementation of the project, and
(3) An adequate delineation of the reservoir, or portion of the
reservoir, from which the ultimate recovery of crude oil is expected to
be increased as a result of the implementation and operation of the
project; and
(E) A statement that the petroleum engineer believes that the
project is a qualified enhanced oil recovery project within the meaning
of section 43(c)(2)(A).
(ii) Additional information for significantly expanded projects. The
petroleum engineer's certification for a project that is significantly
expanded must in addition contain--
(A) If the expansion affects reservoir volume that was substantially
unaffected by a previously implemented project, an adequate delineation
of the reservoir volume affected by the previously implemented project;
[[Page 164]]
(B) If the expansion involves the implementation of an enhanced oil
recovery project more than 36 months after the termination of a
qualified tertiary recovery method that was applied before January 1,
1991, the date on which the previous tertiary recovery method terminated
and an explanation of the data or assumptions relied upon to determine
the termination date;
(C) If the expansion involves the implementation of an enhanced oil
recovery project less than 36 months after the termination of a
qualified tertiary recovery method that was applied before January 1,
1991, a copy of a private letter ruling from the Internal Revenue
Service that the project implemented after December 31, 1990 is treated
as a significant expansion; or
(D) If the expansion involves the application after December 31,
1990, of a tertiary recovery method or methods that do not affect
reservoir volume that was substantially unaffected by the application of
a different tertiary recovery method or methods before January 1, 1991,
a copy of a private letter ruling from the Internal Revenue Service that
the change in tertiary recovery method is treated as a significant
expansion.
(b) Operator's continued certification of a project--(1) In general.
For each taxable year following the taxable year for which the petroleum
engineer's certification is submitted, the operator or designated owner
must certify, under penalties of perjury, that an enhanced oil recovery
project continues to be implemented substantially in accordance with the
petroleum engineer's certification submitted for the project. An
operator's certification must be submitted for each project.
(2) Timing of certification. The operator or designated owner of an
enhanced oil recovery project must submit an operator's certification to
the Internal Revenue Service Center, Austin, Texas, or such other place
as may be designated by revenue procedure or other published guidance,
not later than the last date prescribed by law (including extensions)
for filing the operator's or designated owner's federal income tax
return for any taxable year after the taxable year for which the
petroleum engineer's certification is filed.
(3) Content of certification. An operator's certification must
contain the following information--
(i) The name and taxpayer identification number of the operator or
the designated owner submitting the certification;
(ii) A statement identifying the project including its geographic
location and the date on which the petroleum engineer's certification
was filed;
(iii) A statement that the project continues to be implemented
substantially in accordance with the petroleum engineer's certification
(as described in paragraph (a) of this section) submitted for the
project; and
(iv) A description of any significant change or anticipated change
in the information submitted under paragraph (a)(3) of this section,
including a change in the date on which the first injection of liquids,
gases, or other matter occurred or is expected to occur.
(c) Notice of project termination--(1) In general. If the
application of a tertiary recovery method is terminated, the operator or
designated owner must submit a notice of project termination to the
Internal Revenue Service.
(2) Timing of notice. The operator or designated owner of an
enhanced oil recovery project must submit the notice of project
termination to the Internal Revenue Service Center, Austin, Texas, or
such other place as may be designated by revenue procedure or other
published guidance, not later than the last date prescribed by law
(including extensions) for filing the operator's or designated owner's
federal income tax return for the taxable year in which the project
terminates.
(3) Content of notice. A notice of project termination must contain
the following information--
(i) The name and taxpayer identification number of the operator or
the designated owner submitting the notice;
(ii) A statement identifying the project including its geographic
location and the date on which the petroleum engineer's certification
was filed; and
[[Page 165]]
(iii) The date on which the application of the tertiary recovery
method was terminated.
(d) Failure to submit certification. If a petroleum engineer's
certification (as described in paragraph (a) of this section) or an
operator's certification (as described in paragraph (b) of this section)
is not submitted in the time or manner prescribed by this section, the
credit will be allowed only after the appropriate certifications are
submitted.
[T.D. 8384, 56 FR 67177, Dec. 30, 1991; 57 FR 6074, Feb. 20, 1992; 57 FR
6353, Feb. 24, 1992. Redesignated and amended by T.D. 8448, 57 FR 54927,
Nov. 23, 1992]
Sec. 1.43-4 Qualified enhanced oil recovery costs.
(a) Qualifying costs--(1) In general. Except as provided in
paragraph (e) of this section, amounts paid or incurred in any taxable
year beginning after December 31, 1990, that are qualified tertiary
injectant expenses (as described in paragraph (b)(1) of this section),
intangible drilling and development costs (as described in paragraph
(b)(2) of this section), and tangible property costs (as described in
paragraph (b)(3) of this section) are ``qualified enhanced oil recovery
costs'' if the amounts are paid or incurred with respect to an asset
which is used for the primary purpose (as described in paragraph (c) of
this section) of implementing an enhanced oil recovery project. Any
amount paid or incurred in any taxable year beginning before January 1,
1991, in connection with an enhanced oil recovery project is not a
qualified enhanced oil recovery cost.
(2) Costs paid or incurred for an asset which is used to implement
more than one qualified enhanced oil recovery project or for other
activities. Any cost paid or incurred during the taxable year for an
asset which is used to implement more than one qualified enhanced oil
recovery project is allocated among the projects in determining the
qualified enhanced oil recovery costs for each qualified project for the
taxable year. Similarly, any cost paid or incurred during the taxable
year for an asset which is used to implement a qualified enhanced oil
recovery project and which is also used for other activities (for
example, an enhanced oil recovery project that is not a qualified
enhanced oil recovery project) is allocated among the qualified enhanced
oil recovery project and the other activities to determine the qualified
enhanced oil recovery costs for the taxable year. See Sec. 1.613-5(a).
Any cost paid or incurred for an asset which is used to implement a
qualified enhanced oil recovery project and which is also used for other
activities is not required to be allocated under this paragraph (a)(2)
if the use of the property for nonqualifying activities is de minimis
(e.g., not greater than 10%). Costs are allocated under this paragraph
(a)(2) only if the asset with respect to which the costs are paid or
incurred is used for the primary purpose of implementing an enhanced oil
recovery project. See paragraph (c) of this section. Any reasonable
allocation method may be used. A method that allocates costs based on
the anticipated use in a project or activity is a reasonable method.
(b) Costs defined--(1) Qualified tertiary injectant expenses. For
purposes of this section, ``qualified tertiary injectant expenses''
means any costs that are paid or incurred in connection with a qualified
enhanced oil recovery project and that are deductible under section 193
for the taxable year. See section 193 and Sec. 1.193-1. Qualified
tertiary injectant expenses are taken into account in determining the
credit with respect to the taxable year in which the tertiary injectant
expenses are deductible under section 193.
(2) Intangible drilling and development costs. For purposes of this
section, ``intangible drilling and development costs'' means any
intangible drilling and development costs that are paid or incurred in
connection with a qualified enhanced oil recovery project and for which
the taxpayer may make an election under section 263(c) for the taxable
year. Intangible drilling and development costs are taken into account
in determining the credit with respect to the taxable year in which the
taxpayer may deduct the intangible drilling and development costs under
section 263(c). For purposes of this paragraph (b)(2), the amount of the
intangible drilling and development costs for which an integrated oil
company may make an
[[Page 166]]
election under section 263(c) is determined without regard to section
291(b).
(3) Tangible property costs--(i) In general. For purposes of this
section, ``tangible property costs'' means an amount paid or incurred
during a taxable year for tangible property that is an integral part of
a qualified enhanced oil recovery project and that is depreciable or
amortizable under chapter 1. An amount paid or incurred for tangible
property is taken into account in determining the credit with respect to
the taxable year in which the cost is paid or incurred.
(ii) Integral part. For purposes of this paragraph (b), tangible
property is an integral part of a qualified enhanced oil recovery
project if the property is used directly in the project and is essential
to the completeness of the project. All the facts and circumstances
determine whether tangible property is used directly in a qualified
enhanced oil recovery project and is essential to the completeness of
the project. Generally, property used to acquire or produce the tertiary
injectant or property used to transport the tertiary injectant to a
project site is property that is an integral part of the project.
(4) Examples. The following examples illustrate the principles of
this paragraph (b). Assume for each of these examples that the qualified
enhanced oil recovery costs are paid or incurred with respect to an
asset which is used for the primary purpose of implementing an enhanced
oil recovery project.
Example 1. Qualified costs--in general. (i) In 1992, X, a
corporation, acquires an operating mineral interest in a property and
undertakes a cyclic steam enhanced oil recovery project with respect to
the property. X pays a fee to acquire a permit to drill and hires a
contractor to drill six wells. As part of the project implementation, X
constructs a building to serve as an office on the property and
purchases equipment, including downhole equipment (e.g., casing, tubing,
packers, and sucker rods), pumping units, a steam generator, and
equipment to remove gas and water from the oil after it is produced. X
constructs roads to transport the equipment to the wellsites and incurs
costs for clearing and draining the ground in preparation for the
drilling of the wells. X purchases cars and trucks to provide
transportation for monitoring the wellsites. In addition, X contracts
with Y for the delivery of water to produce steam to be injected in
connection with the cyclic steam project, and purchases storage tanks to
store the water.
(ii) The leasehold acquisition costs are not qualified enhanced oil
recovery costs. However, the costs of the permit to drill are intangible
drilling and development costs that are qualified costs. The costs
associated with hiring the contractor to drill, constructing roads, and
clearing and draining the ground are intangible drilling and development
costs that are qualified enhanced oil recovery costs. The downhole
equipment, the pumping units, the steam generator, and the equipment to
remove the gas and water from the oil after it is produced are used
directly in the project and are essential to the completeness of the
project. Therefore, this equipment is an integral part of the project
and the costs of the equipment are qualified enhanced oil recovery
costs. Although the building that X constructs as an office and the cars
and trucks X purchases to provide transportation for monitoring the
wellsites are used directly in the project, they are not essential to
the completeness of the project. Therefore, the building and the cars
and trucks are not an integral part of the project and their costs are
not qualified enhanced oil recovery costs. The cost of the water X
purchases from Y is a tertiary injectant expense that is a qualified
enhanced oil recovery cost. The storage tanks X acquires to store the
water are required to provide a proximate source of water for the
production of steam. Therefore, the water storage tank are an integral
part of the project and the costs of the water storage tanks are
qualified enhanced oil recovery costs.
Example 2. Diluent storage tanks. In 1992, A, the owner of an
operating mineral interest, undertakes a qualified enhanced oil recovery
project with respect to the property. A acquires diluent to be used in
connection with the project. A stores the diluent in a storage tank that
A acquires for that purpose. The storage tank provides a proximate
source of diluent to be used in the tertiary recovery method. Therefore,
the storage tank is used directly in the project and is essential to the
completeness of the project. Accordingly, the storage tanks is an
integral part of the project and the cost of the storage tank is a
qualified enhanced oil recovery cost.
Example 3. Oil storage tanks. In 1992, Z, a corporation and the
owner of an operating mineral interest in a property, undertakes a
qualified enhanced oil recovery project with respect to the property. Z
acquires storage tanks that Z will use solely to store the crude oil
that is produced from the enhanced oil recovery project. The storage
tanks are not used directly in the project and are not essential to the
completeness of the project.
[[Page 167]]
Therefore, the storage tanks are not an integral part of the enhanced
oil recovery project and the costs of the storage tanks are not
qualified enhanced oil recovery costs.
Example 4. Oil refinery. B, the owner of an operating mineral
interest in a property, undertakes a qualified enhanced oil recovery
project with respect to the property. Located on B's property is an oil
refinery where B will refine the crude oil produced from the project.
The refinery is not used directly in the project and is not essential to
the completeness of the project. Therefore, the refinery is not an
integral part of the enhanced oil recovery project.
Example 5. Gas processing plant. C, the owner of an operating
mineral interest in a property, undertakes a qualified enhanced oil
recovery project with respect to the property. A gas processing plant
where C will process gas produced in the project is located on C's
property. The gas processing plant is not used directly in the project
and is not essential to the completeness of the project. Therefore, the
gas processing plant is not an integral part of the enhanced oil
recovery project.
Example 6. Gas processing equipment. The facts are the same as in
Example 5 except that C uses a portion of the gas processing plant to
separate and recycle the tertiary injectant. The gas processing
equipment used to separate and recycle the tertiary injectant is used
directly in the project and is essential to the completeness of the
project. Therefore, the gas processing equipment used to separate and
recycle the tertiary injectant is an integral part of the enhanced oil
recovery project and the costs of this equipment are qualified enhanced
oil recovery costs.
Example 7. Steam generator costs allocated. In 1988, D, the owner of
an operating mineral interest in a property, undertook a steam drive
project with respect to the property. In 1992, D decides to undertake a
steam drive project with respect to reservoir volume that was
substantially unaffected by the 1988 project. The 1992 project is a
significant expansion that is a qualified enhanced oil recovery project.
D purchases a new steam generator with sufficient capacity to provide
steam for both the 1988 project and the 1992 project. The steam
generator is used directly in the 1992 project and is essential to the
completeness of the 1992 project. Accordingly, the steam generator is an
integral part of the 1992 project. Because the steam generator is also
used to provide steam for the 1988 project, D must allocate the cost of
the steam generator to the 1988 project and the 1992 project. Only the
portion of the cost of the steam generator that is allocable to the 1992
project is a qualified enhanced oil recovery cost.
Example 8. Carbon dioxide pipeline. In 1992, E, the owner of an
operating mineral interest in a property, undertakes an immiscible
carbon dioxide displacement project with respect to the property. E
constructs a pipeline to convey carbon dioxide to the project site. E
contracts with F, a producer of carbon dioxide, to purchase carbon
dioxide to be injected into injection wells in E's enhanced oil recovery
project. The cost of the carbon dioxide is a tertiary injectant expense
that is a qualified enhanced oil recovery cost. The pipeline is used by
E to transport the tertiary injectant, that is, the carbon dioxide to
the project site. Therefore, the pipeline is an integral part of the
project. Accordingly, the cost of the pipeline is a qualified enhanced
oil recovery cost.
Example 9. Water source wells. In 1992, G the owner of an operating
mineral interest in a property, undertakes a polymer augmented
waterflood project with respect to the property. G drills water wells to
provide water for injection in connection with the project. The costs of
drilling the water wells are intangible drilling and development costs
that are paid or incurred in connection with the project. Therefore, the
costs of drilling the water wells are qualified enhanced oil recovery
costs.
Example 10. Leased equipment. In 1992, H, the owner of an operating
mineral interest in a property undertakes a steam drive project with
respect to the property. H contracts with I, a driller, to drill
injection wells in connection with the project. H also leases a steam
generator to provide steam for injection in connection with the project.
The drilling costs are intangible drilling and development costs that
are paid in connection with the project and are qualified enhanced oil
recovery costs. The steam generator is used to produce the tertiary
injectant. The steam generator is used directly in the project and is
essential to the completeness of the project; therefore, it is an
integral part of the project. The costs of leasing the steam generator
are tangible property costs that are qualified enhanced oil recovery
costs.
(c) Primary purpose--(1) In general. For purposes of this section, a
cost is a qualified enhanced oil recovery cost only if the cost is paid
or incurred with respect to an asset which is used for the primary
purpose of implementing one or more enhanced oil recovery projects, at
least one of which is a qualified enhanced oil recovery project. All the
facts and circumstances determine whether an asset is used for the
primary purpose of implementing an
[[Page 168]]
enhanced oil recovery project. For purposes of this paragraph (c), an
enhanced oil recovery project is a project that satisfies the
requirements of paragraphs (a) (1) and (2) of section 1.43-2.
(2) Tertiary injectant costs. Tertiary injectant costs generally
satisfy the primary purpose test of this paragraph (c).
(3) Intangible drilling and development costs. Intangible drilling
and development costs paid or incurred with respect to a well that is
used in connection with the recovery of oil by primary or secondary
methods are not qualified enhanced oil recovery costs. Except as
provided in this paragraph (c)(3), a well used for primary or secondary
recovery is not used for the primary purpose of implementing an enhanced
oil recovery project. A well drilled for the primary purpose of
implementing an enhanced oil recovery project is not considered to be
used for primary or secondary recovery, notwithstanding that some
primary or secondary production may result when the well is drilled,
provided that such primary or secondary production is consistent with
the unit plan of development or other similar plan. All the facts and
circumstances determine whether primary or secondary recovery is
consistent with the unit plan of development or other similar plan.
(4) Tangible property costs. Tangible property costs must be paid or
incurred with respect to property which is used for the primary purpose
of implementing an enhanced oil recovery project.
If tangible property is used partly in a qualified enhanced oil
recovery project and partly in another activity, the property must be
primarily used to implement the qualified enhanced oil recovery project.
(5) Offshore drilling platforms. Amounts paid or incurred in
connection with the acquisition, construction, transportation, erection,
or installation of an offshore drilling platform (regardless of whether
the amounts are intangible drilling and development costs) that is used
in connection with the recovery of oil by primary or secondary methods
are not qualified enhanced oil recovery costs. An offshore drilling
platform used for primary or secondary recovery is not used for the
primary purpose of implementing an enhanced oil recovery project.
(6) Examples. The following examples illustrate the principles of
this paragraph (c).
Example 1. Intangible drilling and development costs. In 1992, J
incurs intangible drilling and development costs in drilling a well. J
intends to use the well as an injection well in connection with an
enhanced oil recovery project in 1994, but in the meantime will use the
well in connection with a secondary recovery project. J may not take the
intangible drilling and development costs into account in determining
the credit because the primary purpose of a well used for secondary
recovery is not to implement a qualified enhanced oil recovery project.
Example 2. Offshore drilling platform. K, the owner of an operating
mineral interest in an offshore oil field located within the United
States, constructs an offshore drilling platform that is designed to
accommodate the primary, secondary, and tertiary development of the
field. Subsequent to primary and secondary development of the field, K
commences an enhanced oil recovery project that involves the application
of a qualified tertiary recovery method. As part of the enhanced oil
recovery project, K drills injection wells from the offshore drilling
platform K used in the primary and secondary development of the field
and installs an additional separator on the platform.
Because the offshore drilling platform was used in the primary and
secondary development of the field and was not used for the primary
purpose of implementing tertiary development of the field, costs
incurred by K in connection with the acquisition, construction,
transportation, erection, or installation of the offshore drilling
platform are not qualified enhanced oil recovery costs. However, the
costs K incurs for the additional separator are qualified enhanced oil
recovery costs because the separator is used for the primary purpose of
implementing tertiary development of the field. In addition, the
intangible drilling and development costs K incurs in connection with
drilling the injection wells are qualified enhanced oil recovery costs
with respect to which K may claim the enhanced oil recovery credit.
(d) Costs paid or incurred prior to first injection--(1) In general.
Qualified enhanced oil recovery costs may be paid or incurred prior to
the date of the first injection of liquids, gases, or other matter
(within the meaning of Sec. 1.43-2(c)). If the first injection of
liquids, gases, or other matter occurs on or before the date the
taxpayer files the taxpayer's federal income tax return for the taxable
year with respect
[[Page 169]]
to which the costs are allowable, the costs may be taken into account on
that return. If the first injection of liquids, gases, or other matter
is expected to occur after the date the taxpayer files that return,
costs may be taken into account on that return if the Internal Revenue
Service issues a private letter ruling to the taxpayer that so permits.
(2) First injection after filing of return for taxable year costs
are allowable. Except as provided in paragraph (d)(3) of this section,
if the first injection of liquids, gases, or other matter occurs or is
expected to occur after the date the taxpayer files the taxpayer's
federal income tax return for the taxable year with respect to which the
costs are allowable, the costs may be taken into account on an amended
return (or in the case of a Coordinated Examination Program taxpayer, on
a written statement treated as a qualified return) after the earlier
of--
(i) The date the first injection of liquids, gases, or other matter
occurs; or
(ii) The date the Internal Revenue Service issues a private letter
ruling that provides that the taxpayer may take costs into account prior
to the first injection of liquids, gases, or other matter.
(3) First injection more than 36 months after close of taxable year
costs are paid or incurred. If the first injection of liquids, gases, or
other matter occurs more than 36 months after the close of the taxable
year in which costs are paid or incurred, the taxpayer may take the
costs into account in determining the credit only if the Internal
Revenue Service issues a private letter ruling to the taxpayer that so
provides.
(4) Injections in volumes less than the volumes specified in the
project plan. For purposes of this paragraph (d), injections in volumes
significantly less than the volumes specified in the project plan, the
unit plan of development, or another similar plan do not constitute the
first injection of liquids, gases, or other matter.
(5) Examples. The following examples illustrate the provisions of
paragraph (d) of this section.
Example 1. First injection before return filed. In 1992, L, a
calendar year taxpayer, undertakes a qualified enhanced oil recovery
project on a property in which L owns an operating mineral interest. L
incurs $1,000 of intangible drilling and development costs, which L may
elect to deduct under section 263(c) for 1992. The first injection of
liquids, gases, or other matter (within the meaning of Sec. 1.43-2(c))
occurs in March 1993. L files a 1992 federal income tax return in April
1993. Because the first injection occurs before the filing of L's 1992
federal income tax return, L may take the $1,000 of intangible drilling
and development costs into account in determining the credit for 1992 on
that return.
Example 2. First injection after return filed. In 1993, M, a
calendar year taxpayer, undertakes a qualified enhanced oil recovery
project on a property in which M owns an operating mineral interest. M
incurs $2,000 of intangible drilling and development costs, which M
elects to deduct under section 263(c) for 1993. The first injection of
liquids, gases, or other matter is expected to occur in 1995. M files a
1993 federal income tax return in April 1994. Because the first
injection of liquids, gases, or other matter occurs after the date on
which M's 1993 federal income tax return is filed in April 1994, M may
take the $2,000 of intangible drilling and development costs into
account on an amended return for 1993 after the earlier of the date the
first injection of liquids, gases, or other matter occurs, or the date
the Internal Revenue Service issues a private letter ruling that
provides that M may take the $2,000 into account prior to first
injection.
Example 3. First injection more than 36 months after taxable year.
N, a calendar year taxpayer, owns an operating mineral interest in a
property on which N undertakes an immiscible carbon dioxide displacement
project. In 1994, N incurs $5,000 in connection with the construction of
a pipeline to transport carbon dioxide to the project site. The first
injection of liquids, gases, or other matter is expected to occur after
the pipeline is completed in 1998. Because the first injection of
liquids, gases, or other matter occurs more than 36 months after the
close of the taxable year in which the $5,000 is incurred, N may take
the $5,000 into account in determining the credit only if N receives a
private letter ruling from the Internal Revenue Service that provides
that N may take the $5,000 into account prior to first injection.
(e) Other rules--(1) Anti-abuse rule. Costs paid or incurred with
respect to an asset that is acquired, used, or transferred in a manner
designed to duplicate or otherwise unreasonably increase the amount of
the credit are not qualified enhanced oil recovery costs, regardless of
whether the costs would otherwise be creditable for a single taxpayer or
more than one taxpayer.
[[Page 170]]
(2) Costs paid or incurred to acquire a project. A purchaser of an
existing qualified enhanced oil recovery project may claim the credit
for any section 43 costs in excess of the acquisition cost. However,
costs paid or incurred to acquire an existing qualified enhanced oil
recovery project (or an interest in an existing qualified enhanced oil
recovery project) are not eligible for the credit.
(3) Examples. The following examples illustrate the principles of
paragraph (e) of this section.
Example 1. Duplicating or unreasonably increasing the credit. O owns
an operating mineral interest in a property with respect to which a
qualified enhanced oil recovery project is implemented. O acquires
pumping units, rods, casing, and separators for use in connection with
the project from an unrelated equipment dealer in an arm's length
transaction. The equipment is used for the primary purpose of
implementing the project. Some of the equipment acquired by O is used
equipment. The costs paid by O for the used equipment are qualified
enhanced oil recovery costs. O does not need to determine whether the
equipment has been previously used in an enhanced oil recovery project.
Example 2. Duplicating or unreasonably increasing the credit. P and
Q are co-owners of an oil property with respect to which a qualified
enhanced oil recovery project is implemented. In 1992, P and Q jointly
purchase a nitrogen plant to supply the tertiary injectant used in the
project. P and Q claim the credit for their respective costs for the
plant. In 1994, X, a corporation unrelated to P or Q, purchases the
nitrogen plant and enters into an agreement to sell nitrogen to P and Q.
Because this transaction duplicates or otherwise unreasonably increases
the credit, the credit is not allowable for the amounts incurred by P
and Q for the nitrogen purchased from X.
Example 3. Duplicating or unreasonably increasing the credit. The
facts are the same as in Example 2. In addition, in 1995, P and Q
reacquire the nitrogen plant from X. This constitutes the acquisition of
property in a manner designed to duplicate or otherwise unreasonably
increase the amount of the credit. Therefore, the credit is not
allowable for amounts incurred by P and Q for the nitrogen plant
purchased from X.
Example 4. Duplicating or unreasonably increasing the credit. R owns
an operating mineral interest in a property with respect to which a
qualified enhanced oil recovery project is implemented. R acquires a
pump that is installed at the site of the project. After the pump has
been placed in service for 6 months, R transfers the pump to a secondary
recovery project and acquires a replacement pump for the tertiary
project. The original pump is suited to the needs of the secondary
recovery project and could have been installed there initially. The
pumps have been acquired in a manner designed to duplicate or otherwise
unreasonably increase the amount of the credit. Depending on the facts,
the cost of one pump or the other may be a qualified enhanced oil
recovery cost; however, R may not claim the credit with respect to the
cost of both pumps.
Example 5. Acquiring a project. In 1993, S purchases all of T's
interest in a qualified enhanced oil recovery project, including all of
T's interest in tangible property that is an integral part of the
project and all of T's operating mineral interest. In 1994, S incurs
costs for additional tangible property that is an integral part of the
project and which is used for the primary purpose of implementing the
project. S also incurs costs for tertiary injectants that are injected
in connection with the project. In determining the credit for 1994, S
may take into account costs S incurred for tangible property and
tertiary injectants. However, S may not take into account any amount
that S paid for T's interest in the project in determining S's credit
for any taxable year.
[T.D. 8448, 57 FR 54927, Nov. 23, 1992; 58 FR 7987, Feb. 11, 1993]
Sec. 1.43-5 At-risk limitation. [Reserved]
Sec. 1.43-6 Election out of section 43.
(a) Election to have the credit not apply--(1) In general. A
taxpayer may elect to have section 43 not apply for any taxable year.
The taxpayer may revoke an election to have section 43 not apply for any
taxable year. An election to have section 43 not apply (or a revocation
of an election to have section 43 not apply) for any taxable year is
effective only for the taxable year to which the election relates.
(2) Time for making the election. A taxpayer may make an election
under paragraph (a) of this section to have section 43 not apply (or
revoke an election to have section 43 not apply) for any taxable year at
any time before the expiration of the 3-year period beginning on the
last date prescribed by law (determined without regard to extensions)
for filing the return for the taxable year. The time for making the
election (or revoking the election) is prescribed by section 43(e)(2)
and may not be extended under Sec. 1.9100-1.
[[Page 171]]
(3) Manner of making the election. An election (or revocation) under
paragraph (a)(1) of this section is made by attaching a statement to the
taxpayer's federal income tax return or an amended return (or, in the
case of a Coordinated Examination Program taxpayer, on a written
statement treated as a qualified amended return) for the taxable year
for which the election (or revocation) applies. The taxpayer must
indicate whether the taxpayer is electing to not have section 43 apply
or is revoking such an election and designate the project or projects to
which the election (or revocation) applies. For any taxable year, the
last election (or revocation) made by a taxpayer within the period
prescribed in paragraph (a)(2) of this section determines whether
section 43 applies for that taxable year.
(b) Election by partnerships and S corporations. For partnerships
and S corporations, an election to have section 43 not apply (or a
revocation of an election to have section 43 not apply) for any taxable
year is made, in accordance with the requirements of paragraph (a) of
this section, by the partnership or S corporation with respect to the
qualified enhanced oil recovery costs paid or incurred by the
partnership or S corporation for the taxable year to which the election
relates.
[T.D. 8448, 57 FR 54930, Nov. 23, 1992]
Sec. 1.43-7 Effective date of regulations.
The provisions of Secs. 1.43-1, 1.43-2 and 1.43-4 through 1.43-7 are
effective with respect to costs paid or incurred after December 31,
1991, in connection with a qualified enhanced oil recovery project. The
provisions of Sec. 1.43-3 are effective for taxable years beginning
after December 31, 1990. For costs paid or incurred after December 31,
1990, and before January 1, 1992, in connection with a qualified
enhanced oil recovery project, taxpayers must take reasonable return
positions taking into consideration the statute and its legislative
history.
[T.D. 8448, 57 FR 54931, Nov. 23, 1992]
Sec. 1.44-1 Allowance of credit for purchase of new principal residence after March 12, 1975, and before January 1, 1977.
(a) General rule. Section 44 provides a credit against the tax
imposed by chapter 1 of the Internal Revenue Code of 1954 in the case of
an individual who purchases a new principal residence (as defined in
paragraph (a) of Sec. 1.44-5) which is property to which section 44
applies (as provided in Sec. 1.44-2). Subject to the limitations set
forth in paragraph (b) of this section, the credit is in an amount equal
to 5 percent of the purchase price (as defined in paragraph (b) of
Sec. 1.44-5).
(b) Limitations--(1) Maximum credit. The credit allowed under
section 44 and this section may not exceed $2,000.
(2) Limitation to one residence. Such credit shall be allowed with
respect to only one residence of the taxpayer; the combined purchase
prices of more than one new principal residence cannot be aggregated to
increase the credit allowed.
(3) Married individuals. In the case of a husband and wife who file
a joint return under section 6013, the maximum credit allowed on the
joint return is $2,000. In the case of married individuals filing
separate returns the maximum credit allowable to each spouse is $1,000.
Where a husband and wife do not make equal contributions with respect to
the purchase price of the new principal residence, allocation of the
credit is to be made in proportion to their respective ownership
interests in such residence. For this purpose, tenants by the entirety
or joint tenants with right of survivorship are treated as equal owners.
(4) Certain other taxpayers. Where a new principal residence is
purchased by two or more taxpayers (other than a husband and wife), the
amount of the credit allowed will be allocated among the taxpayers in
proportion to their respective ownership interests in such residence,
with the limitation that the sum of the credits allowed to all such
taxpayers shall not exceed $2,000. For this purpose, joint tenants with
right of survivorship are treated as equal
[[Page 172]]
owners. For an example of the operation of this provision see Example
(2) of Sec. 1.44-5(b)(2)(ii).
(5) Application with other credits. The credit allowed by this
section shall not exceed the amount of the tax imposed by chapter 1 of
the Code for the taxable year, reduced by the sum of the credits
allowable under--
(i) Section 33 (relating to taxes of foreign countries and
possessions of the United States),
(ii) Section 37 (relating to retirement income),
(iii) Section 38 (relating to investment in certain depreciable
property),
(iv) Section 40 (relating to expenses of work incentive program),
(v) Section 41 (relating to contributions to candidates for public
office), and
(vi) Section 42 (relating to personal exemptions).
[T.D. 7391, 40 FR 55851, Dec. 2, 1975]
Sec. 1.44-2 Property to which credit for purchase of new principal residence applies.
The provisions of section 44 and the regulations thereunder apply to
a new principal residence which satisfies the following conditions:
(a) Construction. The construction of the residence must have begun
before March 26, 1975. For this purpose construction is considered to
have commenced in the following circumstances:
(1)(i) Except as provided in subparagraph (2) of this paragraph,
construction is considered to commence when actual physical work of a
significant amount has occurred on the building site of the residence. A
significant amount of construction requires more than drilling to
determine soil conditions, preparation of an architect's sketches,
securing of a building permit, or grading of the land. Land preparation
and improvements such as the clearing and grading (excavation or
filling), construction of roads and sidewalks, and installation of
sewers and utilities are not considered commencement of construction of
the residence even though they might involve a significant expenditure.
However, driving pilings for the foundation, digging of the footings,
excavation of the building foundation, pouring of floor slabs, or
construction of compacted earthen pads when specifically prepared and
designed for a particular residential structure and not merely as a part
of the overall land preparation, constitute a significant amount of
construction of the residence. In the case of a housing or condominium
development construction of recreational facilities no matter how
extensive does not by itself constitute commencement of construction of
any residential unit. However, where residential units are part of a
building structure, as in the case of certain condominium and
cooperative housing units, then digging of the footings or excavation of
the building foundation constitutes commencement of construction for all
units in that building.
(ii) The rules in subdivision (i) of this subparagraph are
illustrated by the following examples:
Example 1. A location chosen for a housing development has extremely
hilly terrain. In order to make the location suitable for development,
the builder moves large amounts of earth and places it elsewhere on the
location. In addition, the earth material which has been moved must be
compacted according to government specifications in order to provide a
stable base. Such activities constitute land preparation and, therefore,
do not constitute the commencement of construction.
Example 2. A location chosen for a housing development has swampy
and marshy terrain. In order to make the location suitable for
development the builder utilizes large quantities of fill. This activity
constitutes land preparation and does not constitute commencement of
construction.
Example 3. Assume the same facts as in either Example 1 or Example 2
except that the builder also constructs an earthen pad of compacted fill
specifically prepared for a particular residential structure and not
merely as a part of the overall land preparation. Construction of the
compacted earthen pad is considered in the same light as excavation of
the building foundation and accordingly constitutes commencement of
construction.
(2) Construction of a factory-made home (as defined in paragraph (e)
of Sec. 1.44-5) is considered to have commenced when construction of
important parts of the factory-made home
[[Page 173]]
has commenced. For this purpose, commencement of construction of
important parts means the cutting and shaping or welding of structural
components for a specific identifiable factory-made home, whether the
work was done by the manufacturer of the home or by a subcontractor
thereof.
(b) Acquisition and occupancy. The residence must be acquired and
occupied by the taxpayer after March 12, 1975, and before January 1,
1977. For this purpose a taxpayer ``acquires'' a residence when legal
title to it is conveyed to him at settlement, or he has possession of it
pursuant to a binding purchase contract under which he makes periodic
payments until he becomes entitled under the contract to demand
conveyance of title. A taxpayer ``occupies'' a residence when he or his
spouse physically occupies it. Thus, for example, moving of furniture or
other household effects into the residence or physical occupancy by a
dependent child of the taxpayer is not ``occupancy'' for purposes of
this paragraph. The credit may be claimed when both the acquisition and
occupancy tests have been satisfied. Thus, where a taxpayer meets the
acquisition and occupancy tests set forth above after March 12, 1975,
and before January 1, 1976, the credit is allowable for 1975. Where a
taxpayer occupied a residence prior to March 13, 1975, without having
acquired it (as where his occupancy was pursuant to a leasing
arrangement pending settlement under a binding contract to purchase or
pursuant to a leasing arrangement where a written option to purchase was
contained in the original lease agreement) he will nonetheless satisfy
the acquisition and occupancy tests set forth above if he acquires the
residence and continues to occupy it after March 12, 1975, and before
January 1, 1977.
(c) Binding contract. Except in the case of self-construction, the
new principal residence must be acquired by the taxpayer (within the
meaning of paragraph (b) of this section) under a binding contract
entered into by the taxpayer before January 1, 1976. An otherwise
binding contract for the purchase of a residence which is conditioned
upon the purchaser's obtaining a loan for the purchase of the residence
(including conditions as to the amount or interest rate of such loan) is
considered binding notwithstanding that condition.
(d) Self-constructed residence. A self-constructed residence (as
defined in paragraph (d) of Sec. 1.44-5) must be occupied by the
taxpayer before January 1, 1977. Where self-construction of a principal
residence was begun before March 13, 1975, only that portion of the
basis of the property allocable to construction after March 12, 1975,
and before January 1, 1977, shall be taken into consideration in
determining the amount of the credit allowable. For this purpose, the
portion of the basis attributable to the pre-March 13 period includes
the total cost of land acquired (as defined in paragraph (b) of this
section) prior to March 13, 1975, on which the new principal residence
is constructed and the cost of expenditures with respect to construction
work performed prior to March 13, 1975. The costs incurred in
stockpiling materials for later stages of construction, however, are not
allocated to the pre-March 13 period. Thus, for example, if prior to
March 13, 1975, a taxpayer who qualifies for the credit has constructed
a portion of a residence at a cost of $10,000 (including the cost of the
land purchased prior to March 13, 1975) and the total cost of the
residence is $40,000 and the taxpayer's basis after the application of
section 1034(e) (relating to the reduction of basis of new principal
residence where gain is not recognized upon the sale of the old
residence) is $36,000, the amount subject to the credit will be $27,000:
($30,000$40,000) x $36,000.
[T.D. 7391, 40 FR 55852, Dec. 2, 1975; 40 FR 58138, Dec. 15, 1975]
Sec. 1.44-3 Certificate by seller.
(a) Requirement of certification by seller. Taxpayers claiming the
credit should attach Form 5405, Credit for Purchase or Construction of
New Principal Residence, to their tax returns on which the credit is
claimed. Except in the case of self-construction (as defined in
Sec. 1.44-5(d)), taxpayers must attach a certification by the seller
that construction of the residence began before March 26, 1975, and that
the purchase
[[Page 174]]
price is the lowest price at which the residence was offered for sale
after February 28, 1975. For purposes of section 44(e)(4) and this
section, the term ``price'' generally does not include costs of
acquisition other than the amount of the consideration from the
purchaser to the seller. However, for rules relating to adjustments in
price due to changes in financing terms and closing costs see paragraph
(d)(2) of this section.
(b) Form of certification. The following form of the certification
statement is suggested:
I certify that the construction of the residence at (specify
address) was begun before March 26, 1975, and that this residence has
not been offered for sale after February 28, 1975 in a listing, a
written private offer, or an offer by means of advertisement at a lower
purchase price than (state price), the price at which I sold the
residence to (state name, present address, and social security number of
purchaser) by contract dated (give date).
(Date, seller's signature and taxpayer identification number.)
However, any written certification filed by the taxpayer will be
accepted provided that such certification is signed by the seller and
states that construction of the residence began before March 26, 1975,
and that the purchase price of the residence is the lowest price at
which the residence was offered for sale after February 28, 1975. With
regard to factory-made homes the seller, in the absence of his own
knowledge as to the commencement of construction, may attach to his own
certification a certification from the manufacturer that construction
began before March 26, 1975, and may certify based on the manufacturer's
certification. It is suggested that both certifications include the
serial number, if any, of the residence.
(c) Offer to sell. (1) For purposes of section 44(e)(4) and this
section, an offer to sell is limited to an offer to sell a specified
residence at a specified purchase price.
(2) An ``offer'' includes any written offer, whether made to a
particular purchaser or to the public, and any offer by means of
advertising. Advertising includes an offer to sell published by
billboards, flyers, brochures, price lists (unless the lists are
exclusively for the internal use of the seller and are not made
available to the public), mailings, newspapers, periodicals, radio, or
television. The listing of a property with a real estate agency, the
filing of a prospectus and the registration of construction plans and
price lists with the appropriate authorities (in the case of
condominiums or cooperative housing developments) are to be considered
offers made to the public.
(3) An offer to sell a specified residence includes:
(i) Both an offer to sell an existing residence and an offer to
build and sell a residence of substantially the same design or model as
that purchased by the taxpayer on the same lot as that on which the
taxpayer's new principal residence was constructed. It does not include
an offer to sell the same model residence on a different lot. Where a
residence of a particular design or model is offered at a specific base
price, additions of property to the residence, no matter how extensive,
will not result in the residence being treated as a different residence
for the purpose of determining the lowest offer (as defined in paragraph
(f) of Sec. 1.44-5).
(ii) In the case of a condominium or cooperative housing development
where units are offered for sale on the basis of models (e.g., all Model
C two-bedroom apartments sell at a specified base price), an offer to
sell a specified residence includes an offer to sell a specific type of
unit (with appropriate adjustments to be made for the location of such
unit and as provided in paragraph (d) of this section).
(iii) In the case of a factory-made home, an offer to sell a
specified residence includes an offer to sell the same model home as
that purchased by the taxpayer, provided that the offer is made after
the seller has the right to sell the home purchased by the taxpayer
(i.e., has that specific home in his inventory). However, it does not
include an offer to sell such home with land which is not included in
the taxpayer's purchase nor an offer to sell such home without land
which is included in the taxpayer's purchase. Appropriate adjustments to
a prior offer shall be made as provided in paragraph
[[Page 175]]
(d) of this section, including adjustments for any delivery and
installation charges as provided in paragraph (d)(3).
(iv) The rules of this subparagraph may be illustrated by the
following examples:
Example 1. In March 1975 A advertised colonial-style homes on
section I of subdivision C at a base price of $40,000. At the time none
of the homes had been completed but construction of all homes on section
I was commenced before March 26, 1975. After one-half of the homes were
sold, A offers to sell the remaining homes in May 1975 at a base price
of $45,000. Under the facts above the base price of $45,000 is not the
lowest offer since the seller had offered to sell the same model home on
the same lot at a lower purchase price after February 28, 1975.
Example 2. In June 1975 A offers houses, otherwise qualifying, on
section II for the first time for a base price of $50,000. They are
colonial homes and substantially the same as the homes he previously
offered on section I. Under the facts stated above the base price of
$50,000 is the lowest offer since the same model home on the same lot
was not previously offered for sale.
Example 3. In March 1975 B, a condominium developer, offers to sell
any two-bedroom unit in a particular high rise condominium for $45,000
with an added $5,000 for units with a lakefront view and an additional
$2,000 for units on higher floors. With regard to all two-bedroom units
in the condominium an offer to sell a specified residence at a specified
purchase price has been made. This is true even though at the time of
the offer construction had not reached the floor on which the particular
unit will be located.
(4) A specified purchase price means a stated definite price for a
particular residence or a specific base price for a residence of a
particular model or design. An offer to sell for an indefinite price
(e.g., an advertisement that all houses sell in the $40,000's) is not
considered an offer to sell at a specified purchase price.
(5) An offer to sell includes an offer to sell subject to special
conditions imposed by the seller. Thus, if the lowest price at which a
house was advertised was ``at $40,000 for March only'', the $40,000
price would be the lowest offer. However, certain conditions may
necessitate adjustments in determining the lowest offer. See paragraph
(d) of this section.
(6) An offer to sell two or more residences together as for example,
in a bulk sale shall be disregarded, even though each residence is
assigned a specific purchase price for the purpose of such a sale. With
regard to factory-made homes an offer to sell does not include an offer
made by the manufacturer to a dealer in such homes.
(7)(i) Where new residences are purchased at a foreclosure sale
(including a conveyance by the owner in lieu of foreclosure) and prior
to the foreclosure sale such residences had been offered for sale by the
foreclosure seller at specified prices, the foreclosure purchaser is
bound by such prices in determining the lowest offer. He is not bound by
the prices paid to the foreclosure seller since such prices do not
constitute voluntary offers.
(ii) For this purpose, if the foreclosure seller and foreclosure
purchaser are not related parties (as defined in subdivision (iii) of
this subparagraph), and if the foreclosure purchaser does not have
knowledge of the date of commencement of construction and the lowest
offer made by such seller with respect to each of the foreclosed
residences, the foreclosure purchaser must request and try to obtain
from the foreclosure seller a certificate specifying such facts. Upon a
subsequent sale of a particular residence by the foreclosure purchaser,
he must certify whether the price is the lowest offer for that
particular residence based on the certification of the foreclosure
seller, a copy of which must be attached to the certification of the
foreclosure purchaser. If the foreclosure seller refuses to so certify,
the foreclosure purchaser must make a reasonable effort to determine the
date construction commenced and the lowest offer made by the foreclosure
seller. For this purpose, reasonable effort includes the effort to
locate and examine advertising and listings published or used by the
foreclosure seller. If the foreclosure seller and foreclosure purchaser
are related parties (as defined in subdivision (iii) of this
subparagraph), the foreclosure purchaser will be considered as having
knowledge of the date of the commencement of construction and the lowest
offer made by such seller with respect to each of the foreclosed
residences, and, upon a subsequent sale of a particular residence by
[[Page 176]]
the foreclosure purchaser, he must comply with the certification
requirements prescribed by paragraphs (a) and (b) of this section.
(iii) For purposes of this subparagraph related parties shall
include the relationships described in subparagraph (2) of Sec. 1.44-
5(c), and the constructive ownership rules of section 318 shall apply,
but family members for this purpose shall include spouses, ancestors,
and lineal descendants.
(d) Adjustments in determining lowest price. (1)(i) In determining
whether a residence was sold at the lowest offer appropriate adjustment
shall be made for differences in the property offered and in the terms
of the sale. Where the sale to the taxpayer includes property which was
not the subject of the prior offer or excludes property which was
included in the prior offer, the amount of the prior offer shall be
adjusted to reflect the fair market value of such property, provided
that, in the case of property included in the sale which was not a part
of the residence at the time of execution of the contract of purchase,
the taxpayer had the option to require inclusion or exclusion of such
property. The fair market value of any excluded property is to be
determined at the time of the prior offer, while all additions are to be
valued at their fair market value on the date of execution of the
contract of sale. If a seller increases his present offer to include
financing or other costs of the seller in connection with his ownership
of the residence, the present offer does not qualify as being the lowest
offer.
(ii) The rules in subdivision (i) of this subparagraph are
illustrated by the following examples:
Example 1. A offered to sell a new home without a garage for
$35,000. Having found no buyers A added a garage and sold the home for
$40,000. At the time the contract of sale was executed the fair market
value of the garage was $5,000. The offer to sell for $40,000 qualifies
since it equals the seller's lowest offer plus the fair market value of
the garage.
Example 2. B, unable to sell colonial-style homes presently under
construction and previously offered for sale for $40,000, makes
extensive changes in decor and identifies the homes as his new
Williamsburg model. The Williamsburg models are not different residences
for purposes of this section. To the extent that the additions have not
yet been added at the time of execution of a contract of sale, in order
to qualify for the credit the taxpayer must have the option as to
whether to include these additions, and if these additions are included
B must charge no more than the fair market value of the additions on
that date of execution of the contract of sale.
(2) Appropriate adjustment to a prior offer to sell shall be made
for differences in financing terms and closing costs which increase the
seller's actual net proceeds and the purchaser's actual costs. A seller
may pass on to the purchaser without affecting the purchase price only
those additional amounts he is required to expend in connection with
such differences. The seller may not by changing the financing terms or
closing costs indirectly increase the purchase price. For these purposes
closing costs include all charges paid at settlement for obtaining the
mortgage loan and transferring real estate title. Thus, for example,
where a seller previously offered a residence for sale for $40,000 and
agreed to pay financing ``points'' required by the mortgagee, and now
offers the same residence also for $40,000 but requires the purchaser to
pay the points, the present offer does not constitute the lowest offer.
On the other hand, a prior offer to sell based upon a large down payment
by the prospective purchaser may be adjusted to reflect the additional
costs to the seller of accepting a small down payment from the taxpayer.
For purposes of determining the seller's net proceeds, proceeds received
by all related parties within the meaning of section 318 must be taken
into account. For purposes of determining the lowest offer, where an
offer provided for a rebate (e.g., of cash or of a contribution toward
mortgage payments) or included, without additional charge or at less
than fair market value, property not normally included in the sale of a
residence (e.g., an automobile), such offer must be reduced by the
amount of such rebate or by the amount by which the fair market value of
such property at the time of the offer exceeds the amount paid for it by
the purchaser. Thus, where a residence was advertised for sale at
$40,000, but the seller agreed to pay $200 a month on the purchaser's
mortgage
[[Page 177]]
for 10 months, such residence is considered to have been offered for
sale at $38,000.
(3) In the case of a factory-made home, where delivery and
installation costs are included in the specified base price of such home
an appropriate adjustment is to be made in such specified base price for
differences in the fair market value of the delivery and installation in
determining the lowest offer.
(e) Civil and criminal penalties. If a person certifies that the
price for which the residence was sold does not exceed the lowest offer
and if it is found that the price for which the residence was sold
exceeded the lowest offer, then such person is liable (under section
208(b) of the Tax Reduction Act of 1975) to the purchaser for damages in
an amount equal to three times the excess of the certified price over
the lowest offer plus reasonable attorney's fees. No income tax
deduction shall be allowed for two-thirds of any amount paid or incurred
pursuant to a judgment entered against any person in a suit based on
such liability. However, attorney's fees, court costs, and other such
amounts paid or incurred with respect to such suit which meet the
requirements of section 162 are deductible under that section. In
addition, an individual who falsely certifies may be subject to criminal
penalties. For example, section 1001 of Title 18 of the United States
Code provides as follows:
Sec. 1001 Statements or entries generally.
Whoever, in any matter within the jurisdiction of any department or
agency of the United States knowingly and willfully falsifies, conceals
or covers up by any trick, scheme, or device a material fact, or makes
any false, fictitious or fraudulent statements or representations, or
makes or uses any false writing or document knowing the same to contain
any false, fictitious or fraudulent statement or entry, shall be fined
not more than $10,000 or imprisoned not more than five years, or both.
The treble damages and criminal sanctions provided under this paragraph
apply only with regard to false certification as to the lowest offer,
not to false certification as to commencement of construction. However,
with regard to false certification as to commencement of construction
there may exist contractual or tort remedies under State law.
(f) Denial of credit. In the absence of the taxpayer's participation
in, or knowledge of, a false certification by the seller, the credit is
not denied to a taxpayer who otherwise qualifies for the credit solely
because the seller has falsely certified that the new principal
residence was sold at the lowest offer. However, if certification as to
the commencement of construction is false, no credit is allowed since
such residence does not qualify as a new principal residence
construction of which began before March 26, 1975.
[T.D. 7391, 40 FR 55852, Dec. 2, 1975]
Sec. 1.44-4 Recapture for certain dispositions.
(a) In general. (1) Under section 44(d) except as provided in
paragraphs (b) and (c) of this section, if the taxpayer disposes of
property, with respect to the purchase of which a credit was allowed
under section 44(a), at any time within 36 months after the date on
which he acquired it (or, in the case of construction by the taxpayer,
the date on which he first occupied it as his principal residence), then
the tax imposed under chapter 1 of the Code for the taxable year in
which the replacement period (as provided under subparagraph (2) of this
paragraph) terminates is increased by an amount equal to the amount
allowed as a credit for the purchase of such property.
(2) The replacement period is the period provided for purchase of a
new principal residence under section 1034 of the Code without
recognition of gain on the sale of the old residence. In the case of
residences sold or exchanged after December 31, 1974, it is generally 18
months in the case of acquisition by purchase and 2 years in the case of
construction by the taxpayer provided, however, that such construction
has commenced within the 18-month period. Thus, a calendar-year taxpayer
who disposes of his old principal residence in December 1975 and does
not qualify under paragraph (b) or (c) of this section will include the
amount previously allowed as additional tax on his 1977 tax return.
(3) Except as provided in paragraphs (b) and (c) of this section,
section 44(d)
[[Page 178]]
applies to all dispositions of property, including sales (including
foreclosure sales), exchanges (including tax-free exchanges such as
those under sections 351, 721, and 1031), and gifts.
(4) In the case of a husband and wife who were allowed a credit
under section 44(a) claimed on a joint return, for the purpose of
section 44(d) and this section the credit shall be allocated between the
spouses in accordance with the provisions of paragraph (b)(3) of
Sec. 1.44-1.
(b) Acquisition of a new residence. (1) Section 44(d)(1) and
paragraph (a) of this section shall not apply to a disposition of
property with respect to the purchase of which a credit was allowed
under section 44(a) in the case of a taxpayer who purchases or
constructs a new principal residence (within the meaning of Sec. 1.44-
5(a)) within the applicable replacement period provided in section 1034.
In determining whether a new principal residence qualifies for purposes
of this section the rules relating to construction, acquisition, and
occupancy under Sec. 1.44-2 do not apply. Where a disposition has
occurred and the taxpayer's purchase (or construction) costs of a new
principal residence are less than the adjusted sales price (as defined
in section 1034(b)) of the old residence, the tax imposed by chapter 1
of the Code for the taxable year following the taxable year during which
disposition occurs is increased by an amount which bears the same ratio
to the amount allowed as a credit for the purchase of the old residence
as (i) the adjusted sales price of the old residence (within the meaning
of section 1034), reduced (but not below zero) by the taxpayer's cost of
purchasing (or constructing) the new residence (within the meaning of
such section) bears to (ii) the adjusted sales price of the old
residence.
(2) The rules of subparagraph (1) of this paragraph may be
illustrated by the following example:
Example. On July 15, 1975, A purchases a new principal residence for
a total purchase price of $40,000. The property meets the tests of
Sec. 1.44-2, and A is allowed a credit of $2,000 on his 1975 tax return.
On January 15, 1977 (within 36 months after acquisition) A sells his
residence for an adjusted sales price of $50,000 and on March 15, 1977,
purchases a new principal residence at a cost of $40,000. Since the new
principal residence was purchased within the 18-month replacement period
(provided in section 1034), the amount recaptured is limited to $400,
determined by multiplying the amount of the credit allowed ($2,000) by a
fraction, the numerator of which is $10,000 (determined by reducing the
adjusted sales price of the old residence ($50,000) by A's cost of
purchasing the new principal residence ($40,000)) and the denominator of
which is $50,000 (the adjusted sales price). Therefore, A's tax
liability for 1978, the year following the taxable year in which the
disposition occurred, is increased by $400.
(c) Certain involuntary dispositions. Section 44(d)(1) and paragraph
(a) of this section shall not apply to the following:
(1) A disposition of a residence made on account of the death of any
individual having a legal or equitable interest therein occurring during
the 36-month period described in paragraph (a) of this section,
(2) A disposition of the residence if it is substantially or
completely destroyed by a casualty described in section 165(c)(3),
(3) A disposition of the residence if it is compulsorily and
involuntarily converted within the meaning of section 1033(a), or
(4) A disposition of the residence pursuant to a settlement in a
divorce or legal separation proceeding where the other spouse retains
the residence as principal residence (as defined in Sec. 1.44-5(a)).
[T.D. 7391, 40 FR 55854, Dec. 2, 1975; 40 FR 58138, Dec. 15, 1975]
Sec. 1.44-5 Definitions.
For purposes of section 44 and the regulations thereunder--
(a) New principal residence. The term ``new principal residence''
means a principal residence, the original use of which commences with
the taxpayer. The term ``principal residence'' has the same meaning as
under section 1034 of the Code. For this purpose, the term ``residence''
includes, without being limited to, a single family structure, a
residential unit in a condominium or cooperative housing project, a
townhouse, and a factory-made home. In the case of a tenant-stockholder
in a cooperative housing corporation references to property used by the
taxpayer as his principal residence and references to
[[Page 179]]
the residence of a taxpayer shall include stock held by the tenant-
stockholder in a cooperative housing project provided, however, that the
taxpayer used as his principal residence the house or apartment which he
was entitled as such stockholder to occupy. ``Original use'' of the new
principal residence by the taxpayer means that such residence has never
been used as a residence prior to its use as such by the taxpayer. For
this purpose, a residence will qualify if the first occupancy was by the
taxpayer pursuant to a lease arrangement pending settlement under a
binding contract to purchase or pursuant to a lease arrangement where a
written option to purchase the then existing residence was contained in
the original lease agreement.
A renovated building does not qualify as new, regardless of the extent
of the renovation nor does a condominium conversion qualify.
(b) Purchase price--(1) General rule. For purposes of section 44(a)
and Sec. 1.44-1, the term ``purchase price'' means the adjusted basis of
the new principal residence on the date of acquisition and includes all
amounts attributable to the acquisition or construction, but only to the
extent that such amounts constitute capital expenditures and are not
allowable as deductions in computing taxable income. Such capital
expenditures include but are not limited to the cost of acquisition or
construction, title insurance, attorney's fees, transfer taxes, and
other costs of transfer. For these purposes the adjusted basis of a
factory-made home includes the cost of moving the home and setting it up
as the taxpayer's principal residence only where such cost is included
in the base price of the residence; it also includes the purchase price
of the land on which the home is located, but only if such land was
purchased by the taxpayer after March 12, 1975 and only if the taxpayer
acquired the land prior to or in conjunction with the acquisition of
such factory-made home. However, the adjusted basis does not include any
expenditures involved in connection with the leasing of land on which
the factory-made home is located. In the case of factory-made homes the
adjusted basis includes furniture only where it is included in the base
price of the unit.
(2) Sale of old principal residence. (i) The adjusted basis is
reduced by any gain from the sale or involuntary conversion of an old
principal residence, which is not recognized due to the application of
section 1033 or section 1034. However, no reduction will be made for any
gain excluded from tax by reason of the special treatment provided under
the tax laws in the case of a sale by a taxpayer who has attained age 65
(section 121 of the code).
(ii) The rules in subdivision (i) of this subparagraph are
illustrated by the following examples:
Example 1. A sells an old principal residence for $30,000 which has
an adjusted basis of $20,000. A reinvests the proceeds by purchasing a
new principal residence for $40,000 (including settlement costs which
are capital in nature), and this purchase satisfies the statutory
criteria under section 1034 for nonrecognition of gain. The credit under
section 44 applies with respect to $30,000 ($40,000 costs minus $10,000
unrecognized gain) of the cost of the new principal residence.
Example 2. B and C, two sisters, purchase a new principal residence
as joint tenants with the right of survivorship for a total purchase
price of $40,000. B has previously sold her old principal residence for
$25,000 and a $10,000 gain on the sale has qualified for nonrecognition
under section 1034. B contributes $25,000 and C contributes $15,000. The
adjusted basis of the new principal residence is $30,000 representing
the total purchase price of $40,000 less $10,000 representing
unrecognized gain under section 1034. The total credit allowable,
therefore, is $1,500. Since joint tenants are treated as equal owners
and since allocation of the credit is made in proportion to the
taxpayer's respective ownership interests in such residence B and C each
will receive a credit of $750.
Example 3. Taxpayer D is 65 years old and sells his old principal
residence for $20,000 excluding all gain under section 121. He then
purchases a new principal residence for $30,000. D's adjusted basis in
his new principal residence is $30,000, and he is allowed a credit of
$1,500.
(3) Tie-in sales. In the case of a purchase of a new principal
residence which is tied in to the transfer of other property by the
seller to the purchaser, whether purportedly by sale or gift, the
adjusted basis of the residence is reduced by the amount of the excess
of the fair market value of such other
[[Page 180]]
property received over the amount, if any, purportedly paid for it by
the purchaser of the residence. For example, if a taxpayer receives a
new car with a fair market value of $2,500 upon the purchase of a
condominium apartment for a total purchase price of $40,000 (including
settlement costs which are capital in nature) his adjusted basis in the
residence for computation of the credit is $37,500.
(4) Basis of new principal residence. The taxpayer's basis in his
new principal residence is not in any way affected by the allowance of
the credit.
(c) Purchase--(1) General rule. Except as provided in subparagraph
(2) of this paragraph, the term ``purchase'' means any acquisition of
property.
(2) Exceptions. (i) An acquisition does not qualify as a purchase
for the purpose of this paragraph if the property is acquired from a
person whose relationship to the person acquiring it would result in the
disallowance of losses under section 267 or 707(b). Such persons
include--
(A) The purchaser's spouse, ancestors and lineal descendants,
(B) Related corporations as provided under section 267(b)(2),
(C) Related trusts as provided under section 267(b), (4), (5), (6),
and (7),
(D) Related charitable organizations as provided under section
267(b)(9), and
(E) Related partnerships as provided under section 707(b)(1).
For purposes of this subdivision the constructive ownership rules of
section 267(c) shall apply except that paragraph (4) of section 267(c)
shall be treated as providing that the family of an individual shall
include only his spouse, ancestors, and lineal descendants.
(ii) An acquisition does not qualify as a purchase for the purpose
of this paragraph if the basis of the property in the hands of the
person acquiring such property is determined--
(A) In whole or in part by reference to the adjusted basis of such
property in the hands of the person from whom acquired (e.g., a gift
under section 1015), or
(B) Under section 1014(a) (relating to property acquired from a
decedent).
(d) Self-construction. The term ``self-construction'' means the
construction of a residence (other than a factory-made home) to the
taxpayer's specifications on land already owned or leased by the
taxpayer at the time of commencement of construction. Thus, where a
taxpayer purchases land and either builds a residence himself or hires
an architect and a contractor to build a residence on that land, the
taxpayer has ``self-constructed'' the residence.
(e) Factory-made home. The term ``factory-made homes'' includes
mobile homes, houseboats and prefabricated and modular homes.
(f) Lowest offer. The term ``lowest offer'' means the lowest price
at which the residence was offered for sale after February 28, 1975.
[T.D. 7391, 40 FR 55855, Dec. 2, 1975]
Sec. 1.44A-1 Expenses for household and dependent care services necessary for gainful employment.
(a) In general. (1) This section applies only for expenses incurred
in taxable years beginning after December 31, 1975. For deductibility of
expenses incurred in taxable years beginning before January 1, 1972, see
Sec. 1.214-1. For deductibility of expenses incurred in taxable years
beginning after December 31, 1971, and before January 1, 1976, see
Secs. 1.214A-1 through 1.214A-5.
(2) Section 44A allows a credit against the tax imposed by chapter 1
of the Code to an individual who maintains a household (within the
meaning of paragraph (d) of this section) which includes as a member one
or more qualifying individuals (as defined in paragraph (b) of this
section). The amount of the credit is equal to the applicable percentage
of the employment-related expenses (as defined in paragraph (c) of this
section) paid by the individual during the taxable year (but subject to
the limits prescribed in Sec. 1.44A-2(a)). However, the credit cannot
exceed the tax imposed by chapter 1, reduced by the sum of the allowable
credits enumerated in section 44A(b). The term ``applicable percentage''
means 30 percent reduced by 1 percentage point for each $2,000 (or
fraction thereof) by which the taxpayer's adjusted gross income for the
taxable year exceeds $10,000, but in no event
[[Page 181]]
shall the percent be less than 20 percent. Thus, for example, if a
taxpayer's adjusted gross income is over $10,000, but less than
$12,000.01, the applicable percentage is 29 percent. (For expenses
incurred in taxable years beginning before January 1, 1982, the
applicable percentage is a flat 20 percent).
(3) Generally, the credit for employment-related expenses is
allowable, regardless of the taxpayer's method of accounting, only for
expenses which are actually paid during the taxable year and which are
incurred during the taxable year or were incurred during a prior taxable
year beginning after December 31, 1975. If the expenses are incurred but
not paid during the taxable year, no credit may be taken for that year
on account of those expenses. Thus, if an expense is incurred in the
last month of a taxable year but not paid until the following taxable
year, a credit for the expense is not allowed for the earlier taxable
year but is allowed for the following taxable year. However, if an
expense is incurred in a taxable year beginning before January 1, 1976,
and paid in a later taxable year, no credit is allowed with respect to
the expense under section 44A. Section 214 and the regulations
thereunder are applicable in determining whether a deduction for the
expense is allowed in the year of payment.
(4) Since an expense cannot be an employment-related expense until
the services for which the expense was incurred are performed (see
paragraph (c) of this section), prepaid expenses may be claimed only in
the taxable year in which the services are performed.
(5) The requirements of section 44A, this section and Secs. 1.44A-2
through 1.44A-4 are applied to expenses as of the time they are incurred
regardless of when they are paid.
(6) For special rules relating to employment-related expenses which
also qualify as medical expenses deductible under section 213, see
Sec. 1.44A-4(b).
(7) For substantiation of the credit, see paragraph (e) of this
section.
(b) Qualifying individual--(1) In general. A person is considered to
be a qualifying individual if he or she is--
(i) The taxpayer's dependent who is under the age of 15 and is an
individual for whom the taxpayer is entitled to a deduction for a
personal exemption under section 151(e);
(ii) The taxpayer's dependent (not described in subdivision (i)) who
is physically or mentally incapable of self-care; or
(iii) The taxpayer's spouse who is physically or mentally incapable
of self-care.
The term ``dependent,'' as used in this paragraph (b)(1), includes any
individual who is a dependent within the meaning of section 152.
However, see paragraph (b)(2) of this section for special rules for
determining which parent may treat a child as a qualifying individual
where the parents are divorced, legally separated, or separated under a
written separation agreement.
(2) Special dependency test in case of divorced or separated
parents. A child (as defined in section 151(e)(3)) who--
(i) Is under age 15 or is physically or mentally incapable of self-
care,
(ii) Receives over half of his or her support during the calendar
year from his or her parents who are divorced or legally separated under
a decree of divorce or separate maintenance or who are separated under a
written separation agreement, and
(iii) Is in the custody of one or both of his or her parents for
more than one-half of the calendar year,
is treated for any taxable year beginning in the calendar year as a
qualifying individual (described in subdivision (i) or (ii), as the case
may be, of paragraph (b)(1) of this section) of that parent who has
custody for a longer period during the calendar year than the other
parent. Accordingly, a child may be treated as a qualifying individual
of a parent even though the parent is not entitled to a dependency
exemption for the child. The child cannot be treated as a qualifying
individual with respect to more than one parent.
(3) Qualification on a daily basis. The status of a person as a
qualifying individual is determined on a daily basis. Thus, if a
dependent or spouse of a taxpayer ceases to be a qualifying individual
on September 16, the dependent or spouse is treated as a qualifying
individual through September 15 only.
(4) Physical or mental incapacity. An individual is considered to be
physically or mentally incapable of self-
[[Page 182]]
care if as a result of a physical or mental defect the individual is
incapable of caring for his or her hygienical or nutritional needs, or
requires full-time attention of another person for his or her own safety
or the safety of others. The fact that an individual, by reason of a
physical or mental defect, is unable to engage in any substantial
gainful activity, or is unable to perform the normal household functions
of a homemaker or to care for minor children, does not of itself
establish that the individual is physically or mentally incapable of
self-care. An individual who is physically handicapped or is mentally
defective, and for such reason requires constant attention of another
person, is considered to be physically or mentally incapable of self-
care.
(c) Employment-related expenses--(1) Gainful employment--(i) In
general. Expenses are considered to be employment-related expenses only
if they are incurred to enable the taxpayer to be gainfully employed and
are paid for household services or for the care of one or more
qualifying individuals. The expenses must be incurred while the taxpayer
is gainfully employed or is in active search of gainful employment. The
employment may consist of service either within or without the home of
the taxpayer and may include self-employment. An expense is not
considered to be employment-related merely because it is incurred while
the taxpayer is gainfully employed. The purpose of the expense must be
to enable the taxpayer to be gainfully employed. Volunteer work for a
nominal salary does not constitute gainful employment. Whether the
purpose of an expense is to enable the taxpayer to be gainfully employed
depends upon the facts and circumstances of the particular case. Any tax
required to be paid by the taxpayer under section 3111 (relating to the
Federal Insurance Contributions Act) and 3301 (relating to the Federal
Unemployment Tax Act), or under similar State payroll taxes, in respect
of any wages which otherwise constitute employment-related expenses is
considered to be an employment-related expense.
(ii) Determination of period of employment on a daily basis. An
allocation of expenses is required on a daily basis when the expenses
cover any period during part of which the taxpayer is gainfully employed
or is in active search of gainful employment and during the other part
of which there is no employment or active search for gainful employment.
Thus, for example, if a taxpayer incurs during each month of the taxable
year $60 of expenses which would be employment-related if he or she were
gainfully employed all year, and the taxpayer is gainfully employed, or
in active search of gainful employment, for only 2 months and 10 days
during such year, the amount of employment-related expenses is limited
to $140.
(2) Household services. Expenses are considered to be paid for
household services if they are paid for the performance in and about the
taxpayer's home of ordinary and usual services necessary to the
maintenance of the household. However, expenses are not considered as
paid for household services unless the expenses are attributable in part
to the care of the qualifying individual. Thus, amounts paid for the
services of a domestic maid or cook are considered to be expenses paid
for household services if a part of those services is provided to the
qualifying individual. Amounts paid for the services of an individual
who is employed as a chauffeur, bartender, or gardener, however, are not
considered to be expenses paid for household services.
(3) Care of qualifing individual--(i) In general. The primary
purpose of expenses for the care of a qualifying individual must be to
assure that individual's well-being and protection. Not all benefits
bestowed upon a qualifying individual are considered as provided for the
individual's care. Accordingly, amounts paid to provide food, clothing,
or education are not expenses paid for the care of a qualifying
individual. However, where the manner of providing care is such that the
expense which is incurred includes expenses for other benefits which are
incident to and inseparably a part of the care, the full amount of the
expense is considered to be incurred for care. Thus, for example, the
full amount paid to a nursery school in which a qualifying child is
enrolled is considered as being for the care of the child, even though
[[Page 183]]
the school also furnishes lunch and educational services. Educational
expenses incurred for a child in the first or higher grade level are not
expenses incurred for the care of a qualifying individual. Expenses
incurred for transportation of a qualifying individual described in
paragraph (b)(1)(i) of this section between the taxpayer's household and
a place outside the taxpayer's household where services for the care of
the qualifying individual are provided are not incurred for the care of
a qualifying individual.
(ii) Manner of providing care. The manner of providing the care need
not be the least expensive alternative available to the taxpayer. For
example, the taxpayer's mother may reside at the taxpayer's home and be
available to provide adequate care at no cost for the taxpayer's wife
who is physically or mentally incapable of caring for herself.
Nevertheless, the expenses incurred in providing a nurse for the wife
may be an expense for the care of the wife. See paragraph (c)(1)(i) of
this section with respect to the requirement that the expense must be
for the purpose of permitting the taxpayer to be gainfully employed.
(4) Services outside the taxpayer's household. The credit is allowed
under section 44A with respect to employment-related expenses incurred
for services performed outside the taxpayer's household only if those
expenses are incurred for the care of--
(i) One or more qualifying individuals who are described in
paragraph (b)(1)(i) of this section; or
(ii) One or more qualifying individuals (as to expenses incurred for
taxable years beginning after December 31, 1981) who are described in
paragraph (b)(1) (ii) or (iii) of this section and who regularly spend
at least 8 hours each day in the taxpayer's household.
(5) Dependent care centers. The credit is allowed under section 44A
with respect to employment-related expenses incurred in taxable years
beginning after December 31, 1981, for services provided outside the
taxpayer's household by a dependent care center only if--
(i) The center complies with all applicable laws and regulations of
a State or unit of local government (e.g., State or local requirements
for licensing, if applicable, and building and fire Code regulations);
and
(ii) The requirement provided in paragraph (c)(4)(i) or (ii) of this
section is met.
The term ``dependent care center'' means any facility that provides
full-time or part-time care for more than six individuals (other than
residents of the facility) on a regular basis during the taxpayer's
taxable year, and receives a fee, payment, or grant for providing
services for any such individuals (regardless of whether such facility
is operated for profit). For purposes of the preceding sentence, a
facility will be presumed to provide full-time or part-time care for six
or less individuals on a regular basis during the taxpayer's taxable
year if the facility has six or less individuals (including the
qualifying individual) enrolled for full-time or part-time care on the
day the qualifying individual is enrolled in the facility (or on the
first day of the taxable year the qualifying individual attends the
facility in the case where the individual was enrolled in the facility
in the preceding taxable year) unless the Internal Revenue Service
demonstrates that the facility provides full-time or part-time care for
more than six individuals on a regular basis during the taxpayer's
taxable year.
(6) Allocation of expenses. Where a portion of an expense is for
household services or for the care of a qualifying individual and a
portion of such expense is for other purposes, a reasonable allocation
must be made and only the portion of the expense paid which is
attributable to such household services or care is considered to be an
employment-related expense. No allocation is required to be made,
however, if the portion of expense for the other purpose is minimal or
insignificant. An allocation must be made, for example, if a servant
performs household duties, cares for the qualifying children of the
taxpayer, and also performs social services for the taxpayer (for which
a deduction is not allowable) or clerical services in the office of the
taxpayer outside the home (for which a deduction may be allowable under
section 162). Employment-related expenses include household service
expenses which
[[Page 184]]
are provided in conjunction with the care of a qualifying individual.
Thus, if an expense is in part attributable to the care of a qualifying
individual and in part to household services, no allocation is required.
(7) Illustrations. The application of this paragraph (c) may be
illustrated by the following examples:
Example 1. The taxpayer lives with her mother who is physically
incapable of caring for herself. In order to be gainfully employed the
taxpayer hires a practical nurse whose sole duty consists of providing
for the care of the mother in the home while the taxpayer is at work.
All amounts spent for the services of the nurse are employment-related
expenses.
Example 2. The taxpayer has a dependent child 10 years of age who
has been attending public school. The taxpayer, who has been working
part time, is offered a position involving full-time employment which
she can accept only if the child is placed in a boarding school. The
taxpayer accepts the position and the child is sent to a boarding
school. The expenses paid to the school must be allocated between that
part of the expenses which represents care for the child and that part
which represents tuition for education. The part of the expense
representing care of the child is incurred for the purpose of permitting
the taxpayer to be gainfully employed.
Example 3. The taxpayer, in order to be gainfully employed, employs
a full-time housekeeper who cares for the taxpayer's two children, aged
9 and 15 years, respectively, performs regular household services of
cleaning and cooking, and chauffeurs the taxpayer to and from his place
of employment. The chauffeuring service never requires more than 30
minutes out of the total period of employment each day. No allocation is
required for purposes of determining the portion of the expense
attributable to the chauffeuring (not a household service expense) since
it is de minimis. Further, no allocation is required for the purpose of
determining the portion of the expense attributable to the care of the
15-year-old child (not a qualifying individual) since the household
expense is in part attributable to the care of the 9-year-old child, who
is a qualifying individual. Accordingly, the entire expense of employing
the housekeeper is an employment-related expense. However, the total
amount of employment-related expenses taken into account would be
limited to the amount allowable for one qualifying individual.
(d) Maintenance of a household--(1) In general. An individual is
considered to have maintained a household for the taxable year (or
lesser period) only if the individual (and his or her spouse if the
individual is married) have furnished over one-half of the cost incurred
for such taxable year (or lesser period) in maintaining the household.
The household must actually constitute for the taxable year the
principal place of abode of the taxpayer and the qualifying individual
or individuals described in paragraph (b) of this section. It is not
sufficient that the taxpayer maintain the household without being its
occupant. A physical change in the location of the home does not,
however, prevent the home from constituting the principal place of abode
of the taxpayer and a qualifying individual. The fact that an individual
is born or dies during the taxable year does not prevent a home from
constituting his or her principal place of abode for such year. An
individual is not considered to have terminated a household as his or
her principal place of abode merely by reason of temporary absences
therefrom by reason of illness, education, business, vacation, military
service, or a custody agreement.
(2) Two or more families. Solely for purposes of section 44A and
this section, if two or more families occupy living quarters in common,
each of the families is treated as constituting a separate household,
and the taxpayer who provides more than one-half of the costs of
maintaining such a separate household is treated as maintaining that
household. Thus, for example, if two unrelated taxpayers each with
children occupy living quarters in common and each taxpayer pays more
than one-half of the household costs incurred by each respective family,
each taxpayer will be treated as maintaining a separate household.
(3) Costs of maintaining a household. The costs of maintaining a
household are the expenses incurred for the mutual benefit of the
occupants thereof by reason of its operation as the principal place of
abode of the occupants. The expenses of maintaining a household include
property taxes, mortgage interest, rent, utility charges, upkeep and
repairs, property insurance, and food
[[Page 185]]
consumed on the premises. These expenses do not include the cost of
clothing, education, medical treatment, vacations, life insurance, or
transportation or payments on mortgage principal or for the purchase,
permanent improvement, betterment, or replacement of property. Further,
the costs of maintaining a household do not include the value of
services performed in the household by a qualifying individual described
in paragraph (b) of this section. An expense incurred by a taxpayer
which is paid or reimbursed by another is not considered as a cost of
maintaining a household.
(4) Monthly proration of annual costs. In determining the cost
incurred for a period of less than a taxable year in maintaining a
household, the cost incurred during the entire taxable year must be
prorated on the basis of the number of calendar months within such
lesser period. For this purpose a period of less than a calendar month
will be treated as a calendar month. Thus, for example, if the cost of
maintaining a household for a taxable year is $6,600, and the period in
respect of which a determination is being made under section 44A is from
June 20 to December 31, the taxpayer must furnish more than $1,925
([$6,600 x \7/12\] x 50 percent) in maintaining the household from June
1 to December 31.
(e) Substantiation. A taxpayer claiming a credit under paragraph (a)
of this section for employment-related expenses must substantiate by
adequate records or other sufficient evidence any credit taken under
this section. For example, if requested, the taxpayer must furnish
information as to the nature and period of the physical or mental
incapacity of any dependent or spouse in respect of whom a credit is
claimed, including necessary information from the attending physician as
to the nature of the physical or mental incapacity.
(Secs. 44A(g) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1565, 26 U.S.C. 44A(g); 68A Stat. 917, 26 U.S.C. 7805))
[T.D. 7643, 44 FR 50332, Aug. 28, 1979, as amended by T.D. 7951, 49 FR
18091, Apr. 27, 1984]
Sec. 1.44A-2 Limitations on amount creditable.
(a) Annual dollar limit on amount creditable. The amount of the
employment-related expenses incurred during any taxable year which may
be taken into account under Sec. 1.44A-1 (a) cannot exceed--
(1) $2,400 ($2,000 in the case of expenses incurred in taxable years
beginning before January 1, 1982) if there is one qualifying individual
with respect to the taxpayer at any time during the taxable year, or
(2) $4,800 ($4,000 in the case of expenses incurred in taxable years
beginning before January 1, 1982) if there are two or more qualifying
individuals with respect to the taxpayer at any one time during the
taxable year.
For example, a calendar year taxpayer whose only qualifying individual
reaches age 15 on April 1, 1982, is subject for 1982 to the entire
annual dollar limit of $2,400, without proration of the $2,400 limit.
However, only expenses incurred prior to the child's 15th birthday may
be employment-related expenses.
(b) Earned income limitation--(1) In general. The amount of
employment-related expenses incurred during any taxable year which may
be taken into account under Sec. 1.44A-1(a) cannot exceed--
(i) For an individual not married at the close of the year, the
individual's earned income for the year, or
(ii) For an individual married at the close of the year, the lesser
of the individual's earned income or the earned income of his or her
spouse for the year.
For purposes of this paragraph (b)(1), the earned income of only the
spouse to whom the taxpayer is married at the close of the year is taken
into account (and not the earned income of another spouse who died or
was divorced from the taxpayer during the year). Further, the spouse's
earned income for the entire year is taken into account, even though the
taxpayer and his or her spouse were married for only a part of the year.
For purposes of this paragraph (b), certain married individuals legally
separated or living apart are
[[Page 186]]
treated as not married (see Sec. 1.44A-3 (b) and (c), respectively).
(2) Earned income. For purposes of this section, earned income
means--
(i) Wages, salaries, tips, other employee compensation, and
(ii) Net earnings from self-employment (within the meaning of
section 1402(a) and the regulations thereunder).
For taxable years beginning before January 1, 1979, earned income
includes only amounts described in subdivision (i) or (ii) of this
paragraph (b)(2) which are includible in the eligible individual's gross
income for the taxable year of the individual in which the credit is
claimed. For all taxable years, however, earned income is computed
without regard to any community property laws which may otherwise be
applicable. Earned income is reduced by any net loss in earnings from
self-employment. Earned income does not include amounts received as a
pension or an annuity or an amount to which section 871(a) and the
regulations thereunder apply (relating to income of nonresident alien
individuals not connected with United States business).
(3) Special rule for spouse who is a student or incapable of self-
care. (i) For purposes of this section, a spouse is deemed, for each
month during which the spouse is a full-time student or is a qualifying
individual described in Sec. 1.44A-1(b)(1)(iii), to be gainfully
employed and to have earned income of not less than--
(A) $200 ($166 for taxable years beginning before January 1, 1982)
if there is one qualifying individual with respect to the taxpayer at
any one time during the taxable year, or
(B) $400 ($333 for taxable years beginning before January 1, 1982),
if there are two or more qualifying individuals with respect to the
taxpayer at any one time during the taxable year.
However, in the case of any husband and wife, this subparagraph shall
apply with respect to only one spouse for any one month.
(ii) A ``full-time student'' is an individual who is enrolled at and
attends and educational institution during each of 5 calendar months of
the taxable year of the taxpayer for the number of course hours which is
considered to be a full-time course of study. The enrollment for 5
calendar months need not be consecutive. School attendance exclusively
at night does not constitute a full-time course of study. However, a
full-time course of study may include some attendance at night.
(iii) For the definition of ``educational institution'', see
Sec. 1.151-3(c).
(4) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. During the 1982 taxable year, A, a married taxpayer,
incurs and pays employment-related expenses of $4,000 for the care of a
qualifying individual. A's earned income for the taxable year is $20,000
and his wife's earned income is $1,500. Under these circumstances, the
amount of employment-related expenses for the year which may be taken
into account under Sec. 1.44A-1(a) is $1,500, determined as follows:
Employment-related expenses incurred during taxable year ($4,000, but
limited to $2,400 by paragraph (a)(1) of this section), . . . . . .
$2,400
Application of paragraph (b)(1)(ii) of this section (employment-related
expenses, may not exceed wife's earned income of $1,500 . . . . . $1,500
Employment-related expenses taken into account . . . . . $1,500
Example 2. Assume the same facts as in Example 1 except that A's
wife is a full-time student for nine months of the taxable year and
earns no income for the year. Under these circumstances, the amount of
employment-related expenses for the year which may be taken into account
under Sec. 1.44A-1(a) is $1,800, determined as follows:
Employment-related expenses incurred during taxable year ($4,000, but
limited to $2,400 by paragraph (a)(1) of this section . . . . . $2,400
Application of paragraph (b)(3) of this section [employment-related
expenses may not exceed wife's earned income of $1,800 (200 x 9) . .
$1,800
Employment-related expenses taken into account . . . .$1,800
(Secs. 44A(g) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1565, 26 U.S.C. 44A(g); 68A Stat. 917, 26 U.S.C. 7805))
[T.D. 7643, 44 FR 50334, Aug. 28, 1979, as amended by T.D. 7951, 49 FR
18092, Apr. 27, 1984]
Sec. 1.44A-3 Special rules applicable to married individuals.
(a) Joint return requirement. This section applies only if the
taxpayer is married at the close of a taxable year in which employment-
related expenses
[[Page 187]]
are paid. In such a case the credit provided by section 44A with respect
to employment-related expenses is allowed only if for the taxable year
the taxpayer and his or her spouse file a joint return. If either spouse
dies during the taxable year and a joint return may be made for the year
under section 6013(a)(2) for the survivor and the deceased spouse, the
credit is allowed for the year only if a joint return is made. If,
however, the surviving spouse remarries before the end of the taxable
year in which his or her first spouse dies, a credit is allowed on the
separate return which is made for the decedent spouse. For purposes of
this section, certain married individuals legally separated or living
apart are treated as not married, as provided in paragraphs (b) and (c),
respectively, of this section.
(b) Marital status. For purposes of section 44A, an individual
legally separated from his or her spouse under a decree of divorce or of
separate maintenance is not considered as married.
(c) Certain married individuals living apart. For purposes of
section 44A, an individual who is married within the meaning of section
143(a) is treated as not married for the entire taxable year, if the
individual--
(1) Files a separate return for the year,
(2) Maintains as his or her home a household which constitutes for
more than one-half of the taxable year the principal place of abode of a
qualifying individual, and
(3) Furnishes over one-half of the cost of maintaining the household
for the year,
and if the individual's spouse is not a member of the household at any
time during the last 6 months of the year. Thus for example, an
individual who is married during the taxable year, but is treated as not
married by reason of this paragraph, may determine the earned income
limitation upon the amount of employment-related expenses without taking
into account the earned income of his or her spouse under Sec. 1.44A-
2(b).
[T.D. 7643, 44 FR 50335, Aug. 28, 1979]
Sec. 1.44A-4 Other special rules relating to employment-related expenses.
(a) Payments to related individuals--(1) Taxable years beginning
after December 31, 1978. For taxable years beginning after December 31,
1978, a credit is not allowed under section 44A with respect to the
amount of any employment-related expenses paid by the taxpayer to an
individual--
(i) With respect to whom for the taxable year a deduction under
section 151(e) (relating to deduction for personal exemptions for
dependents) is allowable either to the taxpayer or his or her spouse, or
(ii) Who is a child of the taxpayer (within the meaning of section
151(e)(3)) who is under age 19 at the close of the taxable year.
For purposes of this paragraph (a)(1), the term ``taxable year''means
the taxable year of the taxpayer in which the service is performed.
(1943)
(2) Taxable years beginning before January 1, 1979. For taxable
years beginning before January 1, 1979, except as otherwise provided in
paragraph (a)(3) of this section, a credit is not allowed under section
44A with respect to the amount of any employment-related expenses paid
by the taxpayer to an individual who bears to the taxpayer any
relationship described in section 152(a) (1) through (8). These
relationships are those of a son or daughter or descendant thereof; a
stepson or stepdaughter; a brother, a sister, stepbrother, or
stepsister; a father or mother or an ancestor, of either; a stepfather
or stepmother; a nephew or niece; an uncle or aunt; or a son-in-law,
daughter-in-law, father-in-law, mother-in-law, brother-in-law, or
sister-in-law. In addition, no credit is allowed with respect to the
amount of any employment-related expenses paid by the taxpayer to an
individual who qualifies as a dependent of the taxpayer for the taxable
year within the meaning of section 152(a)(9), which relates to an
individual (other than the taxpayer's spouse) whose principal place of
abode for the taxable year is the home of the taxpayer and who is a
member of the taxpayer's household.
(3) Exception for payments to certain related individuals. For
taxable years beginning before January 1, 1979, a credit
[[Page 188]]
is allowed for the amount of any employment-related expenses paid by the
taxpayer to an individual provided that neither the taxpayer nor his or
her spouse is entitled to a deduction under section 151(e) (relating to
deduction for personal exemptions for dependents) with respect to such
individual for the taxable year in which the service is performed; and
the service with respect to which the amount is paid constitutes
employment within the meaning of section 3121(b). The following services
performed for a taxpayer by a relative who is an employee of the
taxpayer may qualify as employment within the meaning of section
3121(b):
(i) Services performed by the taxpayer's child age 21 or over.
(ii) Domestic services in the taxpayer's home performed by the
taxpayer's parent if--
(A) The taxpayer has living in his or her home a child (as defined
in section 151(e)(3)) who is under age 18 or who has a physical or
mental condition requiring the personal care of an adult during at least
4 continuous weeks in the calendar quarter, and
(B) The taxpayer is a widow or widower or is divorced, or has a
spouse living in the home who, because of a physical or mental
condition, is incapable of caring for his or her child during at least 4
continuous weeks in the calendar quarter in which services are rendered.
(iii) Services of all relatives other than a child, spouse, or
parent of the taxpayer.
For taxable years beginning before January 1, 1979, a credit is not
allowed under section 44A with respect to employment-related expenses
paid by the taxpayer to a relative for services which do not constitute
employment under section 3121(b). Services performed by a relative do
not constitute employment if they relate to the relative's trade or
business the income from which is includible in computing the relative's
net earnings for purposes of the self-employment tax under section 1401.
(4) Payments to entities or partnerships. If the services are
performed by an entity or partnership, paragraph (a) (1) and (2) of this
section is normally not applicable. If, however, the entity or
partnership is established or maintained primarily to avoid the
application of paragraph (a) (1) or (2) in order to permit the taxpayer
to obtain the credit with respect to employment-related expenses, for
purposes of this paragraph (a), the payments of employment-related
expenses shall be treated as made directly to each owner of the entity
or partner in proportion to his or her share of the entity or
partnership. A factor to consider for purposes of determining whether an
entity or partnership is so established or maintained is whether the
entity or partnership is set up solely to care for the taxpayer's
qualifying individual and to provide household services to the taxpayer.
(5) Illustrations. The application of this paragraph may be
illustrated by the following examples:
Example 1. For A's taxable year ending December 31, 1978, A, a
divorced taxpayer, pays $5,000 of employment-related expenses to his
mother for the care of his child age 5. A's mother cares for the child
in her home. The services performed by A's mother do not constitute
employment under section 3121(b). Accordingly, A is not allowed a credit
with respect to the amounts paid to the mother for the care of his
child.
Example 2. Assume the same facts as in Example 1 except that A's
taxable year under consideration begins after December 31, 1978. A is
not entitled to a deduction under section 151(e) for his mother.
Accordingly, A is allowed a credit with respect to the amounts paid to
the mother for the care of his child even though the services performed
by A's mother do not constitute employment under section 3121(b).
Example 3. For B's taxable year ending December 31, 1978, B, a
divorced taxpayer, pays $6,000 of employment-related expenses to his
sister (who is not a dependent of the taxpayer) for the care of his
child. The services performed by B's sister in the care of his child
constitute a trade or business the income from which is includible in
computing net earnings for purposes of the self-employment tax under
section 1401. Accordingly, B is not allowed a credit with respect to the
amounts paid to the sister for the care of his child.
Example 4. Assume the same facts as in Example 3 except that B's
taxable year under consideration begins after December 31, 1978. B is
allowed a credit with respect to the amounts paid to the sister for the
care of his child, even though the services performed by
[[Page 189]]
B's sister do not constitute employment under section 3121(b).
(b) Expenses qualifying as medical expenses. An expense which may
constitute an amount otherwise deductible under section 213, relating to
medical, etc., expenses, may also constitute an expense with respect to
which a credit is allowable under section 44A. In such a case, that part
of the amount with respect to which a credit is allowed under section
44A will not be considered as an expense for purposes of determining the
amount deductible under section 213. On the other hand, where an amount
is treated as a medical expense under section 213 for purposes of
determining the amount deductible under that section, it may not be
treated as an employment-related expense for purposes of section 44A.
The application of this paragraph may be illustrated by the following
examples:
Example 1. In 1982, a calendar year taxpayer incurs and pays $5,000
of employment-related expenses during the taxable year for the care of
his child when the child is physically incapable of self-care. These
expenses are incurred for services performed in the taxpayer's household
and are of a nature which qualify as medical expenses under section 213.
The taxpayer's adjusted gross income for the taxable year is $100,000.
Of the total expenses, the taxpayer may take $2,400 into account under
section 44A; the balance of the expenses, or $2,600, may be treated as
medical expenses to which section 213 applies. However, this amount does
not exceed 3 percent of the taxpayer's adjusted gross income for the
taxable year and is thus not allowable as a deduction under section 213.
Example 2. Assume the same facts as in Example 1. It is not proper
for the taxpayer first to determine his deductible medical expenses of
$2,000 ($5,000--[$100,000 x 3 percent]) under section 213 and then claim
the $3,000 balance as employment-related expenses for purposes of
section 44A. This is because the $3,000 balance has been treated as a
medical expense in computing the amount deductible under section 213.
Example 3. In 1982, a calendar year taxpayer incurs and pays $12,000
of employment-related expenses during the taxable year for the care of
his child. These expenses are incurred for services performed in the
taxpayer's household, and they also qualify as medical expenses under
section 213. The taxpayer's adjusted gross income for the taxable year
is $18,000. The taxpayer takes $2,400 of such expenses into account
under section 44A. The balance, or $9,600, he treats as medical expenses
for purposes of section 213. The allowable deduction under section 213
for the expenses is limited to the excess of the balance of $9,600 over
$540 (3 percent of the taxpayer's adjusted gross income of $18,000), or
$9,060.
(Secs. 44A(g) and 7805 of the Internal Revenue Code of 1954 (90 Stat.
1565, 26 U.S.C. 44A(g); 68A Stat. 917, 26 U.S.C. 7805))RE
[T.D. 7643, 44 FR 50335, Aug. 28, 1979, as amended by T.D. 7951, 49 FR
18092, Apr. 27, 1984]
Sec. 1.44B-1 Credit for employment of certain new employees.
(a) In general--(1) Targeted jobs credit. Under section 44B a
taxpayer may elect to claim a credit for wages (as defined in section
51(c) paid or incurred to members of a targeted group (as defined in
section 51(d)). Generally, to qualify for the credit, the wages must be
paid or incurred to members of a targeted group first hired after
September 26, 1978. However, wages paid of incurred to a vocational
rehabilitation referral (as defined in section 51(d)(2)) hired before
September 27, 1978, may qualify for the credit if a credit under section
44B (as in effect prior to enactment of the Revenue Act of 1978) was
claimed for the individual by the taxpayer for a taxable year beginning
before January 1, 1979. The amount of the credit shall be determined
under section 51. Section 280C(b) (relating to the requirement that the
deduction for wages be reduced by the amount of the credit) and the
regulations thereunder will not apply to taxpayers who do not elect to
claim the credit.
(2) New jobs credit. Under section 44B (as in effect prior to
enactment of the Revenue Act of 1978) a taxpayer may elect to claim as a
credit the amount determined under sections 51, 52, and 53 (as in effect
prior to enactment of the Revenue Act of 1978). Section 280C(b)
(relating to the requirement that the deduction for wages be reduced by
the amount of the credit) and the regulations thereunder will not apply
to taxpayers who do not elect to claim the credit.
(b) Time and manner of making election. The election to claim the
targeted jobs credit and the new jobs credit is made by claiming the
credit on an original return, or on an amended return, at any time
before the expiration
[[Page 190]]
of the 3-year period beginning on the last date prescribed by law for
filing the return for the taxable year (determined without regard to
extensions). The election may be revoked within the above-described 3-
year period by filing an amended return on which the credit is not
claimed.
(c) Election by partnership, electing small business corporation,
and members of a controlled group. In the case of a partnership, the
election shall be made by the partnership. In the case of an electing
small business corporation (as defined in section 1371(a)), the election
shall be made by the corporation. In the case of a controlled group of
corporations (within the meaning of section 52(a) and the regulations
issued thereunder) not filing a consolidlated return under section 1501,
the election shall be made by each member of the group. In the case of
an affiliated group filing a consolidated return under section 1501, the
election shall be made by the group.
(Secs. 44B, 381, and 7805 of the Internal Revenue Code of 1954 (92 Stat.
2834, 26 U.S.C. 44B; 91 Stat. 148, 26 U.S.C. 381(c)(26); 68A Stat. 917,
26 U.S.C. 7805)
[T.D. 7921, 48 FR 52904, Nov. 23, 1983]
rules for computing credit for investment in certain depreciable
property
Sec. 1.46-1 Determination of amount.
(a) Effective dates--(1) In general. This section is effective for
taxable years beginning after December 31, 1975. However, transitional
rules under paragraph (g) of this section are effective for certain
earlier taxable years.
(2) Acts covered. This section reflects changes made by the
following Acts of Congress:
Act and Section
Tax Reduction Act of 1975, section 301.
Tax Reform Act of 1976, sections 802, 1701, 1703.
Revenue Act of 1978, sections 311, 312, 315.
Energy Tax Act of 1978, section 301.
Economic Recovery Tax Act of 1981, section 212.
Technical Corrections Act of 1982, section 102(f).
Tax Reform Act of 1986, section 251.
(3) Prior regulations. For taxable years beginning before January 1,
1976, see 26 CFR 1.46-1 (Rev. as of April 1, 1979). Those regulatons do
not reflect changes made by Pub. L. 89-384, Pub. L. 89-389, and Pub. L.
91-172.
(b) General rule. The amount of investment credit (credit) allowed
by section 38 for the taxable year is the portion of credit available
under section 46(a)(1) that does not exceed the limitation based on tax
under section 46(a)(3).
(c) Credit available. The credit available for the taxable year is
the sum of--
(1) Unused credit carried over from prior taxable years under
section 46(b) (carryovers).
(2) Amount of credit determined under section 46(a)(2) for the
taxable year (credit earned), and
(3) Unused credit carried back from succeeding taxable years under
section 46(b) (carrybacks).
(d) Credit earned. The credit earned for the taxable year is the sum
of the following percentages of qualified investment (as determined
under section 46 (c) and (d))--
(1) The regular percentage (as determined under section 46),
(2) For energy property, the energy percentage (as determined under
section 46), and
(3) For the portion of the basis of a qualified rehabilitated
building (as defined in Sec. 1.48-12(b)) that is attributable to
qualified rehabilitation expenditures (as defined in Sec. 1.48-12(c)),
the rehabilitation percentage (as determined under section 46(b)(4)).
(e) Designation of credits. The credit available for the taxable
year is designated as follows:
(1) The credit attributable to the regular percentage is the
``regular credit''.
(2) The credit attributable to the ESOP percentage is the ``ESOP
credit''.
(3) The credit attributable to the energy percentage for energy
property other than solar or wind is the ``nonrefundable energy
credit''.
(4) The credit attributable to the energy percentage for solar or
wind energy property is the ``refundable energy credit''.
(5) The credit attributable to the rehabilitation percentage for
qualified rehabilitation expenditures is the rehabilitation investment
credit.
[[Page 191]]
(f) Special rules for certain energy property. Energy property is
defined in section 48(l). Under section 46(a)(2)(D), energy property
that is section 38 property solely by reason of section 48(l)(1)
qualifies only for the energy credit. Other energy property qualifies
for both the regular credit (and, if applicable, the ESOP credit) and
the energy credit. For limitation on the energy percentage for property
financed by industrial development bonds, see section 48(l)(11).
(g) Transitional rule for regular and ESOP credit--(1) In general.
Although section 46(a)(2) was amended by section 301(a)(1) of the Energy
Tax Act of 1977 to eliminate the transitional rules under section
46(a)(2)(D), those rules still apply in certain instances. Section
46(a)(2)(D) was added by section 301(a) of the Tax Reduction Act of 1975
and amended by section 802(a) of the Tax Reform Act of 1976.
(2) Regular credit. Under section 46(a)(2)(D), the regular credit is
10 percent and applies for the following property:
(i) Property to which section 46 (d) does not apply, the
construction, reconstruction, or erection of which is completed by the
taxpayer after January 21, 1975, but only to the extent of basis
attributable to construction, reconstruction, or erection after that
date.
(ii) Property to which section 46(d) does not apply, acquired by the
taxpayer after January 21, 1975.
(iii) Qualified progress expenditures (as defined in section 46(d))
made after January 21, 1975.
(3) ESOP credit. See section 48(m) for transitional rules limiting
the period for which the ESOP percentage under section 46(a)(2)(E)
applies. For prior statutes, see section 46(a)(2) (B) and (D), as added
by section 301 of the Tax Reduction Act of 1975 and amended by section
802 of the Tax Reform Act of 1976.
(4) Cross reference. (i) The principles of Sec. 1.48-2 (b) and (c)
apply in determining the portion of basis attributable to construction,
reconstruction, or erection after January 21, 1975, and in determining
the time when property is acquired.
(ii) Section 311 of the Revenue Act of 1978 made the 10 percent
regular credit permanent.
(5) Seven percent credit. To the extent that, under paragraph (g)(1)
of this section, the 10 percent does not apply, the regular credit, in
general, is 7 percent. For a special limitation on qualified investment
for public utility property (other than energy property), see section
46(c)(3)(A).
(6) Qualified progress expenditures. For progress expenditure
property that is constructed, reconstructed, or erected by the taxpayer
within the meaning of Sec. 1.48-2(b), the ten-percent credit applies in
the year the property is placed in service to the portion of the
qualified investment that remains after reduction for qualified progress
expenditures under section 46(c)(4), but only to the extent that the
remaining qualified investment is attributable to construction,
reconstruction, or erection after January 21, 1975. For progress
expenditure property that is acquired by the taxpayer (within the
meaning of Sec. 1.48-2(b)) after January 21, 1975, and placed in service
after that date, the ten-percent credit applies in the year the property
is placed in service to the entire portion of qualified investment that
remains after reduction for qualified progress expenditures.
(h) Tax liability limitation--(1) In general. Section 46(a)(3)
provides a tax liability limitation on the amount of credit allowed by
section 38 (other than the refundable energy credit) for any taxable
year. See section 46(a)(10)(C)(i). Tax liability is defined in paragraph
(j) of this section. The excess of available credit over the applicable
tax liability limitation for the year is an unused credit which may be
carried forward or carried back under section 46(b).
(2) Regular and ESOP tax liability limitation. In general, the tax
liability limitation for the regular and ESOP credits is the portion of
tax liability that does not exceed $25,000 plus a percentage of the
excess, as determined under section 46(a)(3)(B).
(3) Nonrefundable energy credit tax liability limitation. (i) For
nonrefundable energy credit carrybacks to a taxable year ending before
October 1, 1978, the tax liability limitation is the portion of tax
liability that does not exceed
[[Page 192]]
$25,000 plus a percentage of the excess, as determined under section
46(a)(3)(B).
(ii) For a taxable year ending after September 30, 1978, the tax
liability limitation for available nonrefundable energy credit is 100
percent of the year's tax liability.
(4) Alternative limitations. Alternative limitations apply for
certain utilities, railroads, and airlines in determining the regular
tax liability limitation and, for nonrefundable energy credit carrybacks
to taxable years ending before October 1, 1978, the nonrefundable energy
credit tax liability limitation. These alternative limitations do not
apply in determining the energy tax liability limitation for a taxable
year ending after October 1, 1978. The provisions listed below set forth
the alternative limitations:
------------------------------------------------------------------------
Code section Type Years applicable
------------------------------------------------------------------------
46(a)(6) \1\ Utilities Taxable years ending in
1975-1978
46(a)(7) \2\ Utilities Taxable year ending in
1979
46(a)(8) Railroads and Airlines Taxable year ending in
1979 or 1980
46(a)(8) \3\ Railroads Taxable years ending in
1977 or 1978
46(a)(9) \3\ Airlines Taxable years ending in
1977 or 1978
------------------------------------------------------------------------
\1\ Section 46(a)(6) was added by section 301(b)(2) of the Tax Reduction
Act of 1975 and redesignated as section 46(a)(7) by section 302(a)(1)
of the Tax Reform Act of 1976.
\2\ Section 46(a)(7) was amended by section 312(b)(1) of the Revenue Act
of 1978.
\3\ These provisions were repealed by section 312(b)(2) of the Revenue
Act of 1978.
(i) [Reserved]
(j) Tax liability--(1) In general. ``Tax liability'' for purposes of
the regular and ESOP credit and carrybacks of nonrefundable energy
credit to a taxable year ending before October 1, 1978, means the
liability for tax as defined in section 46(a)(4). For ordering of
regular, ESOP, and nonrefundable energy credits, see paragraph (m) of
this section. In addition to taxes excluded under section 46(a)(4), tax
liability does not include tax resulting from recapture of credit under
section 47 and the alternative minimum tax imposed by section 55. See
sections 47(c) and 55(c)(1).
(2) Certain nonrefundable energy credit. For a taxable year ending
after September 30, 1978, ``tax liability'' for purposes of the
nonrefundable energy credit is liability for tax, as defined in section
46(a)(4) and paragraph (j)(1) of this section, reduced by the regular
and ESOP credit allowed for the taxable year. Thus, carrybacks of
regular or ESOP credit to a taxable year may displace nonrefundable
energy carryovers or credit earned taken into account in that year.
However, carrybacks of regular, ESOP, or nonrefundable energy credit do
not affect refundable energy credit which is treated as an overpayment
of tax under section 6401(b). See paragraph (k) of this section.
(k) Special rule for refundable energy credit. The amount of the
refundable energy credit is determined under the rules of section 46
(other than section 46(a)(3)). However, to permit the refund, the
refundable energy credit for purposes of the Internal Revenue Code
(other than section 38, part IVB, and chapter 63 of the Code) is treated
as allowed by section 39 and not by section 38. The refundable credit is
not applied against tax liability for purposes of determining the tax
liability limitation for other investment credits. Rather, it is treated
as an overpayment of tax under section 6401(b).
(l) FIFO rule. If the credit available for a taxable year is not
allowed in full because of the tax liability limitation, special rules
determine the order in which credits are applied. Under the first-in-
first-out rule of section 46(a)(1) (FIFO), carryovers are applied
against the tax liability limitation first. To the extent the tax
liability limitation exceeds carryovers, credit earned, and carrybacks
are then applied.
(m) Special ordering rule--(1) In general. Under section
46(a)(10)(A), the FIFO rule applies separately--
(i) First, with respect to regular and ESOP credits, and
(ii) Second, with respect to nonrefundable energy credit.
(2) Regular and ESOP credit. Under Sec. 1.46-8(c)(9)(ii), regular
and ESOP credits available are applied in the following order:
(i) Regular carryovers;
(ii) ESOP carryovers;
(iii) Regular credit earned;
(iv) ESOP credit earned;
(v) Regular carrybacks; and
(vi) ESOP carrybacks.
[[Page 193]]
(3) Example. For an example of the order of application of regular
and ESOP credits, see Sec. 1.46-8(c)(9)(iii).
(n) Examples. The following examples illustrate paragraphs (a)
through (m) of this section.
Example 1. (a) Corporation M's regular credit available for its
taxable year ending December 31, 1979 is as follows:
Regular carryovers........................................... $5,000
Regular credit earned........................................ 10,000
Regular carrybacks........................................... 15,000
----------
Credit available......................................... 30,000
(b) M's ``tax liability'' for 1979 is $30,000. M's tax liability
limitation for 1979 for the regular credit is $28,000, consisting of
$25,000 plus 60 percent of the $5,000 of ``tax liability'' in excess of
$25,000.
(c) The regular carryovers and credit earned are allowed in full.
However, only $13,000 of the regular carryback is allowed for 1979. The
remaining $2,000 must be carried to the next year to which it may be
carried under section 46(b).
Example 2. (a) For its taxable year ending December 31, 1980,
corporation N has $30,000 regular credit earned and $9,000 nonrefundable
energy credit earned. N has no carryovers to 1980 and no ``tax
liability'' for pre-1980 years.
(b) N's ``tax liability'' for 1980 for the regular credit is
$35,000. N's tax liability limitation for 1980 for the regular credit is
$32,000, consisting of $25,000 plus 70 percent of the $10,000 of ``tax
liability'' in excess of $25,000.
(c) The entire regular credit is allowed in 1980.
(d) N's ``tax liability'' for 1980 for the nonrefundable energy
credit is $5,000, consisting of $35,000 less $30,000 regular credit
allowed for 1980. N's tax liability limitation for 1980 for the
nonrefundable energy credit is 100 percent of $5,000.
(e) $5,000 of the nonrefundable energy credit is allowed for 1980.
The remaining $4,000 energy credit is an unused nonrefundable energy
credit which must be carried to the next year to which it may be carried
under section 46(b).
Example 3. (a) Assume the same facts as in Example 2 except that in
its taxable year ending December 31, 1981, N earns a regular credit of
which it may carry back $2,000 to 1980.
(b) The $30,000 regular credit earned and $2,000 of the regular
carryback is allowed for 1980. N's ``tax liability'' for 1980 for the
nonrefundable energy credit is reduced to $3,000, consisting of $35,000
less $32,000 regular credit allowed for 1980. The nonrefundable energy
credit allowed for 1980 is reduced to $3,000. The remaining $6,000 is an
unused nonrefundable energy credit which must be carried to the next
year to which it may be carried under section 46(b).
Example 4. (a) For its taxable year ending December 31, 1980,
corporation P's regular credit earned is $20,000. P also has a $9,000
refundable energy credit for 1980. There are no carryovers or carrybacks
to 1980.
(b) P's ``tax liability'' for 1980 for the regular credit is $25,000
which is also the tax liability limitation for the regular credit.
(c) The entire $20,000 regular credit is allowed for 1980. The
entire $9,000 refundable energy credit is treated as an overpayment of
tax under section 6401(b), even though ``tax liability'' remains.
Example 5. Assume the same facts as in Example 4, except that in the
following year P earns a regular credit, $5,000 of which it may carry
back to 1980. The $5,000 carryback is allowed in full in 1980.
Example 6. (i) Corporation X, a calendar year taxpayer, constructs a
ship on which it begins construction on January 1, 1973, and which, when
placed in service on December 31, 1980, has a basis of $450,000. Of that
amount, $100,000 is attributable to construction before January 22,
1975. X makes an election under section 46(d) (qualified progress
expenditures) for taxable years after 1975.
(ii) For 1976, 1977, 1978, and 1979, qualified progress expenditures
total $200,000. The ten-percent credit applies to those expenditures.
(iii) For 1980, qualified investment for the ship is $450,000. Under
section 46(c)(4), X must reduce this amount by $200,000, the amount of
qualified progress expenditures taken into account. The ten-percent
credit applies to the portion of the remaining qualified investment
attributable to construction after January 21, 1975 ($150,000). The
seven-percent credit applies to the portion of qualified investment
attributable to construction before January 22, 1975 ($100,000).
Example 7. (i) Corporation Y agrees to build a ship for Corporation
X, which uses the calendar year. In 1973, Y begins construction of the
ship which X acquires and places in service on December 31, 1980. X
makes an election under section 46(d) for taxable years after 1974. The
contract price is $400,000.
(ii) For 1975, 1976, 1977, 1978, and 1979, qualified progress
expenditures total $250,000. The ten-percent credit applies to those
expenditures.
(iii) For 1980, qualified investment for the ship is $400,000, which
is the contract price. X must reduce qualified investment by $250,000,
the amount of qualified progress expenditures. The ten-percent credit
applies to the $150,000 of qualified investment that remains after
reduction for qualified progress expenditures.
[[Page 194]]
(o) Married individuals. If a separate return is filed by a husband
or wife, the tax liability limitation is computed by substituting a
$12,500 amount for the $25,000 amount that applies under section
46(a)(3). However, this reduction of the $25,000 amount to $12,500
applies only if the taxpayer's spouse is entitled to a credit under
section 38 for the taxable year of such spouse which ends with, or
within, the taxpayer's taxable year. The taxpayer's spouse is entitled
to a credit under section 38 either because of investment made in
qualified property for such taxable year of the spouse (whether directly
made by such spouse or whether apportioned to such spouse, for example,
from an electing small business corporation, as defined in section
1371(b)), or because of an investment credit carryback or carryover to
such taxable year. The determination of whether an individual is married
shall be made under the principles of section 143 and the regulations
thereunder.
(p) Apportionment of $25,000 amount among component members of a
controlled group--(1) In general. In determining the tax liability
limitation under section 46(a)(3) for corporations that are component
members of a controlled group on December 31, only one $25,000 amount is
available to those component members for their taxable years that
include that December 31. See subparagraph (2) of this paragraph for
apportionment of such amount among such component members. See
subparagraph (3) of this paragraph for definition of ``component
member''.
(2) Manner of apportionment. (i) In the case of corporations which
are component members of a controlled group on a particular December 31,
the $25,000 amount may be apportioned among such members for their
taxable years that include such December 31 in any manner the component
members may select, provided that each such member less than 100 percent
of whose stock is owned, in the aggregate, by the other component
members of the group on such December 31 consents to an apportionment
plan. The consent of a component member to an apportionment plan with
respect to a particular December 31 shall be made by means of a
statement, signed by a person duly authorized to act on behalf of the
consenting member, stating that such member consents to the
apportionment plan with respect to such December 31. The statement shall
set forth the name, address, employer identification number, and taxable
year of each component member of the group on such December 31, the
amount apportioned to each such member under the plan, and the location
of the Service Center where the statement is to be filed. The consent of
more than one component member may be incorporated in a single
statement. The statement shall be timely filed with the Service Center
where the component member having the taxable year first ending on or
after such December 31 files its return for such taxable year and shall
be irrevocable after such filing. If two or more component members have
the same such taxable year, a statement of consent may be filed by any
one of such members. However, if the due date (including any extensions
of time) of the return of such member is on or before December 15, 1971,
the required statement shall be considered as timely filed if filed on
or before March 15, 1972. Each component member of the group on such
December 31 shall keep as a part of its records a copy of the statement
containing all the required consents.
(ii) An apportionment plan adopted by a controlled group with
respect to a particular December 31 shall be valid only for the taxable
year of each member of the group which includes such December 31. Thus,
a controlled group must file a separate consent to an apportionment plan
with respect to each taxable year which includes a December 31 as to
which an apportionment plan is desired.
(iii) If the apportionment plan is not timely filed, the $25,000
amount specified in section 46(a)(3) shall be reduced for each component
member of the controlled group, for its taxable year which includes a
December 31, to an amount equal to $25,000 divided by the number of
component members of such group on such December 31.
(iv) If a component member of the controlled group makes its income
tax return on the basis of a 52-53-week taxable year, the principles of
section
[[Page 195]]
441(f)(2)(A)(ii) and paragraph (b)(1) of Sec. 1.441-2 apply in
determining the last day of such taxable year.
(3) Definitions of controlled group of corporations and component
member of controlled group. For the purpose of this paragraph, the terms
``controlled group of corporations'' and ``component member'' of a
controlled group of corporations shall have the same meaning assigned to
those terms in section 1563 (a) and (b). For purposes of applying
Sec. 1.1563-1(b)(2)(ii)(c), an electing small business corporation shall
be treated as an excluded member whether or not it is subject to the tax
imposed by section 1378.
(4) Members of a controlled group filing a consolidated return. If
some component members of a controlled group join in filing a
consolidated return pursuant to Sec. 1.1502-3(a)(3), and other component
members do not join, then, unless a consent is timely filed apportioning
the $25,000 amount among the group filing the consolidated return and
the other component members of the controlled group, each component
member of the controlled group (including each component member which
joins in filing the consolidated return) shall be treated as a separate
corporation for purposes of equally apportioning the $25,000 amount
under subparagraph (2)(iii) of this paragraph. In that case, the tax
liability limitation for the group filing the consolidated return is
computed by substituting for the $25,000 amount under section 46(a)(3)
the total amount apportioned to each component member that joins in
filing the consolidated return. If the affiliated group filing the
consolidated return and the other component members of the controlled
group adopt an apportionment plan, the affiliated group shall be treated
as a single member for the purpose of applying subparagraph (2)(i) of
this paragraph. Thus, for example, only one consent executed by the
common parent to the apportionment plan is required for the group filing
the consolidated return. If any component member of the controlled group
which joins in the filing of the consolidated return is an organization
to which section 593 applies or a cooperative organization described in
section 1381(a), see paragraph (a)(3)(ii) of Sec. 1.1502-3.
(5) Examples. The provisions of this paragraph may be illustrated by
the following examples:
Example 1. At all times during 1976 Smith, an individual, owns all
the stock of corporations X, Y, and Z. Corporation X files an income tax
return on a calendar year basis. Corporation Y files an income tax
return on the basis of a fiscal year ending June 30. Corporation Z files
an income tax return on the basis of a fiscal year ending September 30.
On December 31, 1976, X, Y, and Z are component members of the same
controlled group. X, Y, and Z all consent to an apportionment plan in
which the $25,000 amount is apportioned entirely to Y for its taxable
year ending June 30, 1977 (Y's taxable year which includes December 31,
1976). Such consent is timely filed. For purposes of computing the
credit under section 38, Y's tax liability limitation for its taxable
year ending June 30, 1977, is so much of Y's tax liability as does not
exceed $25,000, plus 50 percent of Y's tax liability in excess of
$25,000. X's and Z's limitations for their taxable years ending December
31, 1976, and September 30, 1977, respectively, are equal to 50 percent
of X's tax liability for 50 percent of Z's tax liability. On the other
hand, if an apportionment plan is not timely filed, X's limitation would
be so much of X's tax liability as does not exceed $8,333.33, plus 50
percent of X's liability in excess of $8,333.33, and Y's and Z's
limitations would be computed similarly.
Example 2. At all times during 1976, Jones, an individual, owns all
the outstanding stock of corporations P, Q, and R. Corporations Q and R
both file returns for taxable years ending December 31, 1976. P files a
consolidated return as a common parent for its fiscal year ending June
30, 1977, with its two wholly-owned subsidiaries N and O. On December
31, 1976, N, O, P. Q, and R are component members of the same controlled
group. No consent to an apportionment plan is filed. Therefore, each
member is apportioned $5,000 of the $25,000 amount ($25,000 divided
equally among the five members). The tax liability limitation for the
group filing the consolidated return (P, N, and O) for the year ending
June 30, 1977 (the consolidated taxable year within which December 31,
1976, falls) is computed by using $15,000 instead of the $25,000 amount.
The $15,000 is arrived at by adding together the $5,000 amounts
apportioned to P, N, and O.
(q) Rehabilitation percentage--(1) General rule--(i) In general. Due
to amendments made by the Tax Reform Act of 1986, different rules apply
depending on when the property attributable to the qualified
rehabilitated expenditures (as
[[Page 196]]
defined in Sec. 1.48-12(c)) is placed in service. Paragraph (q)(1)(ii)
of this section contains the general rule relating to property placed in
service after December 31, 1986. Paragraph (q)(1)(iii) of this section
contains rules relating to property placed in service before January 1,
1987. Paragraph (q)(1)(iv) of this section contains rules relating to
property placed in service after December 31, 1986, that qualifies for a
transition rule.
(ii) Property placed in service after December 31, 1986. Except as
otherwise provided in paragraph (q)(1)(iv) of this section, in the case
of section 38 property described in section 48(a)(1)(E) placed in
service after December 31, 1986, the term ``rehabilitation percentage''
means--
(A) 10 percent in the case of qualified rehabilitation expenditures
with respect to a qualified rehabilitated building other than a
certified historic structure, and
(B) 20 percent in the case of qualified rehabilitation expenditures
with respect to a certified historic structure.
(iii) Property placed in service before January 1, 1987. For
qualified rehabilitation expenditures (as defined in Sec. 1.48-12(c))
with respect to property placed in service before January 1, 1987,
section 46(b)(4)(A) as in effect prior to the enactment of the Tax
Reform Act of 1986 provided for a three-tier rehabilitation percentage.
The applicable rehabilitation percentage for such expenditures depends
on whether the qualified rehabilitated building is a ``30-year
building,'' a ``40-year building,'' or a certified historic structure
(as defined in section 48(g)(3) and Sec. 1.48-12(d)(1)). The
rehabilitation percentage for such qualified rehabilitation expenditures
incurred with respect to a qualified rehabilitated building is 15
percent to the extent that the building is a 30-year building (i.e., at
least 30 years, but less than 40 years, has elapsed between the date the
physical work on the rehabilitation began and the date the building was
first placed in service), 20 percent to the extent that the building is
a 40-year building (i.e., at least 40 years has so elapsed), and 25
percent for certified historic structures, regardless of age. See
paragraph (q)(2)(ii) of this section for rules concerning buildings to
which additions have been added.
(iv) Property placed in service after December 31, 1986, that
qualifies under the transition rules. In the case of section 38 property
described in section 48(a)(1)(E) placed in service after December 31,
1986, and to which the amendments made by section 251 of the Tax Reform
Act of 1986 do not apply because the transition rules in section 251(d)
of that Act and Sec. 1.48-12(a)(2)(iv)(B) or (C) apply, the
rehabilitation percentage for a ``30-year building'' (within the meaning
of paragraph (q)(1)(iii) of this section) shall be 10 percent, the
rehabilitation percentage for a ``40-year building'' (within the meaning
of paragraph (q)(1)(iii) of this section) shall be 13 percent, and the
rehabilitation percentage for a certified historic structure shall be 25
percent.
(2) Special rules--(i) Moved buildings. With respect to paragraph
(q)(1)(ii) of this section, Sec. 1.48-12(b)(5) provides that a building
(other than a certified historic structure) is not a qualified
rehabilitated building unless it has been at the location where it is
being rehabilitated since January 1, 1936. In addition, for purposes of
paragraph (q)(1) (iii) and (iv) of this section, a building is not a
``30-year building'' unless it has been at the location where it is
being rehabilitated for the thirty-year period immediately preceding the
beginning of the rehabilitation process, and is not a ``40-year
building'' unless it has been at the location where it is being
rehabilitated for the forty-year period immediately preceding the
beginning of the rehabilitation process.
(ii) Building to which additions have been added--(A) Property
placed in service after December 31, 1986. For purposes of paragraph
(q)(1)(ii) of this section, if part of a building meets the definition
of a qualified rehabilitated building, and part of the building does not
meet the definition of a qualified rehabilitated building because such
part is an addition that was placed in service after December 31, 1935,
the qualified rehabilitation expenditures made to the building must be
allocated to the pre-1936 portion of the building and the post-1935
portion of the building using the principles in Sec. 1.48-12(c)(10)(ii).
Qualified rehabilitation expenditures
[[Page 197]]
attributable to the post-1935 addition shall not qualify for the 10
percent rehabilitation percentage.
(B) Property placed in service before January 1, 1987, and property
qualifying for a transitional rule. For purposes of paragraphs (q)(1)
(iii) and (iv) of this section, if part of a building meets the
definition of a ``40-year building'' and part of the building is an
addition that was placed in service less than forty years before
physical work on the rehabilitation began but more than thirty years
before such date, then the qualified rehabilitation expenditures made to
the building shall be allocated between the forty year old portion of
the building and the thirty year old portion of the building, and a 20
percent rehabilitation percentage shall be applied to the forty year old
portion of the building and a 15 percent rehabilitation percentage shall
be applied to the thirty year old portion. This allocation shall be made
using the principles in Sec. 1.48-12(c)(10)(ii). If an allocation cannot
be made between the expenditures to the forty year old portion of the
building and the thirty year old portion of the building, then the
building will be considered to be a 30-year building. Furthermore, for
purposes of this paragraph (q), a building (other than a certified
historic structure) is not a qualified rehabilitated building to the
extent of that portion of the building that is less than 30 years old.
If rehabilitation expenditures are incurred with respect to an addition
to a qualified rehabilitated building, but the addition is not
considered to be part of the qualified rehabilitated building because
the addition does not meet the age requirement in section 48(g)(1)(B)
(as in effect prior to its amendment by the Tax Reform Act of 1986) and
Sec. 1.48-12(b)(4)(i)(B), then no rehabilitation percentage will be
applied to the expenditures attributable to the rehabilitation of the
addition. Thus, for purposes of paragraphs (q)(1) (iii) and (iv) of this
section, it may be necessary to allocate rehabilitation expenditures
incurred with respect to a building between the original portion of the
building and the addition.
(iii) Mixed-use buildings. If qualified rehabilitation expenditures
are incurred for property that is excluded from section 38 property
described in section 48(a)(1)(E) (because, for example, they are made
with respect to a portion of the building used for lodging within the
meaning of section 48(a)(3) and Sec. 1.48-1(h)), an allocation of the
expenditures must be made between the expenditures that result in an
addition to basis that is section 38 property and the expenditures that
result in an addition to basis that is excluded from the definition of
section 38 property since the rehabilitation percentage is applicable
only to section 38 property. These allocations should be made using the
principles contained in Sec. 1.48-12(c)(10)(ii).
(3) Regular and energy percentages not to apply. The regular
percentage and the energy percentage shall not apply to that portion of
the basis of any building that is attributable to qualified
rehabilitation expenditures (as defined in Sec. 1.48-12(c)).
(4) Effective date. The rehabilitation percentage is applicable only
to qualified rehabilitation expenditures (as defined in Sec. 1.48-
12(c)). For rules relating to applicability of the regular percentage to
qualified rehabilitation expenditures (as defined in Sec. 1.48-11(c)),
see Sec. 1.48-11.
[T.D. 6731, 29 FR 6064, May 8, 1964]
Editorial Note: For Federal Register citations affecting Sec. 1.46-
1, see the List of CFR Sections Affected in the Finding Aids section of
this volume.
Sec. 1.46-2 Carryback and carryover of unused credit.
(a) Effective date. This section is effective for taxable years
beginning after December 31, 1975. For taxable years beginning before
January 1, 1976, see 26 CFR 1.46-2 (Rev. as of April 1, 1979).
(b) In general. Under section 46(b)(1), unused credit may be carried
back and carried over. Carrybacks and carryovers of unused credit are
taken into account in determining the amount of credit available and the
credit allowed for the taxable years to which they may be carried. In
general, the application of the rules of this section to regular and
ESOP credits are separate from their application to nonrefundable energy
credits. For example, the limitations on carrybacks and
[[Page 198]]
carryovers of unused nonrefundable energy credit under section 46(b) (2)
and (3), respectively, differ in amount from the limitations on the
regular and ESOP credits because the tax liability limitations for those
credits differ. See Sec. 1.46-1(h). For a further example, see the
special ordering rule in Sec. 1.46-1(m). Section 46(b) does not apply to
the refundable energy credit.
(c) Unused credit. If carryovers and credit earned (as defined in
Sec. 1.46-1(c)(1)) exceed the applicable tax liability limitation, the
excess attributable to credit earned is an unused credit. The taxable
year in which an unused credit arises is referred to as the ``unused
credit year''.
(d) Taxable years to which unused credit may be carried. An unused
credit is a carryback to each of the 3 taxable years preceding the
unused credit year and a carryover to each of the 7 taxable years
succeeding the unused credit year. An unused credit must be carried
first to the earliest of those 10 taxable years. An unused credit then
must be carried to each of the other 9 taxable years (in order of time)
to the extent that the unused credit was not absorbed during a prior
taxable year because of the limitations under section 46(b) (2) and (3).
(e) Special rule for pre-1971 years--(1) In general. For unused
credit years ending before January 1, 1971, unused credit is allowed a
10-year carryover rather than the 7-year carryover. The principles of
paragraph (d) of this section apply to this 10-year carryover.
(2) Cross reference. For limitations on the taxable years to which
unused credit from pre-1971 credit years may be carried, see paragraph
(g) of this section.
(f) Limitations on carrybacks. Under the FIFO rule to section
46(a)(1), carryovers and credit earned are applied against the tax
liability limitation before carrybacks. Thus, carrybacks to a taxable
year may not exceed the amount by which the applicable tax liability
limitation for that year exceeds the sum of carryovers to and credit
earned for that year. Carrybacks from an unused credit year are applied
against tax liability before carrybacks from a later unused credit year.
To the extent an unused credit cannot be carried back to a particular
preceding taxable year, the unused credit must be carried to the next
succeeding taxable year to which it may be carried.
(g) Limitations on carryovers--(1) General rule. Carryovers to a
taxable year may not exceed the applicable tax liability limitation for
that year. Carryovers from an unused credit year are applied before
carryovers from a later unused credit year.
(2) Exception. A 10-year carryover from a pre-1971 unused credit
year may, under certain circumstances, be postponed to prevent a later-
earned 7-year carryover from expiring. This exception does not extend
the 10-year carryover period for pre-1971 unused credit. See section
46(b)(1)(D).
(h) Examples. The following examples illustrate paragraphs (a)
through (g) of this section.
Example 1. (a) Corporation M is organized on January 1, 1977 and
files its income tax return on a calendar year basis. Assume the facts
set forth in columns (1) and (2) of the following table. The
determination of the regular credit allowed for each of the taxable
years indicated is set forth in the remaining portions of the table.
----------------------------------------------------------------------------------------------------------------
(1) (2) (3) (4) (5) (6) (7)
--------------------------------------------------------------------------------
Tax
liability
limitation Credit Remaining Unused
Credit Tax (remaining allowed tax credit
available liability Percent from col. (lower of liability ((1)-(5))
(6) on (1) or limitation or (amount
preceding (4)) ((4)-(5)) absorbed)
line)
----------------------------------------------------------------------------------------------------------------
1977:
A. Credit earned............. $20,000 $45,000 50 $35,000 $20,000 $15,000 0
B. Carryback from 1978....... *15,000 ......... ......... [15,000] 15,000 .......... ..........
1978:
A. Credit earned............. 80,000 55,000 50 40,000 40,000 0 $20,000
Carryback to 1977.......... ......... ......... ......... ........... ......... .......... (*15,000)
Carryover to 1979.......... ......... ......... ......... ........... ......... .......... (*5,000)
1979:
A. Carryover from 1978....... *5,000 50,000 60 40,000 6,000 35,000 ..........
[[Page 199]]
B. Credit earned............. 50,000 ......... ......... [35,000] 35,000 0 15,000
Carryover to 1980.......... ......... ......... ......... ........... ......... .......... (*15,000)
1980:
A. Carryover from 1979....... *15,000 55,000 70 46,000 15,000 31,000 ..........
B. Credit earned............. 25,000 ......... ......... [31,000] 25,000 6,000 0
----------------------------------------------------------------------------------------------------------------
*For line ``A'' each year: Lesser of (1) tax liability or (2) $25,000 + (percentage in col. (3) x [col. (2) -
$25,000]). See, Sec. 1.46-1(h). For other lines: Amount in col. (6) on preceding line.
Example 2. (a) Assume the same facts as in Example 1 except for 1979
M earns a $35,000 nonrefundable energy credit. The following table shows
the determinations for each year.
--------------------------------------------------------------------------------------------------------------------------------------------------------
(1) (2) (3) (4) (5) (6) (7)
-------------------------------------------------------------------------------------------------
Tax liability Tax
---------------------------- liability
limitation* Credit Remaining Unused
Credit (remaining allowed tax credit
available (a) (b) Energy Percent from col. (lower of liability ((1)-(5))
Regular ((2)(a)-(5)(R)) (6) on (1) or limitation or (amount
preceding (4)) ((4)-(5)) absorbed)
line)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1977:
Regular:
A. Credit earned.................................. $20,000 $45,000 ............... 50 $35,000 $20,000R $15,000 0
B. Carryback from 1978............................ *15,000 ......... ............... ......... [15,000] 15,000R 0 ..........
1978:
Regular:
A. Credit earned.................................. 60,000 55,000 ............... 50 40,000 40,000R 0 $20,000
Carryback to 1977............................... ......... ......... ............... ......... ........... ......... .......... (*15,000)
Carryover to 1979............................... ......... ......... ............... ......... ........... ......... .......... (*5,000)
Energy:
A. Carryback from 1979............................ *15,000 ......... $15,000 100 15,000 15,000E 0 ..........
1979:
Regular:
A. Carryover from 1978............................ *5,000 50,000 ............... 60 40,000 5,000R 35,000 ..........
B. Credit earned.................................. 50,000 ......... ............... ......... [35,000] 35,000R 0 15,000
Carryover to 1980............................... ......... ......... ............... ......... ........... ......... .......... (*15,000)
Energy:
A. Credit earned.................................. 35,000 ......... 10,000 100 10,000 10,000E 0 25,000
Carryback to 1978............................... ......... ......... ............... ......... ........... ......... .......... (*15,000)
Carryover to 1980............................... ......... ......... ............... ......... ........... ......... .......... (*10,000)
1980:
Regular:
A. Carryover from 1979............................ *15,000 55,000 ............... 70 46,000 15,000R 31,000 ..........
B. Credit earned.................................. 25,000 ......... ............... ......... [31,000] 25,000R 6,000 0
Energy:
A. Carryover from 1979............................ *10,000 ......... 15,000 100 15,000 10,000E 5,000 ..........
--------------------------------------------------------------------------------------------------------------------------------------------------------
*See footnote to the chart in Example 1.
(b) Although, in general, a nonrefundable energy credit may be
carried back to taxable years ending before October 1, 1978, in this
example the unused nonrefundable energy credit from 1979 may not be
absorbed in 1977. The 1977 tax liability limitation for the
nonrefundable energy credit is the same as it is for the regular credit,
reduced by regular credit previously allowed for 1977. See Secs. 1.46-
1(h)(3) and 1.46-1(m).
Example 3. (a) Assume the same facts as in Example 2 except M has
regular credit of $37,000 for 1981 and M's tax liability for 1981 is
$32,500. The determinations for 1980 and 1981 are set forth in the
following table.
[[Page 200]]
--------------------------------------------------------------------------------------------------------------------------------------------------------
(1) (2) (3) (4) (5) (6) (7)
----------------------------------------------------------------------------------------------
Tax liability Tax
------------------------- liability
limitation* Credit Remaining Unused
Credit (remaining allowed tax credit
available (a) (b) Energy Percent from col. (lower of liability ((1)-(5))
Regular ((2)-(5)(R)) (6) on (1) or limitation or (amount
preceding (4)) ((4)-(5)) absorbed)
line)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1979 (restated):
Energy:
To be carried over................................... ......... ......... ............ ......... ........... ......... .......... $10,000
Carryover to 1980.................................. ......... ......... ............ ......... ........... ......... .......... (*9,000)
Carryover to 1981.................................. ......... ......... ............ ......... ........... ......... .......... (*1,000)
1980 (restated):
Regular:
A. Carryover from 1979............................... $15,000 $55,000 ............ 70 $46,000 $15,000R $31,000 ..........
B. Credit earned..................................... *25,000 ......... ............ ......... [31,000] 25,000R 6,000 0
C. Carryback from 1981............................... *6,000 ......... ............ ......... [6,000] 6,000R 0 ..........
Energy:
A. Carryover from 1979............................... *9,000 ......... $9,000 100 9,000 9,000E .......... ..........
1981: Regular:
A. Credit earned..................................... 37,000 32,500 ............ 80 31,000 31,000R 0 6,000
Carryback to 1980.................................. ......... ......... ............ ......... ........... ......... .......... (*6,000)
Energy:
A. Carryover from 1979............................... *1,000 ......... 1,500 100 1,500 1,000E 500 0
--------------------------------------------------------------------------------------------------------------------------------------------------------
*See footnote to chart under Example 1.
(b) Allowance of the regular carryback in 1980 from 1981 requires
that the computations for 1980 be restated. The energy tax liability
limitation for 1980 is reduced from $15,000 (as determined in Example 2)
to $9,000. Thus, $1,000 of the $10,000 energy credit allowed for 1980 is
displaced by the regular carryback. That amount may not be carried back
because there is no remaining energy tax liability limitation for the
prior 3 years (see table in Example 2). It may be carried over to 1981
and allowed in full in that year.
(i) [Reserved]
(j) Electing small business corporation. A shareholder of an
electing small business corporation (as defined in section 1371(b)) may
not take into account unused credit of the corporation attributable to
unused credit years for which the corporation was not an electing small
business corporation. However, a taxable year for which the corporation
is an electing small business corporation is counted as a taxable year
for determining the taxable years to which that unused credit may be
carried.
(k) Periods of less than 12 months. A fractional part of a year that
is considered a taxable year under sections 441(b) and 7701(a)(23) is
treated as a preceding or succeeding taxable year for determining under
section 46(b) the taxable years to which an unused credit may be
carried.
(l) Corporate acquisitions. For carryover of unused credits in the
case of certain corporate acquisitions, see section 381(c)(23).
(Secs. 7805 (68A Stat. 917, 26 U.S.C. 7805) and 38(b) (76 Stat. 962, 26
U.S.C. 38))
[T.D. 7751, 46 FR 1679, Jan. 7, 1981]
Sec. 1.46-3 Qualified investment.
(a) In general. (1) With respect to any taxable year, the qualified
investment of the taxpayer is the aggregate (expressed in dollars) of
(i) the applicable percentage of the basis of each new section 38
property placed in service by the taxpayer during such taxable year,
plus (ii) the applicable percentage of the cost of each used section 38
property placed in service by the taxpayer during such taxable year.
With respect to any section 38 property, qualified investment means the
applicable percentage of the basis (or cost) of such property. Section
38 property placed in service by the taxpayer during the taxable year
includes the taxpayer's share of the basis (or cost) of section 38
property placed in service by a partnership in the taxable year of such
partnership
[[Page 201]]
ending with or within the taxpayer's taxable year. In the case of a
shareholder of an electing small business corporation (as defined in
section 1371(b)), or a beneficiary of an estate or trust, see
Secs. 1.48-5 and 1.48-6, respectively, for apportionment of the basis
(or cost) of section 38 property placed in service by such corporation,
estate, or trust. For the definitions of new section 38 property and
used section 38 property, see Secs. 1.48-2 and 1.48-3, respectively. See
Sec. 1.46-5 for special rules for progress expenditure property.
(2) The basis (or cost) of section 38 property placed in service
during a taxable year shall not be taken into account in determining
qualified investment for such year if such property is disposed of or
otherwise ceases to be section 38 property during such year, except
where Sec. 1.47-3 applies. Thus, if individual A places in service
during a taxable year section 38 property and later in the same year
sells such property, the basis (or cost) of such property shall not be
taken into account in determining A's qualified investment. On the other
hand, if A places in service section 38 property during a taxable year
and dies later in the same year, the basis (or cost) of such property
would be taken into account in computing qualified investment.
Similarly, if section 38 property is destroyed by fire in the same year
in which it is placed in service and paragraph (h) of this section
applies to reduce the basis (or cost) of replacement property, the basis
(or cost) of the destroyed property would be taken into account in
computing qualified investment. In order to determine whether section 38
property is disposed of or otherwise ceases to be section 38 property
see Sec. 1.47-2.
(3) Qualified investment is reduced in the case of property which is
``public utility property'' (see paragraph (h) of this section), and in
the case of property of organizations to which section 593 applies,
regulated investment companies or real estate investment trusts subject
to taxation under subchapter M, chapter 1 of the Code, and cooperative
organizations described in section 1381(a) (see Sec. 1.46-4).
(b) Applicable percentage. The applicable percentage to be applied
to the basis (or cost) of property is 33\1/3\ percent if the estimated
useful life of the property is 3 years or more but less than 5 years;
66\2/3\ percent if the estimated useful life is 5 years or more but less
than 7 years; or 100 percent if the estimated useful life is 7 years or
more. In the case of property which is not described in section 50, the
preceding sentence shall be applied by substituting ``4 years'' for ``3
years'', ``6 years'' for ``5 years'', and ``8 years'' for ``7 years''.
The provisions of this paragraph may be illustrated by the following
example:
Example. Corporation Y acquires and places in service during 1972
the following new and used section 38 properties:
------------------------------------------------------------------------
Estimated
useful Basis (or
Property life cost)
(years)
------------------------------------------------------------------------
A (new).......................................... 4 $60,000
B (new).......................................... 10 90,000
C (new).......................................... 6 150,000
D (used)......................................... 3 30,000
------------------------------------------------------------------------
Corporation Y's qualified investment for 1972 is $220,000 determined
in the following manner:
------------------------------------------------------------------------
Basis (or Applicable Qualified
Property cost) percentage investment
------------------------------------------------------------------------
A................................ $60,000 33\1/3\ $20,000
B................................ 90,000 100 90,000
C................................ 150,000 66\2/3\ 100,000
D................................ 30,000 33\1/3\ 10,000
--------------------------------------
Total.................................................... 220,000
------------------------------------------------------------------------
(c) Basis or cost. (1) The basis of any new section 38 property
shall be determined in accordance with the general rules for determining
the basis of property. Thus, the basis of property would generally be
its cost (see section 1012), unreduced by the adjustment to basis
provided by section 48(g)(1) with respect to property placed in service
before January 1, 1964, and any other adjustment to basis, such as that
for depreciation, and would include all items properly included by the
taxpayer in the depreciable basis of the property, such as installation
and freight costs. However, for purposes of determining qualified
investment, the basis of new section 38 property constructed,
reconstructed, or erected by the taxpayer
[[Page 202]]
shall not include any depreciation sustained with respect to any other
property used in the construction, reconstruction, or erection of such
new section 38 property. (See paragraph (b)(4) of Sec. 1.48-1.) If new
section 38 property is acquired in exchange for cash and other property
in a transaction described in section 1031 in which no gain or loss is
recognized, the basis of the newly acquired property for purposes of
determining qualified investment would be equal to the adjusted basis of
the other property plus the cash paid. See Sec. 1.48-4 for the basis of
property to a lessee where the lessor has elected to treat such lessee
as a purchaser.
(2) The cost of any used section 38 property shall be determined in
accordance with paragraph (b) of Sec. 1.48-3. However, the aggregate
cost of used section 38 property which may be taken into account in any
taxable year in computing qualified investment cannot exceed $50,000
(see paragraph (c) of Sec. 1.48-3).
(3) For reduction in the basis (or cost) of certain property which
replaces other property which was destroyed or damaged by fire, storm,
shipwreck, or other casualty, or which was stolen, see paragraph (h) of
this section.
(d) Placed in service. (1) For purposes of the credit allowed by
section 38, property shall be considered placed in service in the
earlier of the following taxable years:
(i) The taxable year in which, under the taxpayer's depreciation
practice, the period for depreciation with respect to such property
begins; or
(ii) The taxable year in which the property is placed in a condition
or state of readiness and availability for a specifically assigned
function, whether in a trade or business, in the production of income,
in a tax-exempt activity, or in a personal activity.
Thus, if property meets the conditions of subdivision (ii) of this
subparagraph in a taxable year, it shall be considered placed in service
in such year notwithstanding that the period for depreciation with
respect to such property begins in a succeeding taxable year because,
for example, under the taxpayer's depreciation practice such property is
accounted for in a multiple asset account and depreciation is computed
under an ``averaging convention'' (see Sec. 1.167(a)-10), or
depreciation with respect to such property is computed under the
completed contract method, the unit of production method, or the
retirement method.
(2) In the case of property acquired by a taxpayer for use in his
trade or business (or in the production of income), the following are
examples of cases where property shall be considered in a condition or
state of readiness and availability for a specifically assigned
function:
(i) Parts are acquired and set aside during the taxable year for use
as replacements for a particular machine (or machines) in order to avoid
operational time loss.
(ii) Operational farm equipment is acquired during the taxable year
and it is not practicable to use such equipment for its specifically
assigned function in the taxpayer's business of farming until the
following year.
(iii) Equipment is acquired for a specifically assigned function and
is operational but is undergoing testing to eliminate any defects.
(iv) Reforestation expenditures (as defined in Sec. 1.194-3(c)) are
incurred during the taxable year in connection with qualified timber
property (as defined in Sec. 1.194-3(a)).
However, fruit-bearing trees and vines shall not be considered in a
condition or state of readiness and availability for a specifically
assigned function until they have reached an income-producing stage.
Moreover, materials and parts acquired to be used in the construction of
an item of equipment shall not be considered in a condition or state of
readiness and availability for a specifically assigned function.
(3) Notwithstanding subparagraph (1) of this paragraph, property
with respect to which an election is made under Sec. 1.48-4 to treat the
lessee as having purchased such property shall be considered placed in
service by the lessor in the taxable year in which possession is
transferred to such lessee.
(4)(i) The credit allowed by section 38 with respect to any property
shall be allowed only for the first taxable year in which such property
is placed in
[[Page 203]]
service by the taxpayer. The determination of whether property is
section 38 property in the hands of the taxpayer shall be made with
respect to such first taxable year. Thus, if a taxpayer places property
in service in a taxable year and such property does not qualify as
section 38 property (or only a portion of such property qualifies as
section 38 property) in such year, no credit (or a credit only as to the
portion which qualifies in such year) shall be allowed to the taxpayer
with respect to such property notwithstanding that such property (or a
greater portion of such property) qualifies as section 38 property in a
subsequent taxable year. For example, if a taxpayer places property in
service in 1963 and uses the property entirely for personal purposes in
such year, but in 1964 begins using the property in a trade or business,
no credit is allowable to the taxpayer under section 38 with respect to
such property. See Sec. 1.48-1 for the definition of section 38
property.
(ii) Notwithstanding subdivision (i) of this subparagraph, if, for
the first taxable year in which property is placed in service by the
taxpayer, the property qualifies as section 38 property but the basis of
the property does not reflect its full cost for the reason that the
total amount to be paid or incurred by the taxpayer for the property is
indeterminate, a credit shall be allowed to the taxpayer for such first
taxable year with respect to so much of the cost as is reflected in the
basis of the property as of the close of such year, and an additional
credit shall be allowed to the taxpayer for any subsequent taxable year
with respect to the additional cost paid or incurred during such year
and reflected in the basis of the property as of the close of such year.
The estimated useful life used in computing each additional credit with
respect to the property shall be the same as the estimated useful life
used in computing the credit for the first taxable year in which the
property was placed in service by the taxpayer. Assume, for example,
that in 1964 X Corporation, a utility company which makes its return on
the basis of a calendar year, enters into an agreement with Y
Corporation, a builder, to construct certain utility facilities for a
housing development built by Y. Assume further that part of the funds
for the construction of the utility facilities is advanced by Y under a
contract providing that X will repay the advances over a 10-year period
in accordance with an agreed formula, after which no further amounts
will be repayable by X even though the full amount advanced by Y has not
been repaid. Assuming that the utility facilities are placed in service
in 1964 and qualify as section 38 property, X is allowed a credit for
1964 with respect to its basis in the utility facilities at the close of
1964. For each succeeding taxable year X is allowed an additional credit
with respect to the increase in the basis of the utility facilities
resulting from the repayments to Y during such year.
(e) Estimated useful life--(1)(i) In general. With respect to assets
placed in service by the taxpayer during any taxable year, for the
purpose of computing qualified investment the estimated useful lives
assigned to all assets which fall within a particular guideline class
(within the meaning of Revenue Procedure 62-21) may be determined, at
the taxpayer's option, under either subparagraph (2) or (3) of this
paragraph. Thus, the taxpayer may assign estimated useful lives to all
the assets falling in one guideline class in accordance with
subparagraph (2) of this paragraph, and may assign estimated useful
lives to all the assets falling within another guideline class in
accordance with subparagraph (3) of this paragraph. See subparagraphs
(4) and (5) of this paragraph for determination of estimated useful
lives of assets not subject to subparagraph (2) or (3) of this
paragraph.
(ii) Except as provided in subparagraph (7), this paragraph shall
not apply to property described in section 50.
(2) Class life system. The taxpayer may assign to each asset falling
within a guideline class, which is placed in service during the taxable
year, the class life of the taxpayer for the guideline class for such
year as determined under section 4, part II of Revenue Procedure 62-21.
The preceding sentence may be applied to the assets falling within a
guideline class irrespective of whether
[[Page 204]]
the taxpayer uses single asset accounts or multiple asset accounts in
computing depreciation with respect to such assets and irrespective of
whether the taxpayer chooses to have his depreciation allowance with
respect to such assets examined under the rules provided in Revenue
Procedure 62-21.
(3) Individual useful life system. (i) The taxpayer may assign an
individual estimated useful life to each asset falling within a
guideline class which is placed in service during the taxable year. With
respect to the assets falling within the guideline class which are
placed in single asset accounts for purposes of computing depreciation,
the estimated useful life used for each asset for that purpose shall be
used in determining qualified investment. With respect to the assets
falling within the guideline class which are placed in multiple asset
accounts (including a guideline class account described in Revenue
Procedure 62-21) for which a group, classified, or composite rate is
used in computing depreciation (or in single asset accounts for which an
average life rate is used), the determination of estimated useful life
for each asset in the account shall be made individually on the best
estimate obtainable on the basis of all the facts and circumstances. The
individual estimated useful lives used for all the assets placed in a
multiple asset account, when viewed together, must be consistent with
the group, classified, or composite life used for the account for
purposes of computing depreciation.
(ii) In determining the individual estimated useful lives of assets
similar in kind contained in a multiple asset account (or in single
asset accounts for which an average life rate is used), the taxpayer may
(a) assign to each of such assets the average useful life of such assets
used for purposes of computing depreciation, or (b) assign separate
lives to such assets based on the estimated range of years taken into
consideration in establishing the average useful life. Thus, for
example, if a taxpayer places nine similar trucks with an average
estimated useful life of 7 years, based on an estimated range of 6 to 8
years (two trucks with a useful life of 6 years, five trucks with a
useful life of 7 years, and two trucks with a useful life of 8 years),
in a multiple asset account for which a group rate is used in computing
depreciation, he may either assign a useful life of 6 years to two of
the trucks, 7 years to five of the trucks, and 8 years to two of the
trucks, or he may assign the average useful life of the trucks (7 years)
to each of the nine trucks. Likewise, if a taxpayer places 100 similar
telephone poles with an average useful life of 28 years, based on an
estimated range of 3 to 40 years (two with a useful life of less than 4
years, three with a useful life of 4 to 6 years, four with a useful life
of 6 to 8 years, and 91 with a useful life of more than 8 years), in a
multiple asset account for which a group rate is used in computing
depreciation, he may either assign useful lives corresponding to the
estimated range of years of the poles (i.e., a useful life of less than
4 years to two of the poles, etc.), or he may assign the average useful
life of the poles (28 years) to each of the poles.
(iii) [Reserved]
(iv) For purposes of subdivision (ii) of this subparagraph, assets
(other than ``mass assets'') shall not be considered as ``similar in
kind'' in respect of other assets unless all such assets are
substantially of the same value, nor shall used section 38 property be
considered as ``similar in kind'' to new section 38 property.
(4) Useful life of property subject to amortization--(i) In general.
In the case of property with respect to which amortization in lieu of
depreciation is allowable, the term over which amortization deductions
are taken shall be considered as the estimated useful life of such
property.
(ii) Qualified timber property. In the case of qualified timber
property (within the meaning of section 194(c)(1)), the normal growing
period of such property shall be considered its estimated useful life.
(5) Useful life of property subject to certain methods of
depreciation. If a taxpayer is using a method of depreciation, such as
the unit of production or retirement method, which does not measure the
useful life of the property in terms of years, he must estimate such
useful life in years in order to compute his qualified investment.
[[Page 205]]
(6) Record requirements. The taxpayer shall maintain sufficient
records to determine whether section 47 (relating to certain
dispositions, etc., of section 38 property) applies with respect to any
asset.
(7) Section 50 property. (i) The provisions of this subparagraph and
subparagraphs (4) and (6) of this paragraph shall apply to property
which is described in section 50.
(ii) The estimated useful life of property for purposes of computing
qualified investment shall be the useful life used or to be used by the
taxpayer in computing the allowance for depreciation with respect to
such property under section 167 for the taxable year in which the
property is placed in service. Thus, if property is placed in service by
a taxpayer in a taxable year but the period for depreciation with
respect to such property does not begin until a succeeding taxable year
(see paragraph (d)(1) of this section), the estimated useful life for
purposes of computing qualified investment must be the estimated useful
life that the taxpayer uses in computing the allowance for depreciation.
See subdivision (iv) of this subparagraph for rules for determining the
estimated useful life of property with respect to which the allowance
for depreciation under section 167 is computed under the unit of
production method, the income-forecast method, or any other method which
does not measure the useful life of the property in terms of years.
(iii)(a) The estimated useful life of any section 38 property to
which an election under section 167(m) applies shall be the asset
depreciation period selected for such property under Sec. 1.167(a)-
11(b)(4), whether or not such property constitutes mass assets (as
defined in Sec. 1.47-1(e)(4)).
(b) The estimated useful life of any section 38 property to which an
election under section 167(m) does not apply and which is placed in a
multiple asset account for which a group, classified, or composite rate
is used in computing depreciation (or in single asset accounts for which
an average life rate is used) shall be determined individually for each
asset on the best estimate obtainable on the basis of all the facts and
circumstances. The individual estimated useful life for each asset
placed in a multiple asset account (including a mass asset account) must
be the same as the useful life of such asset used in determining the
group, classified, or composite life for the account for purposes of
computing depreciation. The individual estimated useful lives of assets
similar in kind may be determined in accordance with subdivisions (ii)
and (iv) of subparagraph (3) of this paragraph. In the case of mass
assets, subdivision (iii) of subparagraph (3) of this paragraph shall
apply.
(f) Partnerships--(1) In general. In the case of a partnership, each
partner shall take into account separately, for his taxable year with or
within which the partnership taxable year ends, his share of the basis
of partnership new section 38 property and his share of the cost of
partnership used section 38 property placed in service by the
partnership during such partnership taxable year. Each partner shall be
treated as the taxpayer with respect to his share of the basis of
partnership new section 38 property and his share of the cost of
partnership used section 38 property. The estimated useful life to each
partner of such property shall be deemed to be the estimated useful life
of the property in the hands of the partnership. Partnership section 38
property shall not, by reason of each partner taking his share of the
basis or cost into account, lose its character as either new section 38
property or used section 38 property, as the case may be. For
computation of each partner's qualified investment for the energy credit
for a qualified intercity bus, see Sec. 1.48-9(q)(9)(iv).
(2) Determination of partner's share. (i) Each partner's share of
the basis (or cost) of any section 38 property shall be determined in
accordance with the ratio in which the partners divide the general
profits of the partnership (that is, the taxable income of the
partnership as described in section 702(a)(9)) regardless of whether the
partnership has a profit or a loss for its taxable year during which the
section 38 property is placed in service. However, if the ratio in which
the partners divide the general profits of the partnership changes
during the taxable year of the
[[Page 206]]
partnership, the ratio effective for the date on which the property is
placed in service shall apply.
(ii) Notwithstanding subdivision (i) of this subparagraph, if all
related items of income, gain, loss, and deduction with respect to any
item of partnership section 38 property are specially allocated in the
same manner and if such special allocation is recognized under section
704 (a) and (b) and paragraph (b) of Sec. 1.704-1, then each partner's
share of the basis of such item of new section 38 property or the cost
of such item of used section 38 property shall be determined by
reference to such special allocation effective for the date on which the
property is placed in service.
(iii) Notwithstanding subdivisions (i) and (ii) of this
subparagraph, if with respect to a partnership's taxable year the
conditions set forth in (a) through (c) of this subdivision are
satisfied with respect to a partner, then such partner shall not take
into account the basis (or cost) of any section 38 property placed in
service by the partnership during such taxable year. The conditions
referred to in the preceding sentence are:
(a) Such partner's interest in the general profits of the
partnership during the taxable year is 5 percent or less;
(b) Under the partnership agreement, such partner will retire from
the partnership during the taxable year or within 7 years after the end
of such year; and
(c) The partnership agreement provides that the basis (or cost) of
section 38 property placed in service by the partnership during the
taxable year shall not be taken into account by a partner described in
(a) and (b) of this subdivision.
Any basis (or cost) of section 38 property which is not taken into
account by a partner because of the provisions of this subdivision shall
be taken into account by the other partners in accordance with
subdivision (i) of this subparagraph.
(3) Examples. This paragraph may be illustrated by the following
examples:
Example 1. Partnership ABCD acquires and places in service on
January 1, 1962, an item of new section 38 property, and acquires and
places in service on September 1, 1962, another item of new section 38
property. The ABCD partnership and each of its partners reports income
on the basis of the calendar year. Partners A, B, C, and D share
partnership profits equally. Each partner's share of the basis of each
new partnership section 38 property is 25 percent.
Example 2. Assume the same facts as in Example 1 and the following
additional facts: A dies on June 30, 1962, and B purchases A's interest
as of such date. Each partner's share of the profits from January 1 to
June 30 is 25 percent. From July 1 to December 31, B's share of the
profits is 50 percent, and C and D's share of the profits is 25 percent
each. For A's last taxable year (January 1 to June 30, 1962), A shall
take into account 25 percent of the basis of the section 38 property
placed in service on January 1. B shall take into account 25 percent of
the basis of the section 38 property placed in service on January 1 and
50 percent of the basis of the section 38 property placed in service on
September 1, C and D shall each take into account 25 percent of the
basis of each new section 38 property placed in service by the
partnership in 1962.
Example 3. Partnership MR is engaged in the business of renting soda
fountain equipment and icemakers to restaurants. The partnership makes
no elections under Sec. 1.48-4 to treat its lessees as having purchased
such property. Under the terms of the partnership agreement, the income,
gain or loss on disposition, depreciation, and other deductions
attributable to the icemakers are specially allocated 70 percent to
partner M and 30 percent to partner R. In all other respects M and R
share profits and losses equally. If the special allocation with respect
to the icemakers is recognized under section 704 (a) and (b) and
paragraph (b) of Sec. 1.704-1, the basis (or cost) of the icemakers
which qualify as partnership section 38 property shall be taken into
account 70 percent by M and 30 percent by R. The basis (or cost) of
partnership section 38 property not subject to the special allocation
shall be taken into account equally by M and R.
Example 4. Assume the same facts as in Example 3 and the following
additional facts: During November 1962, the partnership, which reports
its income on the basis of a fiscal year ending May 31, acquires and
places in service two items which qualify as new section 38 property, an
icemaker and a soda fountain. The icemaker has an estimated useful life
of 8 years to the partnership and a basis of $1,000. The soda fountain
has an estimated useful life of 6 years to the partnership and a basis
of $600. Partner M also owns and operates a business as a sole
proprietorship and reports income on the calendar year basis. During
1963, M acquires
[[Page 207]]
and places in service in his sole proprietorship a machine which
qualifies as new section 38 property. This machine has an estimated
useful life of 4 years and a basis of $300. M owns no interest in any
other partnerships, electing small business corporations, estates, or
trusts. M's total qualified investment for 1963 is $1,000, computed as
follows:
----------------------------------------------------------------------------------------------------------------
Estimated M's share of Applicable Qualified
Property useful life Basis basis percentage investment
----------------------------------------------------------------------------------------------------------------
Partnership MR
Icemaker........................ 8 $1,000 $700 100 $700
Soda fountain................... 6 600 300 66\2/3\ 200
Sole proprietorship
Machine......................... 4 300 .............. 33\1/3\ 100
-------------------------------------------------------------------------------
Total....................................................................................... 1,000
----------------------------------------------------------------------------------------------------------------
(g) Public utility property--(1) In general--(i) Scope of paragraph.
This paragraph only applies to property described in section 50. For
rules relating to public utility property not described in section 50,
see 26 CFR part 1, Sec. 1.46-3(g) (as revised April 1, 1977). This
paragraph does not reflect amendments to section 46(c) made after
enactment of the Revenue Act of 1971.
(ii) Amount of qualified investment. A taxpayer's qualified
investment in section 38 property that is public utility property is \4/
7\ of the amount otherwise determined under this section.
(2) Meaning and uses of certain terms. For purposes of this
paragraph--
(i) Public utility property. ``Public utility property'' is property
used by a taxpayer predominantly in a trade or business that is a public
utility activity and property that is nonregulated communication
property.
(ii) Public utility activity. A ``public utility activity'' is any
activity in which the goods or services described in section 46(c)(3)(B)
(i), (ii), or (iii) are furnished or sold at regulated rates. If
property is used by a taxpayer both in a public utility activity and in
another activity, the characterization of such property is based on the
predominant use of such property during the taxable year in which it is
placed in service.
(iii) Regulated rates. A taxpayer's rates are ``regulated'' if they
are established or approved on a rate-of-return basis. Rates regulated
on a rate-of-return basis are an authorization to collect revenues that
cover the taxpayer's cost of providing goods or services, including a
fair return on the taxpayer's investment in providing such goods or
services, where the taxpayer's costs and investment are determined by
use of a uniform system of accounts prescribed by the regulatory body. A
taxpayer's rates are not ``regulated'' if they are established or
approved on the basis of maintaining competition within an industry,
insuring adequate service to customers of an industry, or charging
``reasonable'' rates within an industry since the taxpayer is not
authorized to collect revenues based on the taxpayer's cost of providing
goods or services. Rates are considered to have been ``established or
approved'' if a schedule of rates is filed with a regulatory body that
has the power to approve such rates, even though the regulatory body
takes no action on the filed schedule or generally leaves undisturbed
rates filed by the taxpayer.
(iv) Nonregulated communication property. ``Nonregulated
communication property'' is property that is clearly the same type of
property (and is used by the taxpayer predominantly for the same type of
communication purposes) as communication property, but it is used by the
taxpayer predominantly in a trade or business that is not a public
utility activity. For purposes of this paragraph (g)(2)(iv), of this
section, communication property is property ordinarily used for
communication purposes by persons who provide regulated telephone or
microwave communication services described in section 46(c)(3)(B)(iii).
The determination of whether property is clearly of this same type and
is used predominantly for these same communication purposes as
communication property is made on the basis of the facts and
circumstances of each particular case, including the current state of
technology
[[Page 208]]
in the communications industry and the range and type of services
permitted or required to be provided by the regulated telephone and
microwave communication industry. As of 1978, wires or cables used
predominantly to distribute to subscribers the signals of one or more
television broadcast stations or cablecast stations (such as in a CATV
system) are not used for the same type of communication purposes as
communication property. Communication property includes microwave
transmission equipment, private communication equipment (other than land
mobile radio equipment for which the operator must obtain a license from
the Federal Communications Commission), private switchboard (PBX)
equipment, communications terminal equipment connected to telephone
networks, data transmission equipment, and communications satellites.
Communication property does not include (as of 1978) computer terminals
or facsimile reproduction equipment that is connected to telephone lines
to transmit data. It also does not include office furniture stands for
communication property, tools, repair vehicles, and similar property,
even if such property is exclusively used in providing regulated
telephone or microwave communication services.
(3) Leased property. Public utility property includes property which
is leased to others by a taxpayer where the leasing of such property is
part of the lessor's public utility activity. Thus, such leased property
is public utility property even though the lessee uses such property in
an activity which is not a public utility activity, and whether or not
the lessor of such property makes a valid election under Sec. 1.48-4 to
treat the lessee as having purchased such property for purposes of the
credit allowed by section 38. Property leased by a lessor, where the
leasing is not part of a public utility activity, to a lessee who uses
such property predominantly in a public utility activity is public
utility property for purposes of computing the lessor's or lessee's
qualified investment with respect to such property.
(4) Property used in both the production or transmission of gas and
the local distribution of gas. (i) With respect to properties of a
taxpayer engaged in both the production or transmission of gas and the
local distribution of gas, section 38 property shall be considered as
used predominantly in the trade or business of the furnishing or sale of
gas through a local distribution system if expenditures for such
property are chargeable to any of the following accounts under either
the uniform system of accounts prescribed for natural gas companies
(class A and class B) by the Federal Power Commission, effective January
1, 1961, or the uniform system of accounts for class A and B gas
utilities adopted in 1958 by the National Association of Railroad and
Utility Commissioners (or would be chargeable to any of the following
accounts if the taxpayer used either of such systems):
(a) Accounts 360 through 363, inclusive (Local Storage Plant), or
(b) Accounts 374 through 387, inclusive (Distribution Plant).
(ii) If expenditures for section 38 property are chargeable (or
would be chargeable) to any of the following accounts under either of
the systems named in subdivision (i) of this subparagraph, the
determination of whether or not such property is used predominantly in
the trade or business of the furnishing or sale of gas through a local
distribution system shall be made under all the facts and circumstances
relating to the actual use of such property in the year such property is
placed in service:
(a) Accounts 304 through 320, inclusive (Manufactured Gas Production
Plant), or
(b) Accounts 389 through 399, inclusive (General Plant).
For example, if an office machine is used 55 percent of the time for
billing customers of the taxpayer's local distribution system in the
year in which it is placed in service, such office machine shall be
considered as used predominantly in the trade or business of the
furnishing or sale of gas through a local distribution system.
(5) Certain submarine cable property. In the case of any interest in
a submarine cable circuit which is property described in section 50 used
to furnish telegraph service between the United States and a point
outside the United
[[Page 209]]
States of a taxpayer engaged in furnishing international telegraph
service (if the rates for such furnishing have been established or
approved by a governmental unit, agency, instrumentality, commission, or
similar body described in subparagraph (2) of this paragraph), the
qualified investment shall not exceed the qualified investment
attributable to so much of the interest of the taxpayer in the circuit
as does not exceed 50 percent of all interests in the circuit.
(h) Certain replacement property. (1)(i) If section 38 property is
placed in service by the taxpayer to replace property (whether or not
section 38 property) similar or related in service or use, which was
destroyed or damaged before August 16, 1971, by fire, storm, shipwreck,
or other casualty, or was stolen before such date, then for purposes of
paragraph (a) of this section the basis (or cost) of the replacement
section 38 property otherwise determined under paragraph (c) of this
section shall be reduced by an amount equal to the lesser of--
(a) The amount of money, or the fair market value of other property,
received as compensation, by insurance or otherwise, for the property
which was destroyed, damaged, or stolen, or
(b) The adjusted basis of such destroyed, damaged, or stolen
property (immediately before such destruction, damage, or theft).
(ii) For purposes of subdivision (i) of this subparagraph--
(a) Section 38 property placed in service after the due date
(including extensions of time thereof) for filing the taxpayer's income
tax return for the taxable year in which the other property was
destroyed, damaged, or stolen shall not be considered as replacement
section 38 property, and
(b) If the property which is destroyed, damaged, or stolen, is
leased property, no other leased property shall be considered as
replacement property with respect to the property destroyed, damaged, or
stolen, in any case in which the lessor makes or made an election under
section 48(d) (relating to election with respect to certain leased
property) with respect to either the property destroyed, damaged, or
stolen, the other leased property, or both.
(2) Subparagraph (1) of this paragraph shall not apply to
replacement property if the reduction, under such subparagraph (1), in
the basis (or cost) of such replacement property is less than the excess
of--
(i) The qualified investment with respect to the destroyed, damaged,
or stolen property, over
(ii) The recomputed qualified investment with respect to such
property (determined under the principles of paragraph (a) of Sec. 1.47-
1).
(3) This paragraph may be illustrated by the following examples:
Example 1. (i) A acquired and placed in service on January 1, 1962,
machine No. 1, which qualified as section 38 property, with a basis of
$30,000 and an estimated useful life of 6 years. The amount of qualified
investment with respect to such machine was $20,000. On January 2, 1963,
machine No. 1 is completely destroyed by fire. On January 1, 1963, the
adjusted basis of such machine in A's hands is $24,500. On November 1,
1963, A receives $23,000 in insurance proceeds as compensation for the
destroyed machine, and on December 15, 1963, A acquires and places in
service machine No. 2, which qualifies as section 38 property, with a
basis of $41,000 and an estimated useful life of 6 years to replace
machine No. 1.
(ii) Under subparagraph (1) of this paragraph, the $41,000 basis of
machine No. 2 is reduced, for purposes of paragraph (a) of this section,
by $23,000 (that is, the $23,000 insurance proceeds since such amount is
less than the $24,500 adjusted basis of machine No. 1 immediately before
it was destroyed) to $18,000 since such reduction (that is, $23,000) is
greater than the $20,000 reduction in qualified investment which would
be made if paragraph (a) of Sec. 1.47-1 were to apply to machine No. 1
($20,000 qualified investment less zero recomputed qualified
investment).
Example 2. (i) The facts are the same as in Example 1 except that on
November 1, 1963, A receives only $19,000 in insurance proceeds as
compensation for the destroyed machine.
(ii) The $41,000 basis of machine No. 2 is not reduced, for purposes
of paragraph (a) of this section, under this paragraph since the $19,000
reduction which would have been made under this paragraph had it applied
(that is, the $19,000 insurance proceeds since such amount is less than
the $24,500 adjusted basis of machine No. 1 immediately before it was
destroyed) is less than the $20,000 reduction in qualified investment
which is made since paragraph (a) of Sec. 1.47-1 applies to machine No.
1 ($20,000 qualified investment less zero recomputed qualified
investment).
[[Page 210]]
(Secs. 194 (94 Stat. 1989; 26 U.S.C. 194) and 7805 (68A Stat. 917, 26
U.S.C. 7805) of the Internal Revenue Code of 1954; secs. 38(b) (76 Stat.
963, 26 U.S.C. 38(b)), 48(l)(16) (94 Stat. 264, 26 U.S.C. 48(l)(16)),
and 7805 (68A Stat. 917, 26 U.S.C. 7805)RE
[T.D. 6731, 29 FR 6068, May 8, 1964, as amended by T.D. 6931, 32 FR
14026, Oct. 10, 1967; T.D. 7203, 37 FR 17125, Aug. 25, 1972; T.D. 7602,
44 FR 17667, Mar. 23, 1979; T.D. 7927, 48 FR 55849, Dec. 16, 1983; T.D.
7982, 49 FR 39541, Oct. 9, 1984; T.D. 8183, 53 FR 6618, Mar. 2, 1988;
T.D. 8474, 58 FR 25557, Apr. 27, 1993]
Sec. 1.46-4 Limitations with respect to certain persons.
(a) Mutual savings institutions. In the case of an organization to
which section 593 applies (that is, a mutual savings bank, a cooperative
bank, or a domestic building and loan association)--
(1) The qualified investment with respect to each section 38
property shall be 50 percent of the amount otherwise determined under
Sec. 1.46-3, and
(2) The $25,000 amount specified in section 46(a)(2), relating to
limitation based on amount of tax, shall be reduced by 50 percent of
such amount.
For example, if a domestic building and loan association places in
service on January 1, 1963, new section 38 property with a basis of
$30,000 and an estimated useful life of 6 years, its qualified
investment for 1963 with respect to such property computed under
Sec. 1.46-3 is $20,000 (66\2/3\ percent of $30,000). However, under this
paragraph such amount is reduced to $10,000 (50 percent of $20,000). If
an organization to which section 593 applies is a member of an
affiliated group (as defined in section 46(a)(5)), the $25,000 amount
specified in section 46(a)(2) shall be reduced in accordance with the
provisions of paragraph (f) of Sec. 1.46-1 before such amount is further
reduced under this paragraph.
(b) Regulated investment companies and real estate investment
trusts. (1) In the case of a regulated investment company or a real
estate investment trust subject to taxation under subchapter M, chapter
1 of the Code--
(i) The qualified investment with respect to each section 38
property otherwise determined under Sec. 1.46-3, and
(ii) The $25,000 amount specified in section 46(a)(2), relating to
limitation based on amount of tax,
shall be reduced to such person's ratable share of each such amount. If
a regulated investment company or a real estate investment trust is a
member of an affiliated group (as defined in section 46(a)(5)), the
$25,000 amount specified in section 46(a)(2) shall be reduced in
accordance with the provisions of paragraph (f) of Sec. 1.46-1 before
such amount is further reduced under this paragraph.
(2) A person's ratable share of the amount described in subparagraph
(1)(i) and the amount described in subparagraph (1)(ii) of this
paragraph shall be the ratio which--
(i) Taxable income for the taxable year, bears to
(ii) Taxable income for the taxable year plus the amount of the
deduction for dividends paid taken into account under section
852(b)(2)(D) in computing investment company taxable income, or under
section 857(b)(2)(B) (section 857(b)(2)(C), as then in effect, for
taxable years ending before October 5, 1976) in computing real estate
investment trust taxable income, as the case may be.
For purposes of the preceding sentence, taxable income means, in the
case of a regulated investment company its investment company taxable
income (within the meaning of section 852(b)(2)), and in the case of a
real estate investment trust its real estate investment trust taxable
income (within the meaning of section 857(b)(2)). In the case of a
taxable year ending after October 4, 1976, real estate investment trust
taxable income, for purposes of section 46(e) and this paragraph, is
determined by excluding any net capital gain, and by computing the
deduction for dividends paid without regard to capital gains dividends
(as defined in section 857(b)(3)(C)). The amount of the deduction for
dividends paid includes the amount of deficiency dividends (other than
capital gains deficiency dividends) taken into account in computing
investment company taxable income or real estate investment trust
taxable income for the taxable year. See section 860(f) for the
definition of deficiency dividends. For purposes of this paragraph only,
in computing taxable income for a taxable year beginning before January
1, 1964, a regulated
[[Page 211]]
investment company or a real estate investment trust may compute
depreciation deductions with respect to section 38 property placed in
service before January 1, 1964, without regard to the reduction in basis
of such property required under Sec. 1.48-7.
(3) This paragraph may be illustrated by the following example:
Example. (i) Corporation X, a regulated investment company subject
to taxation under section 852 of the Code which makes its return on the
basis of the calendar year, places in service on January 1, 1964,
section 38 property with a basis of $30,000 and an estimated useful life
of 6 years. Corporation X's investment company taxable income under
section 852(b)(2) is $10,000 after taking into account a deduction for
dividends paid of $90,000.
(ii) Under this paragraph, corporation X's qualified investment for
the taxable year 1964 with respect to such property is $2,000, computed
as follows: (a) $20,000 (qualified investment under Sec. 1.46-3),
multiplied by (b) $10,000 (taxable income), divided by (c) $100,000
(taxable income plus the deduction for dividends paid). For 1964, the
$25,000 amount specified in section 46(a)(2) is reduced to $2,500.
(c) Cooperatives. (1) In the case of a cooperative organization
described in section 1381(a)--
(i) The qualified investment with respect to each section 38
property otherwise determined under Sec. 1.46-3, and
(ii) The $25,000 amount specified in section 46(a)(2), relating to
limitation based on amount of tax,
shall be reduced to such cooperative's ratable share of each such
amount. If a cooperative organization described in section 1381(a) is a
member of an affiliated group (as defined in section 46(a)(5)), the
$25,000 amount specified in section 46(a)(2) shall be reduced in
accordance with the provisions of paragraph (f) of Sec. 1.46-1 before
such amount is further reduced under this paragraph.
(2) A cooperative's ratable share of the amount described in
subparagraph (1)(i) and the amount described in subparagraph (1)(ii) of
this paragraph shall be the ratio which--
(i) Taxable income for the taxable year, bears to
(ii) Taxable income for the taxable year plus the sum of (a) the
amount of the deductions allowed under section 1382(b), (b) the amount
of the deductions allowed under section 1382(c), and (c) amounts similar
to the amounts described in (a) and (b) of this subdivision the tax
treatment of which is determined without regard to subchapter T, chapter
1 of the Code and the regulations thereunder.
Amounts similar to deductions allowed under section 1382 (b) or (c) are,
for example, in the case of a taxable year of a cooperative organization
beginning before January 1, 1963, the amount of patronage dividends
which are excluded or deducted and any nonpatronage distributions which
are deducted under section 522(b)(1). In the case of a taxable year of a
cooperative organization beginning after December 31, 1962, such amounts
are the amount of patronage dividends and nonpatronage distributions
which are excluded or deducted without regard to section 1382 (b) or (c)
because they are paid with respect to patronage occurring before 1963.
For purposes of this paragraph only, in computing taxable income for a
taxable year beginning before January 1, 1964, a cooperative may compute
depreciation deductions with respect to section 38 property placed in
service before January 1, 1964, without regard to the reduction in basis
of such property required under Sec. 1.48-7.
(3) This paragraph may be illustrated by the following example:
Example. (i) Cooperative X, an organization described in section
1381(a) which makes its return on the basis of the calendar year, places
in service on January 1, 1964, section 38 property with a basis of
$30,000 and an estimated useful life of 6 years. Cooperative X's taxable
income is $10,000 after taking into account deductions of $20,000
allowed under section 1382(b), deductions of $60,000 allowed under
section 1382(c), and deductions of $10,000 allowed under section
522(b)(1)(B).
(ii) Under this paragraph, cooperative X's qualified investment for
the taxable year 1964 with respect to such property is $2,000, computed
as follows: (a) $20,000 (qualified investment under Sec. 1.46-3),
multiplied by (b) $10,000 (taxable income), divided by (c) $100,000
(taxable income plus the sum of the deductions allowed under sections
1382(b), 1382(c), and 522(b)(1)(B)). For 1964, the $25,000 amount
specified in section 46(a)(2) is reduced to $2,500.
(d) Noncorporate lessors. (1) In the case of a lease entered into
after September
[[Page 212]]
22, 1971, a credit is allowed under section 38 to a noncorporate lessor
of property with respect to the leased property only if--
(i) Such property has been manufactured or produced by the lessor in
the ordinary course of his business, or
(ii) The term of the lease (taking into account any options to
renew) is less than 50 percent of the estimated useful life of the
property (determined under Sec. 1.46-3(e)), and for the period
consisting of the first 12 months after the date on which the property
is transferred to the lessee the sum of the deductions with respect to
such property which are allowable to the lessor solely by reason of
section 162 (other than rents and reimbursed amounts with respect to
such property) exceeds 15 percent of the rental income produced by such
property.
In the case of property of which a partnership is the lessor, the credit
otherwise allowable under section 38 with respect to such property to
any partner which is a corporation shall be allowed notwithstanding the
first sentence of this subparagraph. For purposes of this subparagraph,
an electing small business corporation (as defined in section 1371)
shall be treated as a person which is not a corporation. This paragraph
shall not apply to property used by the taxpayer in his trade or
business (other than the leasing of property) for a period of at least
24 months preceding the day on which any lease of such property is
entered into.
(2) For purposes of subparagraph (1)(ii) of this paragraph, if at
the time the lessor files his income tax return for the taxable year in
which the property is placed in service, the lessor is unable to show
that the more-than-15-percent test has been satisfied, then no credit
may be claimed by the lessor on such return with respect to such
property unless (i) taking into account the lessor's obligations under
the lease it is reasonable to believe that the more-than-15-percent test
will be satisfied, and (ii) the lessor files a statement with his return
from which it may be determined that he expects to satisfy the more-
than-15-percent test. If the more-than-15-percent test is not satisfied
with respect to the property, the taxpayer must file an amended return
for the year in which the property is placed in service.
(3)(i) The more-than-15-percent test described in subparagraph
(1)(ii) of this paragraph is based on the relationship of the expenses
of the lessor relating to or attributable to the property to the gross
income from rents of the taxpayer produced by the property. The test is
applied with respect to such expenses and gross income as are properly
attributable to the period consisting of the first 12 months after the
date on which the property is transferred to the lessee. When more than
one property is subject to a single lease and, pursuant to subparagraph
(4) of this paragraph, the arrangement is considered to be a separate
lease of each property, the test is applied separately to each such
lease by making an apportionment of the payments received and expenses
incurred with respect to each such property, considering all relevant
factors. Such apportionment is made in accordance with any reasonable
method selected and consistently applied by the taxpayer. For example,
under subparagraph (4) of this paragraph, where a taxpayer leases an
airplane which he owns to an airline along with a baggage truck, he is
treated as having made two separate leases, one covering the airplane
and one covering the baggage truck. Thus, the test will be applied by
apportioning the related income and expenses between the two leases.
Similarly, where a taxpayer leases a factory building erected by him
containing section 38 property (machinery and equipment), the test will
be applied to the taxpayer as though he had leased (to the lessee) the
building and the section 38 property separately. Thus, the rental income
and expenses are apportioned between the building and the section 38
property.
(ii) Only those deductions allowable solely by reason of section 162
are taken into account in applying the more-than-15-percent test. Hence,
depreciation allowable by reason of section 167 (including amortization
allowable in lieu of depreciation); interest allowable by reason of
section 163; taxes allowable by reason of section 164; and depletion
allowable by reason
[[Page 213]]
of section 611 are examples of deductions which are not taken into
account in applying the test. Moreover, rents and reimbursed amounts
paid or payable by the lessor are not taken into account notwithstanding
that a deduction in respect of such rents or reimbursed amounts is
allowable solely by reason of section 162. For purposes of this
paragraph, a reimbursed amount is any expense for which the lessee or
some other party is obligated to reimburse the lessor. Section 162
expenses paid or payable by any person other than the lessor are not
taken into account unless the lessor is obligated to reimburse the
person paying the expense. Further, if the lessee is obligated to pay to
the lessor a charge for services which is separately stated or
determinable, the expenses incurred by the lessor with respect to those
services are not taken into account.
(iii) For purposes of the more-than-15-percent test, the gross
income from rents of the lessor produced by the property is the total
amount which is payable to the lessor by reason of the lease agreement
other than reimbursements of section 162 expenses and charges for
services which are separately stated or determinable. The fact that such
amount depends, in whole or in part, on the sales or profits of the
lessee or the performance of significant services by the lessor shall
not affect the characterization of such amounts as gross income from
rents for purposes of this paragraph. Gross income from rents also
includes any taxes imposed on the lessor by local law but which are paid
directly by the lessee on behalf of the lessor.
(4) For purposes of determining under this paragraph whether
property is subject to a lease, the provisions of Sec. 1.57-3(d)(1)
(relating to definition of a lease) shall apply. If a noncorporate
lessor enters into two or more successive leases with respect to the
same or substantially similar items of section 38 property, the terms of
such leases shall be aggregated and such leases shall be considered one
lease for the purpose of determining whether the term of such leases is
less than 50 percent of the estimated useful life of the property
subject to such leases. Thus, for example, if an individual owns an
airplane with an estimated useful life of 7 years and enters into three
successive 3-year leases of such airplane, such leases will be
considered to be one lease for a term of nine years for the purpose of
determining whether the term of the lease is less than 3\1/2\ years (50
percent of the 7-year estimated useful life).
(5) The requirements of this paragraph shall not apply with respect
to any property which is treated as section 38 property by reason of
section 48(a)(1)(E).
(Sec. 860(e) (92 Stat. 2849, 26 U.S.C. 860(e)); sec. 860(g) (92 Stat.
2850, 26 U.S.C. 860(g)); and sec. 7805 (68A Stat. 917, 26 U.S.C. 7805))
[T.D. 6731, 29 FR 6071, May 8, 1964, as amended by T.D. 6958, 33 FR
9170, June 21, 1968; T.D. 7203, 37 FR 17126, Aug. 25, 1972; T.D. 7767,
46 FR 11262, Feb. 6, 1981; T.D. 7936, 49 FR 2105, Jan. 18, 1984; T.D.
8031, 50 FR 26697, June 28, 1985]
Sec. 1.46-5 Qualified progress expenditures.
(a) Effective date. This section applies to taxable years ending
after December 31, 1974. This section reflects amendments to the
Internal Revenue Code made only by the Tax Reduction Act of 1975, the
Tax Reform Act of 1976, and the Revenue Act of 1978.
(b) General rule. Under section 46(d), a taxpayer may elect to take
the investment credit for qualified progress expenditures (as defined in
paragraph (g) of this section). In general, qualified progress
expenditures are amounts paid (paid or incurred in the case of self-
constructed property) for construction of progress expenditure property.
The taxpayer must reasonably estimate that the property will take at
least 2 years to construct and that the useful life of the property will
be 7 years or more. Qualified progress expenditures may not be taken
into account if made before the later of January 22, 1975, or the first
taxable year to which an election under section 46(d) applies. In
general, qualified progress expenditures are not allowed for the year
property is placed in service, nor for the first year or any subsequent
year recapture is required under section 47(a)(3). There is a percentage
limitation on qualified progress expenditures for taxable years
beginning before January 1, 1980. For a
[[Page 214]]
special rule relating to transfers of progress expenditure property, see
paragraph (r) of this section.
(c) Reduction of qualified investment. Under section 46(c)(4), a
taxpayer must reduce qualified investment for the year property is
placed in service by qualified progress expenditures taken into account
by that person or a predecessor. A ``predecessor'' of a taxpayer is a
person whose election under section 46(d) carries over to the taxpayer
under paragraph (o)(3) of this section.
(d) Progress expenditure property. Progress expenditure property is
property constructed by or for the taxpayer, with a normal construction
period of 2 years or more. The taxpayer must reasonably believe that the
property will be new section 38 property with a useful life of 7 years
or more when placed in service. Whether property is progress expenditure
property is determined on the basis of facts know at the close of the
taxable year of the taxpayer in which construction begins (or, if later,
at the close of the first taxable year to which an election under
section 46(d) applies). For purposes of this paragraph (d), property is
constructed by or for the taxpayer only if it is built or manufactured
from materials and component parts. Accordingly, progress expenditure
property does not include property such as orchards, vineyards,
livestock, or motion picture films or videotapes.
(e) Normal construction period--(1) In general. (i) The normal
construction period is the period the taxpayer reasonably expects will
be required to construct the property. The period begins on the date
physical work on construction of the property commences and ends on the
date the property is available to be placed in service. The normal
construction period does not include, however, construction before
January 22, 1975, nor construction before the first day of the first
taxable year for which an election under section 46(d) is in effect.
Physical work on construction of property does not include preliminary
activities such as planning, designing, preparing blueprints, exploring,
or securing financing.
(ii) The determination of the time when physical work on
construction commences is based on the facts and circumstances of each
case. Physical work on construction of property may include the physical
work done by a subcontractor on a component specifically designated as
part of the property. Also, the commencement of physical work on
construction may occur at a site different from the main site of
construction of the property. For example, if a shipyard orders a
turbine before it begins work on building a ship, the normal
construction period of the ship is measured from the time the
subcontractor commences physical work on construction of the turbine (if
it is normal for such work to precede the work of the main contractor).
(iii) Generally, physical work on construction does not include
physical activity that is not necessary to complete construction of the
property, nor does it include physical work on construction of a
building or other property that will not be new section 38 property when
placed in service. Physical work on construction also does not include
research and development activities in a laboratory or experimental
setting.
(iv) The normal construction period of property ends on the date it
is expected the property will be available to be placed in service.
Property is considered available to be placed in service when
construction is completed and the property is available for delivery to
the site of its assigned function. It is not necessary that property be
in a state of readiness for a specifically assigned function. Nor is it
necessary that it actually be delivered to the site of its assigned
function.
(2) Estimates. Taxpayers should refer to normal industry practice in
estimating the normal construction period of particular items. A
different period may be used if special circumstances exist making it
impractical to make the estimate on the basis of normal industry
practice. The estimate must be based on information available at the
close of the taxable year in which physical work on construction of the
property begins, or, if later, at the close of the first taxable year
for which an election under section 46(d) is in effect for the taxpayer.
If the estimate is reasonable when made, the actual time it
[[Page 215]]
takes to complete the work is, in general, irrelevant in determining
whether property is progress expenditure property. However, if there is
a significant error in estimating the normal construction period, it may
be evidence that the estimate was unreasonable when made. For taxable
years ending after April 1, 1988, a taxpayer not relying or normal
industry practice to estimate the normal construction period of
particular property must attach to the tax return for the taxable year
in which physical work on construction of the property begins (or, if
later, the first taxable year for which an election under section 46(d)
is in effect) a statement of the basis relied upon in estimating the
normal construction period of the property.
(3) Integrated unit. (i) In determining whether property has a
normal construction period of 2 years or more, property that will be
placed in service separately is to be considered separately. For
example, if two ships are contracted for at the same time, each ship is
considered separately under this paragraph. However, for property that
will be placed in service as an integrated unit, the taxpayer must
determine the normal construction period of the integrated unit. If the
normal construction period of the integrated unit is 2 years or more,
the normal construction period of each item of new section 38 property
that is a part of the integrated unit is considered to be 2 years or
more. Thus, the normal construction period of an integrated unit may be
2 years or more even if no part of the unit has a normal construction
period of 2 years or more.
(ii) Property is part of an integrated unit only if the operation of
that item is essential to the performance of the function to which the
unit is assigned. Property essential to the performance of the function
to which the unit is assigned includes property the use of which is
significantly connected to that function and which effects the safe,
proper, or efficient performance of the unit. Generally, property must
be placed in service at the same time to be considered part of the same
integrated unit. Properties are not an integrated unit, however, solely
because they are to be placed in service at the same time.
(iii) The normal construction period for an integrated unit begins
on the date the normal construction period of the first item of new
section 38 property that is part of the unit begins. It is not necessary
that physical work commence at the main construction site of the
integrated unit.
The period ends on the date the last item of new section 38 property
that is part of that unit is available to be placed in service. Property
that is not new section 38 property, such as a building, is not
considered part of an integrated unit for purposes of determining the
normal construction period of that unit. For example, if a manufacturing
plant has a normal construction period of two years or more but the
equipment (i.e., new section 38 property) to be installed in the plant
has a normal construction period of less than two years, the plant and
the equipment do not constitute an integrated unit with a construction
period of two years or more and the equipment is not progress
expenditure property.
(4) Examples. The following examples illustrate this paragraph (e).
Example 1. On July 1, 1974, corporation X begins physical work on
construction of a machine with an estimated useful life when placed in
service of more than 7 years. For its taxable year ending June 30, 1975,
X makes an election under section 46(d). For purposes of determining on
June 30, 1975, whether the machine is ``progress expenditure property'',
the normal construction period is treated as having begun on January 22,
1975. Thus, the machine will be considered to be progress expenditure
property on June 30, 1975, only if the estimated time required to
complete construction after June 30 is at least 18 months and 22 days
(i.e., 2 years less the period January 22, 1975, through June 30, 1975).
Example 2. (i) Corporation X constructs a pipeline in two sections
and simultaneously begins physical work on construction of each section
on January 1, 1976. One section extends from city M to city N. The other
extends from city N to city O. Oil will be transferred to storage tanks
at both city N and city O. Corporation X also begins construction on
January 1, 1976, of a pumping station necessary to the operation of the
pipeline from city M to city N. Construction of a pumping station
necessary to the operation
[[Page 216]]
of the pipeline from city N to city O begins on June 30, 1977. For 1976,
corporation X makes an election under section 46(d).
(ii) The section of pipeline from city M to city N and the
associated pumping station will be available to be placed in service on
January 1, 1977. Construction of the section of the pipeline from city N
to city O will be completed on June 30, 1977. However, that section of
the pipeline will not be available to be placed in service until
completion of the associated pumping station on January 1, 1978.
(iii) The section of pipeline from city M to city N and the section
from city N to city O must be considered separately in determining the
normal construction period of the property. Each section will be placed
in service separately. However, each section of the pipeline and the
associated pumping station may be considered an integrated unit. The
pumping stations are essential to the operation of each section of
pipeline. Each section of pipeline and the associated pumping station
are placed in service at the same time.
(iv) The section of pipeline from city M to city N and the
associated pumping station are not progress expenditure property,
because the normal construction period of that unit is only 1 year
(January 1, 1976 to January 1, 1977).
(v) The section of pipeline from city N to city O and the associated
pumping station are progress expenditure property, because the normal
construction of that integrated unit is 2 years (January 1, 1976 to
January 1, 1978). It is immaterial that neither the construction period
of that section of pipeline (January 1, 1976 to June 30, 1977) nor the
construction period of the associated pumping station (June 30, 1977 to
January 1, 1978) is 2 years.
(vi) Assume the pumping station associated with the pipeline from
city N to city O includes backup pumping equipment that will be used
only if the primary pumping equipment fails. The backup equipment is
part of the integrated unit because it serves to effect the safe or
efficient performance of the unit.
(f) New section 38 property with a 7-year useful life--(1) In
general. The taxpayer must determine if property will be new section 38
property with a useful life of 7 years or more when placed in service.
The determination must be made at the close of the taxable year in which
construction begins or, if later, at the close of the first taxable year
to which an election under section 46(d) applies for the taxpayer.
(2) Determination based on reasonably expected use. The
determination of whether property will be ``new section 38 property''
(within the meaning of Secs. 1.48-1 and 1.48-2 when placed in service
must be based on the reasonably expected use of the property by the
taxpayer. There is a presumption that property will be new section 38
property if it would be new section 38 property if placed in service by
the taxpayer when the determination is made. For example, in determining
if property is an integral part of manufacturing under section
48(a)(1)(B)(i), it will be presumed that property will be new section 38
property if the taxpayer is engaged in manufacturing when the
determination is made. Also, significant steps taken to establish a
trade or business will be evidence the taxpayer will be engaged in that
trade or business when the property is placed in service.
(3) Estimated useful life. The determination of whether property
will have an estimated useful life of 7 years or more when placed in
service must be made by applying the principles of Sec. 1.46-3(e). If
the estimated useful life is less than 7 years when the property is
actually placed in service, the credit previously allowed under section
46(d) must be recomputed under section 47(a)(3)(B).
(g) Definition of qualified progress expenditures--(1) In general. A
taxpayer's qualified progress expenditures are the sum of qualified
progress expenditures for self-constructed property (determined under
paragraph (h) of this section), plus qualified progress expenditures for
non-self-constructed property (determined under paragraph (j) of this
section). Only amounts includible under Sec. 1.46-3(c) in the basis of
new section 38 property may be considered as qualified progress
expenditures.
(2) Excluded amounts. Qualified progress expenditures do not
include:
(i) In the case of non-self-constructed property, amounts incurred
(whether or not paid)--
(A) Before the normal construction period begins, or
(B) Before the later of January 22, 1975, or the first day of the
first taxable year for which an election under section 46(d) applies for
the taxpayer;
(ii) In the case of self-constructed property, amounts chargeable to
capital account--
[[Page 217]]
(A) Before the normal construction period begins, or
(B) Before the later of January 22, 1975, or the first day of the
first taxable year for which an election under section 46(d) applies for
the taxpayer,
(See, however, section 46(d)(4)(A) and paragraph (h)(3)(i) of this
section, relating to the time when amounts for component parts and
materials are properly chargeable to capital account);
(iii) Expenditures with respect to particular property in the
earlier of--
(A) The taxable year in which the property is placed in service, or
(B) The taxable year in which the taxpayer must recapture investment
credit under section 47(a)(3) for the property or any subsequent year;
(iv) Expenditures for construction, reconstruction, or erection of
property that is not section 38 property; or
(v) Amounts treated as an expense and deducted in the year paid or
accrued.
(h) Qualified progress expenditures for self-constructed property--
(1) In general. Qualified progress expenditures for self-constructed
property (as defined in paragraph (k) of this section) are amounts
properly chargeable to capital account in connection with that property.
In general, amounts paid or incurred are chargeable to capital account
if under the taxpayer's method of accounting they are properly
includible in computing basis under Sec. 1.46-3. Qualified progress
expenditures for self-constructed property include both direct costs
(e.g., labor, material, parts) and indirect costs (e.g., overhead,
insurance) associated with construction of property to the extent those
costs are properly chargeable to capital account.
(2) Property partially non-self constructed. If an item of property
is self-constructed because more than half of the construction
expenditures are made directly by the taxpayer, then any expenditures
(whether or not made directly by the taxpayer) for construction of that
item of property are not subject to the limitations of section
46(d)(3)(B) and paragraph (j) of this section (relating to actual
payment and progress in construction).
(3) Time when amounts paid or incurred are properly chargeable to
capital account. (i) In general, expenditures for component parts and
materials to be used in construction of self-constructed property are
not properly chargeable to capital account until consumed or physically
attached in the construction process. Component parts and materials that
have been neither consumed nor physically attached in the construction
process, but which have been irrevocably allocated to construction of
that property are properly chargeable to capital account. Component
parts and materials designed specifically for the self-constructed
property may be considered irrevocably allocated to construction of that
property at the time of manufacture of the component parts and
materials. Component parts and materials not designed specifically for
the property may be considered irrevocably allocated to construction at
the time of delivery to the construction site if they would be
economically impractical to remove. For example, pumps delivered to
sites of construction of a tundra pipeline may be treated as irrevocably
allocated to that pipeline on the date of delivery, even if they would
be usable, but for their location on the tundra, in connection with
other property. Component parts and materials are not to be considered
irrevocably allocated to use in self-constructed property until physical
work on construction of that property has begun (as determined under
paragraph (e)(1)(ii) of this section). Mere bookkeeping notations are
not sufficient evidence that the necessary allocation has been made.
(ii) A taxpayer's procedure for determining the time when an
expenditure is properly chargeable to capital account for self-
constructed property is a method of accounting. Under section 446(e),
the method of accounting, once adopted, may not be changed without
consent of the Secretary.
(4) Records requirement. The taxpayer shall maintain detailed
records which permit specific identification of the amounts properly
chargeable by the taxpayer during each taxable year to capital account
for each item of self-constructed property.
(i) [Reserved]
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(j) Qualified progress expenditures for non-self-constructed
property--(1) In general. Qualified progress expenditures for non-self-
constructed property (as defined in paragraph (l) of this section) are
amounts actually paid by the taxpayer to another person for construction
of the property, but only to the extent progress is made in
construction. For example, such expenditures may include payments to the
manufacturer of an item of progress expenditure property, payments to a
contractor building progress expenditure property, or payments for
engineering designs or blueprints that are drawn up during the normal
construction period.
(2) Property partially self-constructed. If an item of property is
non-self-constructed, but a taxpayer uses its own employees to construct
a portion of the property, expenditures for construction of that portion
are made directly by the taxpayer (see Sec. 1.46-5(h)(1)). Subject to
the limitations of paragraph (g) of this section, those expenditures are
qualified progress expenditures for non-self-constructed property if
they satisfy the requirements of paragraphs (j) (4), (5), and (6) of
this section. Wages actually paid to the taxpayer's employees are
presumed to correspond to progress in construction. Other amounts,
including expenditures for materials, parts, and overhead, must be
actually paid, not borrowed from the payee, and attributable to progress
made in construction by the taxpayer.
(3) Property constructed by more than one person. The percentage of
completion limitation (as prescribed in paragraph (j)(6) of this
section), including the presumption of ratable progress in construction,
applies to an item of progress expenditure property as a whole. However,
if several manufacturers or contractors do work in connection with the
same property, the progress that each person makes toward completion of
construction of the property must be determined separately. Section
46(d)(3)(B) is then applied separately to amounts paid to each
manufacturer or contractor based on each person's progress in
construction. For example, assume the taxpayer contracts with three
persons to build an item of equipment. The taxpayer contracts with A to
build the frame, B to build the motor, and C to assemble the frame and
motor. Assume each contract represents 33\1/3\ percent of the
construction costs of the property. If, within the taxable year in which
construction begins, A and B each complete 50 percent of the
construction of the frame and motor, respectively, amounts paid to A
during that taxable year not in excess of 16\2/3\ percent of the overall
cost of the property, and amounts paid to B during that taxable year not
in excess of 16\2/3\ percent of the overall cost of the property, are
qualified progress expenditures. Section 46(d)(3)(B) does not apply,
however, to persons, such as lower-tier subcontractors, that do not have
a direct contractual relationship with the taxpayer. If, in the above
example, A engages a subcontractor to construct part of the frame,
section 46(d)(3)(B) is applied only to amounts paid by the taxpayer to
A, B, and C, but the portion of construction completed by A during a
taxable year includes the portion completed by A's subcontractor.
(4) Requirement of actual payment. Qualified progress expenditures
for non-self-constructed property must be actually paid and not merely
incurred. Amounts paid during the taxable year to another person for
construction of non-self-constructed property may be in the form of
money or property (e.g., materials). However, property given as payment
may be considered only to the extent it will be includible under
Sec. 1.46-3(c) in the basis of the non-self-constructed property when it
is placed in service.
(5) Certain borrowing disregarded. Qualified progress expenditures
for non-self-constructed property do not include any amount paid to
another person (the ``payee'') for construction if the amount is paid
out of funds borrowed directly or indirectly from the payee. Amounts
borrowed directly or indirectly from the payee by any person that is
related to the taxpayer (within the meaning of section 267) or that is a
member of the same controlled group of corporations (as defined in
section 1563(a)) will be considered borrowed indirectly from the payee.
Similarly, amounts borrowed under any financing arrangement that has the
effect of making the payee a
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surety will be considered amounts borrowed indirectly by the taxpayer
from the payee.
(6) Percentage of completion limitation. (i) Under section
46(d)(3)(B)(ii), payments made in any taxable year may be considered
qualified progress expenditures for non-self-constructed property only
to the extent they are attributable to progress made in construction
(percentage of completion limitation). Progress will generally be
measured in terms of the manufacturer's incurred cost, as a fraction of
the anticipated cost (as adjusted from year to year). Architectural or
engineering estimates will be evidence of progress made in construction.
Cost accounting records also will be evidence of progress. Progress will
be presumed to occur not more rapidly than ratably over the normal
construction period. However, the taxpayer may rebut the presumption by
clear and convincing evidence of a greater percentage of completion.
(ii) If, after the first year of construction, there is a change in
either the total cost to the taxpayer or the total cost of construction
by another person, the taxpayer must recompute the percentage of
completion limitation on the basis of revised cost. However, the
recomputation will affect only amounts allowed as qualified progress
expenditures in the taxable year in which the change occurs and in
subsequent taxable years. The recomputation remains subject to the
presumption of pro rata completion.
(iii) If, for any taxable year, the amount paid to another person
for construction of an item of property under section 46(d)(3)(B)(i)
exceeds the percentage of completion limitation in section
46(d)(3)(B)(ii), the excess is treated as an amount paid to the other
person for construction for the succeeding taxable year. If for any
taxable year the percentage of completion limitation for an item of
property exceeds the amount paid to another during the taxable year for
construction, the excess is added to the percentage of completion
limitation for that property for the succeeding taxable year.
(iv) The taxpayer must maintain detailed records which permit
specific identification of the amounts paid to each person for
construction of each item of property and the percentage of construction
completed by each person for each taxable year.
(7) Example. The following example illustrates paragraph (j)(6) of
this section.
Example. (i) Corporation X agrees to build an airplane for
corporation Y, a calendar year taxpayer. The airplane is non-self-
constructed progress expenditure property. Physical work on construction
begins on January 1, 1980. The normal construction period for the
airplane is five years and the airplane is delivered and placed in
service on December 31, 1984.
(ii) The cost of construction to corporation X is $500,000. The
contract price is $550,000. Corporation Y makes a $110,000 payment in
each of the years 1980 and 1981, an $85,000 payment in 1982, a $135,000
payment in 1983, and a $110,000 payment in 1984.
(iii) For 1980, corporation Y makes an election under section 46(d).
Progress is presumed to occur ratably over the 5-year construction
period, which is 20 percent in each year. Twenty percent of the contract
price is $110,000. The percentage of completion limitation for each
year, thus, is $110,000.
(iv) For each of the years 1980 and 1981, the $110,000 payments may
be treated as qualified progress expenditures. The payments equal the
percentage of completion limitation.
(v) For 1982, the $85,000 payment may be treated as a qualified
progress expenditure, because it is less than the percentage of
completion limitation. The excess of the percentage of completion
limitation ($110,000) over the 1982 payment ($85,000) is added to the
percentage of completion limitation for 1983. One hundred and ten
thousand dollars minus $85,000 equals $25,000. Twenty-five thousand
dollars plus $110,000 equals $135,000, which is the percentage of
completion limitation for 1983.
(vi) For 1983, the entire $135,000 payment may be treated as a
qualified progress expenditure. The payment equals the percentage of
completion limitation for 1983.
(vii) For 1984, no qualified progress expenditures may be taken into
account, because the airplane is placed in service in that year.
(viii) See example 2 of paragraph (r)(4) of this section for the
result if Y sells its contract rights to the property on December 31,
1982.
(k) Definition of self-constructed property--(1) In general.
Property is self-constructed property if it is reasonable to believe
that more than half of the construction expenditures for the property
will be made directly by the taxpayer. Construction expenditures made
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directly by the taxpayer include direct costs such as wages and
materials and indirect costs such as overhead attributable to
construction of the property. Expenditures for direct and indirect costs
of construction will be treated as construction expenditures made
directly by the taxpayer only to the extent that the expenditures
directly benefit the construction of the property by employees of the
taxpayer. Thus, wages paid to taxpayers's employees and expenditures for
basic construction materials, such as sheet metal, lumber, glass, and
nails, which are used by employees of the taxpayer to construct progress
expenditure property, will be considered made directly by the taxpayer.
Construction expenditures made by the taxpayer to a contractor or
manufacturer, in general, will not be considered made directly by the
taxpayer. Thus, the cost of component parts, such as boilers and
turbines, which are purchased and merely installed or assembled by the
taxpayer, will not be considered expenditures made directly by the
taxpayer for construction. (See paragraph (h)(3) of this section to
determine when such cost is properly chargeable to capital account.)
(2) Time when determination made. The determination of whether
property is self-constructed is to be made at the close of the taxable
year in which physical work on construction of the property begins, or,
if later, the close of the first taxable year to which an election under
this section applies. Once it is reasonably estimated that more than
half of construction expenditures will be made directly by the taxpayer,
the fact the taxpayer actually makes half, or less than half, of the
expenditures directly will not affect classification of the property as
self-constructed property. Similarly, once a determination has been
made, classification of property as self-constructed property is not
affected by a change in circumstances in a later taxable year. However,
a significant error unrelated to a change in circumstances may be
evidence that the estimate was unreasonable when made.
(3) Determination based on certain expenditures. For purposes of
determining whether more than half of the expenditures for construction
of an item of property will be made directly by the taxpayer, the
taxpayer may take into account only expenditures properly includable by
the taxpayer in the basis of the property under the provisions of
Sec. 1.46-3(c). Thus, property is self-constructed property only if more
than half of the estimated basis of the property to be used for purposes
of determining the credit allowed by section 38 is attributable to
expenditures made directly by the taxpayer.
(l) Definition of non-self-constructed property. Non-self-
constructed property is property that is not self-constructed property.
Thus, property is non-self-constructed property if it is reasonable to
believe that only half, or less than half, of the expenditures for
construction will be made directly by the taxpayer.
(m) Alternative limitations for public utility, railroad, or airline
property. The alternative limitations on qualified investment under
section 46(a) (7) and (8) for public utility, railroad, or airline
property (whichever applies) apply in determining the credit for
qualified progress expenditures. The determination of whether progress
expenditure property will be public utility, railroad, or airline
property (whichever applies) when placed in service must be made at the
close of the taxable year in which physical work on construction begins
or, if later, at the close of the first taxable year for which an
election under section 46(d) is in effect. If, at that time, the
taxpayer is in a trade or business as a public utility, railroad, or
airline (as described in section 46(c)(3)(B) and 46(a)(8) (D) and (E),
respectively), it is evidence the property will be public utility,
railroad, or airline property when placed in service.
(n) Leased property. A lessor of progress expenditure property may
not elect under section 48(d) to treat a lessee (or a person who will be
a lessee) as having made qualified progress expenditures.
(o) Election--(1) In general. The election under section 46(d)(6) to
increase qualified investment by qualified progress expenditures may be
made for any taxable year ending after December 31, 1974. Except as
provided in paragraph (o)(2) of this section, the election
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is effective for the first taxable year for which it is made and for all
taxable years thereafter unless it is revoked with the consent of the
Commissioner. Except as provided in paragraphs (o) (2) and (3) of this
section, the election applies to all qualified progress expenditures
made by the taypayer during the taxable year for construction of any
progress expenditure property. Thus, the taxpayer may not make the
election for one item of progress expenditure property and not for other
items. If progress expenditure property is being constructed by or for a
partnership, S corporation (as defined in section 1361(a)), trust, or
estate, an election under section 46(d)(6) must be made separately by
each partner or shareholder, or each beneficiary if the beneficiary, in
determining his tax liability, would be allowed investment credit under
section 38 for property subject to the election. The election may not be
made by a partnership or S corporation, and may be made by a trust or
estate only if the trust or estate, in determining its tax liability,
would be allowed investment credit under section 38 for property subject
to the election. The election of any partner, shareholder, beneficiary,
trust, or estate will be effective for that person, even if a related
partner, shareholder, beneficiary, trust, or estate does not make the
election. An election made by a partner, shareholder, beneficiary,
trust, or estate applies to all progress expenditure property of that
person. For example, an election made by corporation X, which is a
partner in the XYZ partnership, applies to progress expenditure property
the corporation holds in its own capacity and also to its interest in
progress expenditure property of the partnership.
(2) Time and manner of making election. An election under section
46(d)(6) must be made on Form 3468 and filed with the original income
tax return for the first taxable year ending after December 31, 1974 to
which the election will apply. An election made before March 2, 1988, by
filing a written statement (whether or not attached to the income tax
return) will be considered valid. The election may not be made on an
amended return filed after the time prescribed for filing the original
return (including extensions) for that taxable year. However, an
election under this section may be made or revoked by filing a statement
with an amended return filed on or before May 31, 1988, if the due date
for filing a return for the first taxable year to which the election
applies is before May 31, 1988.
(3) Carryover of election in certain transactions. In general, and
election under section 46(d)(6) does not carry over to the transferee of
progress expenditure property (or an interest therein). However, if
under section 47(b) the property does not cease to be progress
expenditure property because of the transfer, the election will carry
over to the transferee. If so, the election will apply only to the
property transferred. For rules relating to the determination of
qualified progress expenditures of the transferee, see paragraph (r) of
this section.
(p) Partnerships, S corporations, trusts, or estates--(1) In
general. Each partner, shareholder, trust, estate, or beneficiary of a
trust or estate that makes an election under section 46(d) shall take
into account its share of qualified progress expenditures (determined
under paragraph (p)(2) of this section) made by the partnership, S
corporation, trust, or estate. In determining qualified investment for
the year in which the property is placed in service, the basis of the
property is apportioned as provided in Secs. 1.46-3(f), 1.48-6, or 1.48-
5 (whichever applies). Each partner, shareholder, trust, estate, or
beneficiary that made the election must reduce qualified investment
under section 46(c)(4) for the year the property is placed in service by
qualified progress expenditures taken into account by that person.
(2) Determination of share of qualified progress expenditures. The
share of qualified progress expenditures of each partner, shareholder,
trust, estate, or beneficiary that makes an election under section 46(d)
must be determined in accordance with the same ratio used under
Secs. 1.46-3(f)(2), 1.48-5(a)(1), or 1.48-6(a)(1) (whichever applies) to
determine its share of basis (or cost). The last sentence of Sec. 1.46-
3(f)(2)(i) must be applied by referring to the date on which qualified
progress expenditures are
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paid or chargeable to capital amount (whichever is applicable).
(3) Examples. The followng examples illustrate this paragraph (p).
Example 1. (i) Corporation X contracts to build a ship for
partnership AB that qualifies as progress expenditure property. The
contract price is $100,000. Physical work on construction of the ship
begins on January 1, 1980. The ship is placed in service on December 31,
1983.
(ii) The AB partnership reports income on the calendar year basis.
Partners A and B share profits equally. For A's taxable year ending
December 31, 1980, A makes an election under section 46(d) B does not
make the election.
(iii) For each of the years 1980, 1981, 1982, and 1983, the AB
partnership makes $25,000 payments to corporation X. The payments made
in 1980, 1981, and 1982 are qualified progress expenditures. The 1983
payment is not a qualified progress expenditure, because the ship is
placed in service in that year.
(iv) For each of the years 1980, 1981, and 1982, A may take into
account qualified progress expenditures of $12,500 because A had a 50
percent partnership interest in each of those years.
(v) For 1983, qualified investment for the ship is $100,000. A and
B's share are $50,000 each, because each had a 50 percent partnership
interest in 1983. However, A must reduce its $50,000 share for 1983 by
$37,500, the amount of qualified progress expenditures taken into
account by A. B's share is not reduced, because B did not take into
account qualified progess expenditures.
Example 2. (i) The facts are the same as in example 1 except that on
June 30, 1983, the partnership agreement is amended to admit a new
partner, C. The partners agree to share profits equally. There is no
special allocation in effect under section 704 with respect to the ship.
(ii) For each of the years 1980, 1981, and 1982, A may take into
account qualified progress expenditures of $12,500 because A has a 50
percent partnership interest in those years.
(iii) For 1983, A, B, and C's share of qualified investment is
$33,333 each, because each had a 33\1/3\ percent partnership interest in
that year. A must reduce its share to zero, because it took $37,500 into
account as qualified progress expenditures. In addition, the excess of
the $37,500 over the $33,333 applied as a reduction is subject to
recapture under section 47(a)(3)(B). B and C's shares are not reduced,
because neither taxpayer took into account qualified progress
expenditures.
(q) Limitation on qualified progress expenditures for taxable years
beginning before 1980--(1) In general. (i) Under section 46(d)(7),
qualified progress expenditures for any taxable year beginning before
January 1, 1980, are limited. The taxpayer must apply the limitation
under section 46(d)(7) on an item by item basis. In general, the
taxpayer may take into account the applicable percentage (as determined
under the table in section 46(d)(7)(A)) of qualified progress
expenditures for each of those years. In addition, the taxpayer may take
into account for each of those years 20 percent of qualified investment
for each of the preceding taxable years determined without applying the
limitations of section 46(d)(7).
(ii) The applicable percentage under section 46(d)(7)(A) may be
applied only for one taxable year that ends within a calendar year in
determining qualified investment for an item of progress expenditure
property. For example, calendar year partners of a calendar year
partnership may increase qualified investment for 1976 by 20 percent of
qualified progress expenditures made in 1975 for an item of property. If
the partnership incorporates in 1976 and the taxable year of the
corporation begins on July 1, 1976, and ends on June 30, 1977, qualified
investment of the corporation for its taxable year beginning on July 1,
1976, cannot be increased by 20 percent of the 1975 expenditure.
(2) Example. The following example illustrates this paragraph (q).
Example. (i) Corporation X contracts with A on January 1, 1976, to
build an electric generator that qualifies as non-self-constructed
progress expenditure property. A will build the generator at a cost of
$125,000. Corporation X agrees to pay A $150,000. Corporation X reports
income on the calendar year basis. Corporation X makes an election under
section 46(d) for 1976. Physical work on construction begins on January
1, 1976. Corporation X makes payments of $30,000 to A for construction
of the generator in each of the years 1976, 1977, 1978, 1979, and 1980.
A incurs a cost of $25,000 in each of those years for construction of
the property. The property is placed in service in 1980.
(ii) For 1976, X may increase qualified investment by $12,000, 40
percent of the payment made in 1976.
(iii) For 1977, corporation X may increase qualified investment by
$24,000. Eighteen thousand dollars of that amount is 60 percent of the
1977 payment. The remaining $6,000 is 20 percent of the $30,000 payment
made in 1976.
(iv) For 1978, corporation X may increase qualified investment by
$36,000. Twenty-four thousand dollars of that amount is 80 percent of
the 1978 payment. The remaining
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$12,000 is 20 percent of the $30,000 payment made in 1976, plus 20
percent of the $30,000 payment made in 1977.
(v) For 1979, corporation X may increase qualified investment by
$48,000. Thirty thousand dollars of that amount is 100 percent of the
1979 payment. The remaining $18,000 of that amount is 20 percent of the
$30,000 payments made in each of the years 1976, 1977, and 1978.
(vi) Qualified investment for corporation X for 1980 is $30,000. The
$30,000 is the basis (or cost) of the generator ($150,000), reduced by
qualified progress expenditures allowed with respect to that property
($120,000).
(r) Special rules for transferred property--(1) In general. A
transferee of progress expenditure property (or an interest therein) may
take into account qualified progress expenditures for the property only
if--
(i) The property is progress expenditure property in the hands of
the transferee, and
(ii) The transferee makes an election under section 46(d) or the
election made by the transferor (or its predecessor) carries over to the
transferee under paragraph (o)(3) of this section.
(2) Status as progress expenditure property. (i) If the transfer
requires recapture under section 47(a)(3) and Sec. 1.47-1(g) (or would
require recapture if the transferor had made an election under section
46(d)), then--
(A) For purposes of determining if the property is progress
expenditure property in the hands of the transferee, the normal
construction period for the property begins on the date of the transfer,
or, if later, on the first day of the first taxable year for which the
transferee makes an election under section 46(d), and
(B) For purposes of determining whether the property is self-
constructed or non-self-constructed in the hands of the transferee, the
amount paid or incurred for the transfer of the property will not be
considered a construction expenditure made directly by the transferee.
(ii) If the transfer does not require recapture under section
47(a)(3) and Sec. 1.47-1(g), and the election carries over to the
taxpayer under paragraph (o)(3) of this section, the property does not
lose its status as progress expenditure property because of the
transfer.
(3) Amount of qualified progress expenditures for transferee. (i) If
the transfer does not require recapture under section 47(a)(3) and
Sec. 147-1(g), and the election carries over to the taxpayer under
paragraph (o)(3) of this section, the transferee must determine its
qualified progress expenditures--
(A) By using the same normal construction period used by the
transferor,
(B) By treating the property as having the same status as self-
constructed or non-self-constructed as the property had in the hands of
the transferor, and
(C) In the case of non-self-constructed property, by taking into
account any excess described in section 46(d)(4)(C)(i) (relating to the
excess of payments over the percentage-of-completion limitation) or
section 46(d)(4)(C)(ii) (relating to the excess of the percentage-of-
completion limitation over the amount of payments) that the transferor
would have taken into account with respect to that property.
(ii) If the transfer requires recapture under section 47(a)(3) and
Sec. 1.47-1(g) (or would require recapture if the transferor had made an
election under section 46(d)), the amount paid or incurred for the
transfer will be considered a payment for construction of that property
to the extent that--
(A) It is properly includible in the basis of the property under
Sec. 1.46-3(c),
(B) The taxpayer can show the amount is attributable to construction
costs paid or chargeable to capital account by the transferor or other
person after physical work on construction of the property began, and
(C) It does not exceed the amount by which the transferor has
increased qualified investment for qualified progress expenditures
incurred with respect to the property (or would have increased qualified
investment but for the ``lesser of'' limitation of section 46(d)(3)(B)
or the absence of an election under section 46(d)), plus any amount that
would have been treated as a qualified progress expenditure by the
transferor had the property not been transferred.
Once the status of the property as self-constructed or non-self-
constructed property in the hands of the transferee has been determined,
all rules under this section for determining the
[[Page 224]]
amount of qualified progress expenditures for that type of property
apply. For example, if the property is non-self-constructed in the hands
of the transferee, amounts merely incurred (but not paid) for the
transfer are not taken into account as qualified progress expenditures.
Actual payment is necessary (see paragraph (j)(3) of this section). In
applying section 46(d)(3)(B)(ii), the amount paid or incurred for the
transfer (to the extent that it qualifies as a payment for construction
under the first sentence of this paragraph (r)(3)(ii)) is considered to
be part of the overall cost to the transferee of construction by another
person, and the portion of construction which is completed during the
taxable year is determined by taking into account construction that was
completed before the constructed property was acquired by the
transferee. If the transferee makes an election under section 46(d) and
this section for the taxable year in which the transfer occurs, then for
purposes of applying the presumption in section 46(d)(4)(D) that
construction is deemed to occur not more rapidly than ratably over the
normal construction period, the transferee's normal construction period
is considered to have begun on the date on which physical work on
construction of the acquired property began.
(4) Examples. The following examples illustrate this paragraph (r).
Example 1. Corporation X begins physical work on construction of
progress expenditure property for corporation Y on January 1, 1976. Y
accurately estimates a 3-year normal construction period and elects
under section 46(d) on its return for its taxable year ending December
31, 1976. On January 1, 1978, Y sells the contract rights for
construction of the property to corporation Z, which uses a fiscal year
ending June 30. Qualified progress expenditures allowed to Y in 1976 and
1977 are subject to recapture under section 47(a)(3). Because Z's normal
construction period for the property is less than 2 years (January 1,
1978 to January 1, 1979), the property is not progress expenditure
property in Z's hands. Z may not elect progress expenditure treatment
for the property.
Example 2. (i) Assume the same facts as in the example in paragraph
(j)(7) of this section, except, on December 31, 1982, Y sells its
contract rights to the property for $340,000 to corporation Z, which
also uses the calendar year. Z pays Y the full $340,000 on that date.
The property is still to be placed in service on December 31, 1984, and
will not be available for placing in service at an earlier date. Z makes
payments to X of $135,000 on December 31, 1983, and $110,000 on December
31, 1984.
(ii) The investment credit allowed Y in 1980 and 1981 for qualified
progress expenditures is subject to recapture under section 47(a)(3) and
Y may not treat its $85,000 payment in 1982 as a qualified progress
expenditure.
(iii) For purposes of determining if the airplane is qualified
progress expenditure property with respect to Z, the normal construction
period for the property for Z begins on December 31, 1982, the date of
transfer. Since the remaining construction period is two years, the
property is progress expenditure property if it otherwise qualifies in
Z's hands.
(iv) Only $305,000 of the $340,000 payment to Y can qualify as a
qualified progress expenditure, because only that amount is attributable
to construction costs paid by Y and does not exceed the sum of the
amount by which Y increased qualified investment in 1980 and 1981 for
qualified progress expenditures ($220,000) and the amount that Y would
have treated as a qualified progress expenditure in 1982 ($85,000).
(v) Assume that Z cannot establish that progress in construction has
been completed more rapidly than ratably. If Z makes an election under
section 46(d) for 1982, then for purposes of applying the percentage of
completion limitation, Z's normal construction period is considered to
begin on January 1, 1980. Progress is presumed to occur ratably over the
5-year construction period, which is 20 percent in each year.
(vi) For 1982, Z may treat the full $305,000 as a qualified progress
expenditure because it is less than the percentage of completion
limitation, $330,000 ($110,000 a year for 1980, 1981, and 1982).
(vii) For 1983, Z may treat the entire $135,000 payment as a
qualified progress expenditure, since it does not exceed the percentage
of completion limitation for that year, $135,000 ($110,000 plus the
$25,000 excess from 1982).
(viii) For Z's taxable year ending December 31, 1984, no qualified
progress expenditures may be taken into account because the property is
placed in service during that year.
[T.D. 8183, 53 FR 6618, Mar. 2, 1988; 53 FR 11162, Apr. 5, 1988]
Sec. 1.46-6 Limitation in case of certain regulated companies.
(a) In general--(1) Scope of section. This section does not reflect
amendments made to section 46 after enactment of the Revenue Act of
1971, other than the redesignation of section 46(e)
[[Page 225]]
as section 46(f) by the Tax Reduction Act of 1975.
(2) Disallowance of credit. Under section 46(f), a credit otherwise
allowable under section 38 (``credit'') will be disallowed in certain
cases with respect to ``section 46(f) property'' as defined in paragraph
(b)(1) of this section. Paragraph (f) of this section describes
circumstances under which a determination put into effect by a
regulatory body will result in the disallowance of the credit. Such a
determination will result in a disallowance only if section 46(f) (1) or
(2) applies to such property and such determination affects the
taxpayer's cost of service or rate base in a manner inconsistent with
section 46(f) (1) or (2) (whichever is applicable).
(3) General rules. The provisions of section 46(f) (1) and (2) are
limitations on the treatment of the credit for ratemaking purposes and
for purposes of the taxpayer's regulated books of account only. Under
the provisions of section 46(f)(1), the credit may not be flowed through
to income (i.e., used to reduce taxpayer's cost of service) but in
certain circumstances may be used to reduce rate base (provided that
such reduction is restored not less rapidly than ratably). If an
election is made under section 46(f)(2), the credit may be flowed
through to income (but not more rapidly than ratably) and there may not
be any reduction in rate base. If an election is made under section
46(f)(3), none of the limitations of section 46(f) (1) or (2) apply to
certain section 46(f) property of the taxpayer. Thus, under the
provisions of section 46(f)(3), no credit is disallowed if the credit is
treated in any manner for ratemaking purposes, including any manner of
treatment permitted under the limitations of section 46(f) (1) or (2).
(4) Elections. For rules relating to the manner of making, on or
before March 9, 1972, the three elections listed in section 46(f) (1),
(2), and (3), see 26 CFR 12.3. For rules relating to the application of
such elections, see paragraph (h) of this section.
(5) Cross references. For rules with respect to the treatment of
corporate reorganizations, asset acquisitions, and taxpayers subject to
the jurisdiction of more than one regulatory body, etc., see paragraph
(j) of this section.
(6) Nonapplication of prior law. Under section 105 (e) of the
Revenue Act of 1971, section 203 (e) of the Revenue Act of 1964, 78
Stat. 35, does not apply to section 46(f) property.
(b) Definitions. For purposes of this section, the following
definitions apply:
(1) Section 46(f) property. ``Section 46(f) property'' is property
described in section 50 that is--
(i) Public utility property within the meaning of section
46(c)(3)(B) (other than nonregulated communication property described in
Sec. 1.46-3(g)(2)(iv)) or
(ii) Property used predominantly in the trade or business of the
furnishing or sale of steam through a local distribution system or of
the transportation of gas or steam by pipeline, if the rates for the
trade or business are regulated within the meaning of Sec. 1.46-
3(g)(2)(iii).
For purposes of determining whether property is used predominantly in
the trade or business of transportation of gas by pipeline (or of
transportation of gas by pipeline and of furnishing or sale of gas
through a local distribution system), the rules prescribed in Sec. 1.46-
3(g)(4) apply except that accounts 365 through 371 inclusive
(Transmission Plant) are added to the accounts listed in Sec. 1.46-
3(g)(4)(i).
(2) Cost of service. (i)(A) For purposes of this section, ``cost of
service'' is the amount required by a taxpayer to provide regulated
goods or services. Cost of service includes operating expenses
(including salaries, cost of materials, etc.) maintenance expenses,
depreciation expenses, tax expenses, and interest expenses. For purposes
of this section, any effect on a taxpayer's permitted return on
investment that results from a reduction in the taxpayer's rate base
does not constitute a reduction in cost of service, even though, as a
technical ratemaking term, ``cost of service'' ordinarily includes a
permitted return on investment. In addition, taking into account a
deduction for the additional interest that the taxpayer would pay or
accrue if the credit were unavailable in determining Federal income tax
expense
[[Page 226]]
(``synchronization of interest'') does not constitute a reduction in
cost of service for purposes of section 46(f)(2). This adjustment to
Federal income tax expense may be taken into account in determining cost
of service for the regulated accounting period or periods that include
the taxable year to which the adjustment relates or for any subsequent
regulated accounting period.
(B) See paragraph (b)(3)(ii)(B) of this section for rules relating
to the amount of additional interest that the taxpayer would pay or
accrue if the credit were unavailable.
(ii) In determining whether, or to what extent, a credit has been
used to reduce cost of service, reference shall be made to any
accounting treatment that affects cost of service. Examples of such
treatment include reducing by all or a portion of the credit the amount
of Federal income tax expense taken into account for ratemaking purposes
and reducing the depreciable bases of property by all or a portion of
the credit for ratemaking purposes.
(3) Rate base. (i) For purposes of this section, ``rate base'' is
the monetary amount that is multiplied by a rate of return to determine
the permitted return on investment.
(ii)(A) In determining whether, or to what extent, a credit has been
used to reduce rate base, reference shall be made to any accounting
treatment that affects rate base. In addition, in those cases in which
the rate of return is based on the taxpayer's cost of capital, reference
shall be made to any accounting treatment that reduces the permitted
return on investment by treating the credit less favorably than the
capital that would have been provided if the credit were unavailable.
Thus, the credit may not be assigned a ``cost of capital'' rate that is
less than the overall cost of capital rate, determined on the basis of a
weighted average, for the capital that would have been provided if the
credit were unavailable.
(B) For purposes of determining the cost of capital rate assigned to
the credit and the amount of additional interest that the taxpayer would
pay or accrue, the composition of the capital that would have been
provided if the credit were unavailable may be determined--
(1) On the basis of all the relevant facts and circumstances; or
(2) By assuming for both such purposes that such capital would be
provided solely by common shareholders, preferred shareholders, and
long-term creditors in the same proportions and at the same rates of
return as the capital actually provided to the taxpayer by such
shareholders and creditors.
For purposes of this section, capital provided by long-term creditors
does not include deferred taxes as described in section 167(e)(3)(G) or
168(e)(3)(B)(ii).
(C) If a taxpayer's overall rate of return is based on a deemed or
hypothetical capital structure, paragraph (b)(3)(ii)(B) of this section
shall be applied by treating the deemed or hypothetical capital as if it
were the capital actually provided to the taxpayer and determining the
composition of the capital that would have been provided if the credit
were unavailable in a manner consistent with such treatment.
(iii) Whether, or to what extent, a credit has been used to reduce
rate base for any period to which pre-June 23, 1986 rates apply will be
determined under 26 CFR 1.46-6(b) (3) and (4) (revised as of April 1,
1985) if such a determination avoids disallowance of a credit that would
be disallowed under paragraph (b)(3)(ii) or (4)(ii) of this section. For
this purpose, a period of which pre-June 23, 1986 rates apply is any
period for which the effect of the credit on rate base for ratemaking
purposes is established under a determination put into effect (within
the meaning of paragraph (f) of this section) before June 23, 1986.
(4) Indirect reductions to cost of service or rate base. (i) Cost of
service or rate base is also considered to have been reduced by reason
of all or a portion of a credit if such reduction is made in an indirect
manner.
(ii) One type of such indirect reduction is any ratemaking decision
in which the credit is treated as operating income (subject to
ratemaking regulation) or is treated less favorably than the capital
that would have been provided if the credit were unavailable. For
example, if the credit is accounted
[[Page 227]]
for as nonoperating income on a company's regulated books of account but
a ratemaking decision has the effect of treating the credit as operating
income in determining rate of return to common shareholders, then cost
of service has been indirectly reduced by reason of the credit.
(iii) A second type of indirect reduction is any ratemaking decision
intended to achieve an effect similar to a direct reduction to cost of
service or rate base. In determining whether a ratemaking decision is
intended to achieve this effect, consideration is given to all the
relevant facts and circumstances of each case, including, but not
limited to--
(A) The record of the proceeding,
(B) The regulatory body's orders or opinions (including any
dissenting views), and
(C) The anticipated effect of the ratemaking decision on the
company's revenues in comparison to a direct reduction to cost of
service or rate base by reason of the investment tax credits available
to the regulated company.
(iv) This paragraph (b)(4)(iv) describes a situation that is not an
indirect reduction to cost of service or rate base by reason of all or a
portion of a credit. The ratemaking treatment of credits may affect the
financial condition of a company, including the company's ability to
attract new capital, the cost of that capital, the company's future
financial requirements, the market price of the company's securities,
and the degree of risk attributable to investment in those securities.
The financial condition may be reflected in certain customary financial
indicators such as the comparative capital structure of the company,
coverage ratios, price/earnings ratios, and price/book ratios. Under the
facts and circumstances test of paragraph (b)(4)(iii) of this section,
the consideration of a company's financial condition by a regulatory
body is not an indirect reduction to cost of service or rate base, even
though such condition, as affected by the ratemaking treatment of the
company's investment tax credits, is considered in the development of a
reasonable rate of return on common shareholders' investment.
(c) General rule--(1) In general. Section 46(f)(1) applies to all of
the taxpayer's section 46(f) property except property to which an
election under section 46(f) (2) or (3) applies. Under section 46(f)(1),
the credit for the taxpayer's section 46(f) property will be disallowed
if--
(i) The taxpayer's cost of service for ratemaking purposes is
reduced by reason of any portion of such credit, or
(ii) The taxpayer's rate base is reduced by reason of any portion of
the credit and such reduction in rate base is not restored or is
restored less rapidly than ratably within the meaning of paragraph (g)
of this section.
(2) Insufficient natural domestic supply. The provisions of
paragraph (c)(1)(ii) of this section shall not apply to permit any
reduction in taxpayer's rate base with respect to its ``short supply
property'' if it made an election under the last sentence of section
46(f)(1) on or before March 9, 1972.
(3) Short supply property. For purposes of this section, section
46(f) property is ``short supply property'' if--
(i) The property is described in paragraph (b)(1)(ii) of this
section,
(ii) The regulatory body described in section 46(c)(3)(B) that has
jurisdiction for ratemaking purposes with respect to such trade or
business is an agency or instrumentality of the United States, and
(iii) This regulatory body makes a sh